Buy On Dips

With a significant presence in several drug segments, Lupin is attractive, but expensive…

Lupin, a Mumbai-based pharmaceutical major, manufactures and sells generic and branded formulations and active pharmaceutical ingredients (APIs) in markets across the world. It has gained recognition as the world’s largest manufacturer of tuberculosis drugs. The company has a significant presence in the US branded generics market and is one of the leading players in cephalosporin, cardiovascular, diabetology, asthma and NSAID therapy.

Sectoral outlook
The domestic pharma market has grown at a compounded annual growth rate (CAGR) of 13.5 per cent over the last five years. Indian pharma players are steadily moving up the value chain to niche and branded products.
Growth drivers. According to industry experts, the domestic pharma market is expected to grow to US$55 billion by 2020. A significant part of the additional growth is expected to come from the fast-growing chronic or lifestyle segment. Generics are expected to emerge as the preferred play. According to a report from Enam Securities, domestic growth will be driven by deeper penetration into semi-urban and rural markets, and growing affordability. Research and development alliances with multinational companies will act as an additional booster for the sector. Moreover, with drugs having cumulative revenue of US$ 80 billion set to lose their patents over the next few years, a huge opportunity is set to emerge for generic players.
Concerns. Rising FDA (Food & Drug Administration, the US regulator) surveillance will put increasing compliance-related pressures on Indian companies, with the possibility that the latter might receive more warning letters and penalties. The number of such incidents has increased significantly in the past couple of years. Increasing competition from smaller domestic firms is depressing the margins of bigger players. On the other hand, the higher-value segment is dominated by MNCs which have an advantage as they own trusted brands. Further, rising raw material costs are also putting pressure on margins.

Strong footing. Currently, Lupin ranks no. five in the domestic formulation space, up from the no. 11 position it held six years ago. Among the top-five companies in this space, it has grown the fastest, registering a CAGR of 20 per cent over the last three years.
It is currently the fifth-largest generic player in the US in terms of prescription, with 14 out of its 30 generic products ranking no. one, and 27 of its 30 products ranking in the top three by market share.
The company introduced 41 new products in the Indian market in FY11 and has a strong field force of 3,800 medical representatives.
Branded generic business. The high-margin branded generic business has been a key differentiator for Lupin in the Indian pharma space. The company has further cemented its position in the segment by acquiring rights for Antara product. The company reported sales of US$ 130.6 million in FY11 in the US market. Pick-up in the sale of Antara and the new Suprax variants is expected to drive earnings growth in the US branded generics space.
First-mover advantage in Japan. With the acquisition of a company called Kyowa in FY08, Lupin figures among the few Indian pharma companies with a major presence in the world’s second-largest pharma market. The Japanese government has introduced a new policy that aims to increase the contribution of generic drugs from a relatively low 17 per cent in CY07 to 30 per cent of all prescriptions by CY12. This is estimated to open up a US$ 10 billion opportunity for global generic players. Analysts at Angel Broking expect Lupin to post an 18.8 per cent CAGR in revenue between FY11 and FY13 in the Japanese market. The region is likely to contribute 11 per cent of Lupin’s total FY13 sales.

Exploring inorganic growth. The management has indicated its willingness to aggressively explore inorganic growth options as it seeks to strengthen its presence in the branded space in the US and in key emerging markets. The company is scouting for large-sized acquisitions. Lupin’s low level of debt (FY11 debt-equity ratio stood at 0.33) allows it to think of this strategy.
Domestic market growth. For FY12, the company expects a growth of around 20 per cent in the domestic market due to increased focus on chronic therapeutic segments such as oncology, asthma and dermatology.
In the biological space, of the total six products in the pipeline, two have entered the clinical trial stage. The company plans to increase its focus on the opportunistic biotech segment.

Too aspirational. The management has said that it will achieve a revenue target of US$3 billion by FY13-14. This target appears aspirational and will be difficult to achieve unless the company makes a big-ticket investment.
Increased competition. The company has indicated that it may launch oral contraceptives in 2HFY12. It is expected to face massive competition in this segment due to the advent of new entrants.
Launch of Allernaze. Allernaze, an intra-nasal steroid (INS) used to treat allergic rhinitis, is expected to boost revenues from the US. The drug has huge potential as the INS market in the US is valued at around US$ 2.5 billion (` 11,250 crore). However, the company has been delaying its launch, and there is no certainty about when the drug will finally debut in the market.
Significant exposure to domestic formulations. Lupin derives 28 per cent of its revenue from domestic formulations, 15 per cent from API, 7 per cent from emerging markets formulations, and 50 per cent from advanced market formulations. According to analysts at Citigroup Global Markets, the exposure to the domestic formulations leaves Lupin vulnerable to widening of the price control net (the Indian government reserves the right to impose price controls on select drugs in India).
Failure to scale up. Another potential risk is that the company may not be able to scale up the operations of Kyowa or the sales of Antara, which could affect its earnings growth negatively.
Currency fluctuation. Given its exposure to global markets, appreciation of the rupee could hurt the company’s financials.
Moreover, earlier than expected generic competition for Suprax could also act as a dampener.

Peer comparison
If we compare Lupin with peers such as Cipla, Dr. Reddy’s, Ranbaxy Laboratories and Sun Pharma, it currently accounts for 19.2 per cent of this group’s aggregate net sales. In terms of RoNW, Lupin leads its peer group, with a figure of 28.5 per cent in FY11. However, in terms of RoCE, Sun Pharma leads the pack with 23.3 per cent, while Lupin comes a close second with 23 per cent in FY11.

Revenue mix. In FY11, the company derived 68 per cent of its sales from abroad and the balance 32 per cent from India. The formulations business contributed the lion’s share of 85 per cent of total sales while the API business contributed 15 per cent.
Healthy numbers. Since FY2000, the company has been able to increase its total income consistently. Between FY06 and FY11, the company registered a CAGR of 21.9 per cent in total income and 38.37 per cent in profit after tax. It has posted a five-year average return on capital employed (RoCE) of 26.43 per cent and return on net worth (RoNW) of 36.39 per cent. The company enjoyed free cash flow of Rs 903.18 crore in FY11.
Since FY08, Lupin has maintained a low level of debt-to-equity (D/E) ratio, which currently stands at 0.35 (FY11).
Nearly stable margins. The company registered a net profit margin of 17.83 per cent (in FY11), up 0.45 percentage points over the FY10 figure. Its operating profit margin stood at 21.5 per cent in FY11, a drop of a marginal 0.45 percentage points compared to the previous year.

The stock is currently trading at a price-to-earnings (P/E) ratio of 28.78. It is trading higher than its five-year median P/E of 19.79. Over a period of five years, the company has registered earnings per share growth of 31.9 per cent. This translates into a price-to-earnings to growth (PEG) ratio of 0.9.
Lupin is likely to see strong growth in both its business segments (branded and generic) on account of large opportunities, expanding distribution network, geographical spread, new product launches and operating efficiency. Moreover, in the long run, Lupin is likely to benefit from its strategy of building a strong pipeline for the US market through aggressive regulatory filings, and focusing on niche, low-competition segments in the US market. But currently its valuation is slightly expensive (when compared to its five-year median P/E), so one should try to buy this stock on dips and hold it for at least three years.

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