NATCO PHARMA core

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1 VISIT NOTE NATCO PHARMA core India Equity Research Pharmaceuticals We met Mr. Rajeev Nanapaneni of Natco Pharma. With its superb R&D capabilities, we see Natco way ahead of peers in the midcap space. Though adverse ruling in Copaxone will limit the upside, management considers it an attractive opportunity. At 17.6x FY12 EPS of INR19 Natco s base business is fairly valued. Successful monetization of FTF assets will create long term value for shareholders, in our view. EDELWEISS RATINGS Absolute Rating NOT RATED Sustained momentum in base business Natco s base business earnings have posted 10% CAGR over FY09 12, driven by strong momentum in domestic business (38% of sales). Within the domestic, Natco has built a strong presence in oncology. The company expects its PAT to grow 50% over FY12 14E to INR900mn (EPS of INR29 in FY14), driven by Lansoprasole launch in the US. Copaxone remains an attractive opportunity despite adverse ruling Adverse ruling in Copaxone (USD3bn revenues) will limit the upside for Natco from g Copaxone launch, even as management considers it an attractive opportunity. Natco believes that even if it gets 6 12 months window prior to Sep 15, it can still make USD30 50mn profit from this opportunity. Moreover, post Sep 15, g Copaxone can contribute USD15 20mn recurring profit (EPS of INR2.4) for the company. Formidable portfolio through strong R&D Natco has built a formidable portfolio of ANDA filings in the US (23 filed), driven by strong analytical and characterizations capabilities. The portfolio includes two most complex blockbuster drugs Revlimid and Copaxone. We expect significant value creation over the 3 5 years as the FTFs/niche products begin to get commercialized. Outlook and valuations: Monetization of US pipeline key While, at 17.6x FY12 EPS of INR19, Natco s base business is fairly valued, successful monetization of FTF assets in the US will create long term value for shareholders, in our view. Led by Lansoprazole launch in FY13, we will witness at least one limited competition product launch in the US over the next couple of years. Financials Year to March FY09 FY10 FY11 FY12 Revenues (INR mn) 4,384 4,361 4,494 5,185 Rev. growth (%) 32.0 (0.5) EBITDA (INR mn) ,190 Net profit (INR mn) EPS (INR) EPS growth (%) 22.2 (2.7) Diluted P/E (x) EV/EBITDA (x) ROE (%) Edelweiss Research is also available on Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. MARKET DATA (R: NATP.BO, B: NTCPH IN) CMP : INR week range (INR) : 437 / 197 Share in issue (mn) : 31.1 M cap (INR bn/usd mn) : 10.5 / Avg. Daily Vol.BSE/NSE( 000) : 83.5 SHARE HOLDING PATTERN (%) MFs, FIs & Banks 11.5% * Promoters pledged shares (% of share in issue) PRICE PERFORMANCE (%) Sensex Stock Edelweiss Securities Limited : NIL Stock over Sensex 1 month 6.9 (15.0) (21.8) 3 months 0.1 (3.9) (4.0) 12 months (7.5) Manoj Garg manoj.garg@edelcap.com Perin Ali perin.ali@edelcap.com July 1, 2012 Others 25.6% FIIs 5.9% Promoters* 57.1%

2 Pharmaceuticals Sustained momentum in base business Natco s base business earnings have posted 10% CAGR over FY09 12, driven by strong growth momentum in domestic formulation business (38% of business). Within the domestic formulation business, Natco has built strong presence in oncology (80% of domestic formulation business; 18% CAGR over FY09 12). With over a dozen key products in the portfolio, the company claims to be a top oncology player in India. Management expects its base business to continue to grow at the current pace, aided by niche launches in the US. The company expects its PAT to grow 50% over FY12 14E, to INR900mn (EPS of INR29 in FY14), driven by Lansoprazole launch in the US. Chart 1: Revenue mix (FY12) Others 7% US Pharmacy 15% Domestic formulation 39% APIs 27% Export formulation 12% Source: Company, Edelweiss research Leader in Indian oncology segment despite late entry Natco has emerged as the leader in the niche segment of oncology in India. With more than a dozen key products in the portfolio, the company has built a formidable presence in oncology. Also, it has launched some of the difficult to manufacture products in the domestic market like Gleevac, which has resulted in 17% CAGR over FY08 12 to INR1.55bn in FY12. The Indian oncology segment has been growing at 17 19% CAGR, driven by: a) Rise in cancer incidence, b) improved diagnosis and treatment, c) access to cancer therapies, d) better insurance coverage and e) higher healthcare spending. With landmark judgement for Nexavar in its favor, where Indian patent officer has granted compulsory license (first of its kind), we expect growth momentum to sustain going forward. 2 Edelweiss Securities Limited

3 Natco Pharma Chart 2: Revenue progress in oncology 1,800 1,440 (INR mn) 1, CAGR 19% FY08 FY09 FY10 FY11 FY12 Source: Company, Edelweiss research Growing through alliances To establish its presence in the regulated market, Natco follows the strategy of entering into alliances with pharma majors. It has tied up with Mylan (for generic Capoxane; USD3bn drug), Watson for Revlimid (USD2.3bn drug), Lupin (for Lanthanum Carbonate and Tykerb); and Dr. Reddy s Labs (for five oncology products for US and other markets). It is also planning to launch delayed release Lansoprazole with limited competition (USD3bn opportunity; possible launch in Sep 12). We are of the view that these products provide huge upside potential, if launched successfully. Niche launches to drive growth in US Amidst lower base (12% of revenue), we expect export formulation business to drive growth driven by niche launches in the US market. Natco s export formulation business has registered 28% CAGR over FY Also, the company has built a formidable portfolio of ANDA filings in the US (23 filed, including 3 FTFs and 2 limited competition products), driven by strong analytical and characterization capabilities. Monetization of niche pipeline provides significant upside Compared to its size, Natco has built a formidable portfolio, which demonstrates its R&D capabilities. The portfolio in the US includes two most complex blockbuster drugs (FTF, Revlimid; USD2.3bn opportunity and Copaxone USD3bn revenue in the US). Apart from this, the company has also filed niche products such as Lansaprazole (USD mn generic market; 4 players market; expected launch in Sep 12), Lanthanum Carbonate (USD110mn opportunity; shared exclusivity; FY14 launch), Tamiflu (FTF, USD240mn, Jun 17 launch) and Tykerb (FTF, USD110mn, Sep 20 launch). Moreover, it is looking to enhance this pipeline by 2 3 more niche filings every year, going forward. Currently, it is developing two complex products in partnership with Dr Reddy s such as Liposomal Doxorubicin (Doxil) and Nana particle Paclitaxel (Abraxane). We expect significant value creation from the US ANDA pipeline over the next 3 5 years as the FTFs / niche products begin to get commercialized. 3 Edelweiss Securities Limited

4 Pharmaceuticals Table 1: Key launches build in the pipeline for US generics Brand Generic name Revenue (USD mn) Patent expiry Type of ANDA Potential launch date Marketing partner Pervacid Lansoprazole 400 Off patent Para III Sep'12 Actavis (OTC), Breckenridge (Rx) Copaxone Glatiramer 3,000 Patent Para IV May'14/ Sep'15 Mylan Fosrenol Lanthanum carbonate 110 Patent Para IV FY14 Lupin Tamiflu Oseltamivir 240 Patent Para IV/ FTF June'17 Alvogen Revlimid Lenalidomide 2,000 Patent Para IV/ FTF 2019 Watson Tykerb Lapatinib 110 Patent Para IV/ FTF Sep'20 Lupin Doxil Liposomal Doxorubicin 280 Off patent Para III Filing Dr Reddy Abraxane Nano partical Paclitaxal 300 Para III Filing Dr Reddy Source: Company, Edelweiss research Copaxone remains an attractive opportunity despite adverse ruling Adverse ruling in Copaxone (USD3bn revenues) will limit the upside for Natco from g Copaxone launch, even as management believes it to be an attractive opportunity. Earlier, Mylan (Natco s partner for Copaxone) had indicated g Copaxone launch in 2HCY12. However, with this judgment (subject to appeal), Teva (innovator) expects no generic competition until Sep 15. We highlight that Copaxone is an USD3bn product and compound patent is going to expire by May 14, while process patent is valid until Sep 15. Management is of the view that though it is difficult to launch the product before May 14, there is probability of it happening before Sep 15 patent expiry. Natco believes that even if it gets 6 12 months window prior to Sep 15 (2 generic players as other players will launch post Sep 15), subject to approval), it can still make USD30 50mn profit from this opportunity. Moreover, post Sep 15, g Copaxone can contribute USD15 20mn recurring profit (EPS of INR2.4) for the company (90% price erosion, 20% market share for Mylan; 30% revenue sharing for Natco; 90% profit). Outlook and valuations: Monetization of US pipeline key With its superb R&D capabilities, Natco is way ahead of comparable peers in the midcap space. While, at 11x FY14 EPS of INR29, Natco s base business is fairly valued, successful monetization of FTF assets in the US will create long term value for shareholders. Led by Lansoprazole launch in FY13, we will witness at least one limited competition product launch in the US over the next couple of years, which, in our view, will create significant value for its shareholders. 4 Edelweiss Securities Limited

5 Company Description Natco Pharma NATCO Pharma Limited is an Indian enterprise molded by global aspirations. NATCO PHARMA is a large integrated company backed by strong R&D capabilities. It has four finished dosage facility along with two APIs plants. Formulation constitutes around 62% of revenues followed by 32% from API and 3% from CRAMS. With in formulation, Oncology constitutes around 55% of revenue and it is one of the largest players in Oncology segment in India. NATCO has the credit of having pioneered Time Release Technology in India. 5 Edelweiss Securities Limited

6 Pharmaceuticals Financial Statements Income statement (INR mn) Income from operations 3,327 4,384 4,567 4,831 5,556 Direct costs 1,698 2,290 2,174 1,880 2,029 Employee costs Other expenses ,366 1,594 Total operating expenses 2,887 3,817 3,656 3,886 4,401 EBITDA ,155 Depreciation and amortisation EBIT Interest expenses Other income Profit before tax Provision for tax Core profit Extraordinary items Profit after tax Less: Minority interests (8) (14) (11) PAT after minority interest Adjusted net profit EPS (INR) basic Weighted avg Dil equity shares (mn) Dividend payout (%) Tax rate (%) Common size metrics as % of net revenues Operating expenses Depreciation and Amortization Interest expenditure EBITDA margins Net profit margins Growth metrics (%) Revenues EBITDA PBT Net profit EPS Edelweiss Securities Limited

7 Natco Pharma Balance sheet (INR mn) As on 31st March FY08 FY09 FY10 FY11 FY12 Equity capital Reserves & surplus 1,902 2,311 2,776 3,243 4,409 Shareholders funds 2,183 2,591 3,057 3,524 4,720 Secured loans 886 1,207 1,140 1,963 2,208 Long term provisions Minority Intrest & other current liabilities Sources of funds 3,192 3,923 4,302 5,611 7,048 Total fixed assets 2,286 2,813 3,014 3,569 4,903 Investments and other assets ,074 1,092 Inventories ,022 1,104 Sundry debtors Cash and equivalents Other current assets Total current assets 1,905 2,105 1,923 2,562 3,187 Sundry creditors and others ,342 1,839 Provisions Total CL & provisions 795 1, ,344 1,845 Net current assets 1, ,218 1,342 Net deferred tax (204) (205) (268) (251) (289) Uses of funds 3,192 3,923 4,302 5,611 7,048 Adjusted BV per share (INR) Note: FY11 12 are not comparable to FY08 10 due to changes in the schedules format as per new guidelines Free cash flow (INR mn) Net profit Depreciation Gross cash flow Less:Changes in WC 22 6 (58) (98) (119) Operating cash flow Less: Capex (677) (544) (375) (959) (1,175) Free cash flow (193) (285) (540) Profitability & liquidity ratios ROAE (%) (on adjusted profits) ROACE (%) Inventory days Debtors days Payable days Cash conversion cycle Current ratio Debt/EBITDA Interest coverage Fixed assets t/o (x) Debt/equity Edelweiss Securities Limited

8 Pharmaceuticals Valuations parameters Diluted EPS (INR) Y o Y growth (%) (2.7) CEPS Diluted P/E (x) Price/BV (x) EV/Sales (x) EV/EBITDA (X) Edelweiss Securities Limited

9 RATING & INTERPRETATION Company Absolute reco Relative reco Relative risk Company Absolute reco Relative reco Relative Risk Apollo Hospitals Enterprise HOLD None None Aurobindo Pharma HOLD SU H Cadila Healthcare HOLD SP L Cipla HOLD SP L Dr.Reddys Laboratories HOLD SP M Glenmark Pharmaceuticals BUY SO H Lupin BUY SO M Ranbaxy Laboratories REDUCE SU H Sun Pharmaceuticals Industries HOLD SO L Torrent Pharmaceuticals BUY SO H ABSOLUTE RATING Ratings Expected absolute returns over 12 months Buy More than 15% Hold Between 15% and - 5% Reduce Less than -5% RELATIVE RETURNS RATING Ratings Sector Outperformer (SO) Sector Performer (SP) Criteria Stock return > 1.25 x Sector return Stock return > 0.75 x Sector return Stock return < 1.25 x Sector return Sector Underperformer (SU) Stock return < 0.75 x Sector return Sector return is market cap weighted average return for the coverage universe within the sector RELATIVE RISK RATING Ratings Low (L) Medium (M) High (H) Criteria Bottom 1/3rd percentile in the sector Middle 1/3rd percentile in the sector Top 1/3rd percentile in the sector Risk ratings are based on Edelweiss risk model SECTOR RATING Ratings Overweight (OW) Equalweight (EW) Criteria Sector return > 1.25 x Nifty return Sector return > 0.75 x Nifty return Sector return < 1.25 x Nifty return Underweight (UW) Sector return < 0.75 x Nifty return 9 Edelweiss Securities Limited

10 Pharmaceuticals Edelweiss Securities Limited, Edelweiss House, off C.S.T. Road, Kalina, Mumbai Board: (91 22) , Vikas Khemani Head Institutional Equities Nischal Maheshwari Co Head Institutional Equities & Head Research Nirav Sheth Head Sales Coverage group(s) of stocks by primary analyst(s): Pharmaceuticals Apollo Hospitals Enterprise, Aurobindo Pharma, Cadila Healthcare, Cipla, Dr.Reddys Laboratories, Glenmark Pharmaceuticals, Lupin, Ranbaxy Laboratories, Sun Pharmaceuticals Industries, Torrent Pharmaceuticals Recent Research Date Company Title Price (INR) Recos 01 Jul 12 Pharma US Supreme Court upheld healthcare reform; positive for Indian pharma; Sector Update 21 Jun 12 Pharma Domestic Pharma Monthly Review; Monthly Review 20 Jun 12 Cadila Helathcare Positives on Horizon; Visit Note 721 Buy Distribution of Ratings / Market Cap Edelweiss Research Coverage Universe Buy Hold Reduce Total Rating Interpretation Rating Expected to Rating Distribution* * 1 stocks under review > 50bn Between 10bn and 50 bn < 10bn Market Cap (INR) Buy Hold Reduce appreciate more than 15% over a 12 month period appreciate up to 15% over a 12 month period depreciate more than 5% over a 12 month period 10 Edelweiss Securities Limited

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