Strides Shasun - Nirmal Bang

Institutional Equities

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Reuters: STAR.BO; Bloomberg: STR IN

Strides Shasun

Time For Integration Post the successful divestment of injectable business to Mylan and Australian subsidiary Ascent Pharma Health (Ascent) to Watson Pharmaceuticals, Strides Shasun or SSL has rebuilt its business through organic and inorganic expansions over the past few years and we believe the acquisition spree is largely over and the focus has shifted to integration of various acquisitions. We believe SSL will continue to register growth as there is a pick-up in US product approval rate, rise in ANDA (Abbreviated New Drug Application) filing rate, pick-up in anti-malarial drug business and Africa branded drug business, benefits flowing in from the merger of Shasun Pharmaceuticals or SPL with the company and a re-entry into the Australian market with the acquisition of Aspen (Arrow Pharmaceuticals’ portfolio). In our view, SSL represents a right mix of robust growth, improved return ratios and a strong balance sheet. We have assigned Buy rating to SSL with a target price of Rs1,234, valuing the stock at 18xFY18E EPS of Rs68.6, up 17% from the current market price.

SPL’s merger to benefit SSL: SPL’s merger with Strides Arcolab or SAL, which was completed in 3QFY16, will significantly strengthen the combined entity or SSL’s business model and will bring in a great deal of synergy. SPL, being a predominantly API-focused company, brings in vertical integration benefits and thereby is a vertically integrated generics entity. SPL has an impressive but under-exploited infrastructure (US Food and Drug Administration or USFDA-approved finished dosage facility, two API facilities) which is expected to improve, given SAL’s better execution capability. The sale of SPL’s UK CRAMS business will further help in reducing debt.

Inorganic expansion largely complete and the focus to shift to integration and growth: Post disinvestment, the rebuilding of portfolio by SSL in various geographies (Australia, India, US and Africa) through the inorganic expansion route is largely complete and we believe the focus will now shift to integration and growth from it.

Multiple business drivers: There will be multiple growth drivers for SSL post divestment of its key business and rebuilding the business led by organic and inorganic expansion in the past two years. The multiple growth drivers are: a) US business (higher product approvals with expected launches including generics like Lovaza, increase in ANDA filing rate, vertical integration benefits), b) Australian business (Aspen) which will help in improving overall business margins, increase product offerings as well as cost savings led by transfer of manufacturing to India. c) African business (benefits from local manufacturing set-up in Africa, increased geographical reach by entering new regions and expansion in field force). d) Institutional business (focusing on expansion in ARV segment, likely benefits from API integration through SPL, ramp-up in anti-malarial space and additional benefits to flow in from Sovaldi (we have not factored in any revenues from Solvadi). As a result of all this, we expect improvement in the performance of SSL led by a better product mix (higher Australia, US business and vertically integrated institutional business).

Strong balance sheet, improved return ratios: SAL has a debt-free balance sheet (repaid from disinvestment proceeds), but SPL brought in debt of around US$110mn and the recent acquisition of Aspen further added debt to the tune of US$300mn. We expect the net debt to equity ratio of SSL to come down from 1.1x in FY16 to 0.6x in FY18. Further, with expansion in margins, we expect RoE/RoCE to improve from 12.3%/8.6%, respectively, in FY16 to 17.0%/11.8%, respectively, in FY18, which should drive the re-rating of SSL.

BUY

Sector: Pharmaceuticals

CMP: Rs1,059

Target Price: Rs1,234

Upside: 17%

Sumit Singhania [email protected] +91-22-3926 8111

Key Data

Current Shares O/S (mn) 89.3

Mkt Cap (Rsbn/US$bn) 94.6/1.4

52 Wk H / L (Rs) 1,414/847

Daily Vol. (3M NSE Avg.) 369,609

Share holding (%) 4QFY16 3QFY16 2QFY16

Promoter 31.1 31.1 27.7

Institutions 47.0 46.2 44.4

Non-Institutions 21.9 22.8 27.9

One-Year Indexed Stock Performance

60

70

80

90

100

110

120

130

Jun-15 Aug-15 Oct-15 Dec-15 Feb-16 Apr-16 Jun-16

STRIDES SHASUN Nifty 50

Price Performance (%)

1 M 6 M 1 Yr

Strides Shasun (5.5) (17.9) (6.1)

Nifty Index (0.8) 2.9 (3.5)

Source: Bloomberg

Y/E March (Rsmn) FY14 (15M) FY15 FY16 FY17E FY18E

Revenues 13,410 11,958 31,564 42,957 47,828

YoY (%) 39.4 (10.8) 163.9 36.1 11.3

EBITDA 2,234 2,289 5,213 8,763 9,924

EBITDA (%) 16.7 19.1 16.5 20.4 20.8

Reported PAT 17,667 8,450 2,089 5,241 6,127

Adj. PAT (2,062) 1,624 2,460 5,241 6,127

YoY (%) (1,780.2) (178.7) 51.5 113.0 16.9

Fully DEPS 296.6 141.9 23.4 58.7 68.6

Adj. EPS (34.6) 27.3 27.5 58.7 68.6

RoE (%) (13.6) 9.6 12.3 17.3 17.0

RoCE (%) 6.2 8.9 8.6 10.6 11.8

P/E (x) (30.6) 38.8 38.5 18.1 15.4

EV/EBITDA (x) 29.6 33.5 24.2 15.2 13.0

Source: Company, Nirmal Bang Institutional Equities Research

27 June 2016


2 Strides Shasun

Inorganic expansion mostly complete and the focus shifts to integration and growth

Post disinvestment and rebuilding of portfolio by SSL in various geographies (Australia, India, US and Africa) through the inorganic expansion mode mostly complete, we believe the focus now shifts to integration and growth. Exhibit 1 shows the acquisitions which the company made in the past few years which helped in rebuilding its portfolio.

Exhibit 1: List of acquisitions

Date of acquisition Acquisition Value (US$mn) Remarks

July 2014 Bafna Pharmaceuticals

8

Acquisition of branded business in India from Bafna Pharmaceuticals (revenues of Rs246mn-EV of Rs650mn and EV/sales of 2.6x) with the flagship product being Raricap (revenues of Rs200mn). With this acquisition the company, which had its presence largely in South India, was able to able to expand it across India.

July 2014 Oncobiologics 11

It is a biopharmaceutical company engaged in the development of biosimilars and next-generation bio-therapeutics. The total investment amounted to US$11mn (6mn units at an average cost of US$1.8). Oncobiologics was recently listed (May 2016) on Nasdaq whose stock trades around US$4.6, as a result of which the investment grew 2.5 times.

September 2014 SPL 200 This was an all-stock deal. SAL allotted 5 shares of the company for every 16 held in SPL. This merger (resulting in combined entity or SSL) brought in the US pipeline and backward integration benefits for SSL along with manufacturing capabilities.

May 2015 Arrow 300

Re-enters Australian market with this acquisition. It acquired Aspen generic business for A$265mn (US$208mn) with revenues of US$83mn and EBITDA of US$20mn as of June 2014-end. It also acquired six more brands for US$92mn having revenues of US$12mn and EBITDA of US$10mn.

September 2015 Sun Pharmaceutical Industries

25 (Rs1.65bn) Entered CNS segment in India by acquiring two CNS divisions of Sun Pharmaceutical Industries (from its Ranbaxy portfolio). As per IMS, revenues were around Rs920mn for 12-month period ended July 2015.

October 2015 Johnson & Johnson - Acquired seven brands from Johnson & Johnson in dermatology, antiemetic and pain management therapies in India.

October 2015 Medispan - Acquired a 51% stake in Medispan, which is a part of the Shriram Group, having presence in probiotic, nutritional, anti-infective and gastrointestinal drugs. The brands that it will gain from Medispan include Lactovit and Lactogut.

February 2016 Universal Corporation 11mn and 3mn performance payment

Acquired a 51% stake in Nairobi-based Universal Corporation, which is a pharmaceuticals manufacturing as well as marketing company in East Africa with front-end business and access to supply contracts from key donor agencies. Universal Corporation reported revenues of US$22.4mn for CY15. SSL is currently present in West and French Africa, but with this acquisition the company gets an opportunity to enter East African market. This acquisition enables the company to expand its current institutional business.

February 2016 Generic Partners

A$15mn and a commitment of A$10mn to fund future R&D

Acquired a 51% stake in Universal Corporation located in Australia. Generic Partners reported revenues of A$38.9mn and adjusted EBITDA of A$7.1mn for the 12-month period ended June 2015. At the operating level, the management highlighted that it will be suffering losses on account of research and development or R&D costs incurred by the company. There is ready access to 47 commercialised marketing authorisations and also access to 22 registrations which need approval from the TGA and a pipeline of 32 molecules including other drugs going off-patent in future.

March 2016 Moberg Pharma (Swedish company)

10mn (Rs0.67bn) plus inventory value

Gets access to three OTC products which will add US$6.1mn (Rs410mn) in revenues, and are marketed in US, Australia and the Middle East

1) Vanquish – Pain relief tablets 2) Fergon –Iron supplement 3) Jointflex – Arthritis pain relief cream marketed in Australia, Canada, Caribbean

Islands, Singapore and West Asia



3 Strides Shasun

Current business segment

With disinvestment and inorganic expansion the current business segment of SSL comprises four verticals which are given in Exhibit 2.

Exhibit 2: Business verticals Business verticals Remarks

Regulated markets US, EU and Australia.

Emerging business This includes branded generics and generics across Africa, India, Russia CIS and South East Asia.

Institutional business Institutional business includes anti-malarial, Hepatitis-C and ARV business.

PSAI or pharmaceutical services and active ingredients

This now include the legacy business of SPL comprising API and CRAMS. After the sale of CRAMs business, this segment will be known as API.

Source: Company, Nirmal Bang Institutional Equities Research Exhibit 3: Business mix in FY16 (%)

Emerging Business, 14

Regulated Markets, 34

Institutional Business, 19

PSAI, 33

Source: Company, Nirmal Bang Institutional Equities Research SPL merger bodes well with SAL

We believe SPL’s merger significantly strengthens SAL’s business model and will bring in great deal of synergy. In our view, SSL or the merged entity has multiple levers to drive value from the merger of these two companies. Both the entities have complementary business models and the combination of their businesses will add value to the combined entity. SAL, post its merger, is a company with no API integration whereas SPL, on the other hand, is predominantly an API-focused company with a major portion of its revenues coming from the generic segment. The combination of both these entities creates a well diversified and vertically integrated generics company.

SPL merger adds manufacturing capability for SSL

We believe SPL has an impressive infrastructure, but is under-exploited. The company has one USFDA-approved finished dosage facility, two USFDA-approved API facilities and one USFDA-approved CRAMS facility. Put together, both SPL and SAL will have three USFDA-approved finished dosage facilities, two USFDA-approved API facilities and one USFDA-approved CRAMS facility.


4 Strides Shasun

US story yet to play out

Post sale of injectable business to Mylan, SAL is left with a thin product pipeline in the US (52 filings, 23 approved) of solid oral dosages (largely in dermatology and soft gel segments). The management’s efforts are centered at rebuilding the US franchise - over the past few months, the company brought back most of its partnered products (through the funds received from Agila sale) as well as commissioned a new R&D facility for the US market. SSL also set up its own front-end in the US (in January 2014) and all products (barring Vancomycin) are now commercialised on its own. The strategy of SSL is to focus on small off-patent products where it could get a decent share once the product is launched. In FY16, out of partnered portfolio, Vancomycin (Alovgen is SAL’s partner for this product in the US) is the key contributor which has a market share of around 50%. (Vancomycin continues to do well for the company, despite Lupin getting the approval for its product).

SSL has historically focused only on injectable filings owing to which the rest of the pipeline remained slim. The company currently has 52 ANDA filings with the USFDA, of which 23 have received the final approval and the balance 29 are awaiting approval. The company filed 11 ANDAs in FY16 (10 products filed in 4QFY16) and received approval for 5 products from the USFDA. SSL expects to file around 20-25 ANDAs in FY17, largely in to the niche areas. It is expecting approval for around 7-8 products in FY17 (mostly in 2HFY17- total opportunity of around US$1bn), with the largest product being Lovaza.

SPL acquisition has provided SAL with a large complementary product pipeline with expertise in Extended Release (ER) products. Both R&D and filings are slated to pick up materially with the integration of SPL. The other notable approval from the USFDA expected in FY17 is for Lovaza (Omega 3) having a market size of US$700mn. The filing pace is expected to increase considerably with the combined entity likely to file for around 20-25 products in FY17. R&D costs in FY16 stood at Rs750mn and the company has given guidance of Rs1.5bn to Rs2.0bn for FY17 of which 90% will be allocated to regulated markets with major focus on niche and complex filings. Post SPL merger, the combined entity has more than 110 products in the pipeline with the focus on soft gels, dermatology (SAL) and ER (SPL). A few products from SPL are still tied up with existing partners.

Exhibit 4: Unit-wise USFDA inspection status Facility Type Inspection date Status

SAL facilities

Bangalore Formulations Feb-16 Received EIR in June 2016 (received Form 483 with two observations)

Italy Formulations May-15 No observations

SPL facilities

Puducherry Formulations and API Feb -15 Received approval post 483 observation

Cuddalore API Jun-14 483 issued



5 Strides Shasun

Re-enters Australian market with Aspen acqusition

In May 2015, SAL acquired Aspen branded generic business (under Arrow Pharmaceuticals). With this acquisition, SAL re-entered Australian market post divestment of its entire stake in Ascent Pharmaceuticals to Watson Pharmaceuticals in January 2012 for a total consideration of US$395mn, valuing the deal at 22 times EBITDA and 4.3x EV/sales. The business was consolidated for a period of seven months in FY16.

Exhibit 5: Aspen acquisition Particulars Financial details Consideration and valuation

Acquired Aspen branded business and got total 130 products and a pipeline of 51 products

Revenues of US$83mn with EBITDA of US$20mn and EBITDA margin of 24% (June 2014-end)

A$265mn (US$208mn), valuing the deal at 2.5x EV/sales and 10.4 times EV/EBITDA.

Acquisition of six more brands Revenues of US$12mn and EBITDA of US$10mn

US$92mn, valuing the deal at 7.7x EV/sales and 9.2x EV/EBITDA

Total Total revenues of US$95mn and EBITDA of US$30mn with EBITDA margin of 31%

The company paid US$300mn as total consideration, valuing the deal at 10x EV/EBITDA and 3.2x EV/sales


SSL has hired experienced ex-Ascent (SAL) Chief Executive Officer Mr. Denis Bastas to operate its Australian business. The acquired portfolio of Aspen has higher margins compared to company-level margins and this is expected to aid overall margin improvement.

The total Australian generic drug market is valued at US$600mn to US$700mn with the top five players supplying 90% of all generic drugs while three wholesalers cater to the entire generic market. Aspen is the third-largest player in Australian market currently.

Exhibit 6: Australian generic market share (%)

24.5

22.5

21

16

8

32 1 2

Apotex

Mylan

Aspen

Sandoz

Amneal

Lupin

Ranbaxy

DRL

Others


As per the management, Arrow is the preferred generic drug partner of Sigma, the largest pharmacy wholesaler in Australian market.


6 Strides Shasun

Exhibit 7: Australian drug wholesale market share (%)

36

34

30

Sigma

Symbion

API

Source: Company, Nirmal Bang Institutional Equities Research Further expansion in Australia led by acquisition of a 51% stake in Generic Partners Holdings

Aspen is the third-largest player in Australian market currently and SSL aims to reach the second level with its recent acquisition of a 51% stake in Australia-based Generic Partners Holdings in February 2016. SSL currently has a 21% market share in Australia, and with this acquisition it can further gain around 2%-3% market share.

SSL acquired a controlling stake of 51% in Australia-based pharmaceuticals supply and research company, Generic Partners Holdings in an all-cash deal and the total consideration comprises upfront payment of A$15mn and a commitment of A$10mn to fund future R&D. Generic Partners Holdings is one of Australia’s leading B2B supplier of generic pharmaceuticals. The company currently develops and licenses out its products to customers in Australia. Generic Partners Holdings reported revenues of A$38.9mn and adjusted EBITDA of A$7.1mn for the 12-month period ended June 2015. At the operating level, the management highlighted that it will be suffering losses on account of R&D costs incurred by the company.

This acquisition provides SSL immediate access to 47 commercialised marketing authorisations. The acquisition also provides access to 22 registrations pending approval with Therapeutic Goods Administration (TGA) and a pipeline of 32 molecules including other drugs going off-patent in future. Generic Partners Holdings has IPs for products which it gets manufactured from a third party and then sells them in Australian market. The company also engages in transactions with Arrow (around 5%-10% of Arrow’s sales comes from Generic Partners Holdings). Generic Partners Holdings does not own any manufacturing facility. The portfolio acquired from Generic Partners Holdings ensures SSL to have Day 1 launches for most of the products going off-patent in the next two years. With this acquisition, SSL gets the right to shift its production from the third party (from whom Generic Partners Holdings currently gets its products manufactured) to Arrow and this will result in cost savings and expansion in margins.

Generic Partners Holdings currently sells its products only in Australian markets, although it has rights for other markets (UK, Canada and South Africa). In future, SSL will also look at exploring this portfolio to be launched in other markets as well. Going forward, Arrow will consolidate its R&D initiatives for Australian market under Generic Partners Holdings, leveraging its strong product development and registration capabilities. The current management team of Generic Partners Holdings led by its Chief Executive Officer and Managing Director Mr. Sanjiv Puri will continue to manage the business independently. The transaction is subject to statutory approvals and customary closing conditions, and is expected to close in early 2QFY17.


7 Strides Shasun

Enters into strategic partnership with Pharmacy Alliance in Australia to further boost its reach

SSL has entered into a strategic partnership with Pharmacy Alliance, which is Australia’s largest banner of pharmacy management companies. This is a 10-year supply partnership which will strengthen the supply chain as well as services of generic medicines offered in Australia. Earlier, Aspen had an agreement with Pharmacy Alliance which is now retained by SSL. The company expects Pharmacy Alliance to have close to around 1,000 pharmacies in the next two years which will account for around 20% of total pharmacies in Australia. SSL was earlier supplying to around 200-300 pharmacies and with this partnership, the company expects that it can increase its volume by 3x-4x. The expansion in reach at the pharmacy level along with the increase in product offerings, will lead to a rise in volume and thus aid the company in mitigating the problems arising from Pharmaceuticals Benefit Scheme or PBS.

Concerns related to PBS

One of the key concerns in Australian generic market is the price cuts which talks place in PBS which is a pharmaceutical benefit scheme primarily run by the Australian government. In FY16, SSL achieved double-digit volume growth. However, following the PBS impact, it was able to achieve only single-digit growth in value terms. To mitigate this risk, SSL indicated that it will transfer the products to India so as to save costs on manufacturing, launch new products in the market and increase the reach at the pharmacy level so as to achieve volume growth and thereby reduce the impact of price cuts.


8 Strides Shasun

Growth in emerging markets to be driven by Africa

The growth in emerging markets will be led by Africa, which accounted for the bulk of total emerging markets’ revenues in FY16. SSL has adopted a strategy of ‘In Africa, For Africa’ whereby the company operates as a branded generic and OTC (over the counter) player with its footprint across 30 sub-Saharan countries. It has 900 product registrations and ~300 products in the pipeline that are expected to be launched by 2018. Around 45% of the revenues come from branded business and the rest 55% from the generic segment. The company expects branded business to be the main growth driver for African branded business. It seeks to utilise the benefits of dedicated local manufacturing footprint in the area having four manufacturing plants and two packaging units in Africa which will cater to expansion needs of the company. This, coupled with the expected increase in MR (medical representative) count from the current 225 to 500 in FY18 and introduction of new products, will augur well with the growth strategy of the company.

Exhibit 8: SSL plants in Africa

Country Type

1) Botswana 2) Namibia Packaging

1) Cameroon 2) Mozambique 3) Nigeria 4) Sudan Manufacturing

Source: Company, Nirmal Bang Institutional Equities Research India branded formulations business build-up largely through inorganic acquisitions

Indian branded formulations business has been largely built through the inorganic route over the past few years (refer Exhibit1 for the list of acquisitions). The contribution of Indian branded business currently to the company’s overall revenue mix is very small. SSL mainly focused on CNS, diabetes, women’s health, cardiac care and pain management therapies. The company acquired Renerve brand from Grandix in 2007 (for Rs1bn, at around 2x EV/sales) and the entire Renerve family currently accounts for a major portion of its domestic sales. The focus was so far limited to five states in southern and western parts of India, but with the acquisition of domestic branded business of Bafna Pharmaceuticals having revenues of Rs246mn (EV of Rs650mn, EV/sales of 2.6x) including its flagship brand Raricap, the company will have a pan-India presence (except in Rajasthan and Jammu & Kashmir). In FY16, the company acquired the CNS division of Sun Pharmaceutical Industries having revenues of around Rs920mn (IMS as of June 2015-end), seven brands of Johnson & Johnson (revenues of around Rs170mn-Rs180mn) with key products in the acquired portfolio being Otogesic ear drops, Ehnorub ointment and Stugil tablets and a major stake in Medispan for an undisclosed amount (revenues of Rs150mn to Rs160mn). We expect a stable growth rate for the Indian market.


9 Strides Shasun

Institutional business – gains from backward integration

SSL’s institutional business can be broadly classified into Anti Retro Virals (ARVs) which account for around 80% of total institutional business and the balance comes from anti-malaria medicines. The institutional business includes sales of ARVs and malaria medicines to government programmes backed by large donor agencies. SSL is the approved supplier to institutionally-funded aid projects and global procurement agencies like UNITAD, Global Fund, Clinton Health Access Initiative to fight AIDs, tuberculosis and malaria. As the market is largely tender-based/funding-driven, profitability is generally low but post SPL merger, SSL will be among the few vertically integrated players, thereby allowing it to bid aggressively in tenders with relatively better margins. With the help of backward integration, the company will be able to significantly improve cost competiveness which was limited currently because of third-party sourcing of APIs.

SSL has 18 PEPFAR (President's Emergency Plan for AIDS Relief) filings (17 tentative approvals) and over 555 dossiers globally, with 360 product registrations in more than 50 countries including Africa, LatAm and Asia. Its oral dosage facility is pre-qualified by the World Health Organisation or WHO for manufacture of ARV and anti-malarial drugs as well as by the USFDA for ARVS under the PEPFAR programme. SAL supplies Artemether + Lumifantrine (AL) tablets and Artemether injection under its anti-malarial business. The APIs for anti-malarial drugs are sourced from Sequent Scientific.

Vertically integrating benefits are led by SPL merger. Compared to peers like Aurobindo Pharma, Cipla, Hetero Drugs and Mylan - which are vertically integrated - SAL, so far, has been a fringe player in institutional business because of relatively lower margins with the market being largely tender-based. Hence, with an integrated model, we believe the ramp-up can be much faster.

Exhibit 9: SSL is vertically integrated post SPL merger

Company Scale Vertical integration

Aurobindo Pharma

Aspen

Cipla

Hetero Drugs

Mylan

SAL

SAL+Shasun

Source: Industry, Nirmal Bang Institutional Equities Research

Buyout of 51% stake in Nairobi-based Universal Corporation to further aid SSL

SSL has signed a definitive agreement to acquire a controlling stake of 51% in Nairobi-based Universal Corporation (Universal), Kenya, (remaining 49% stake will continue to be held by existing promoters of the company) in an all-cash deal and the total consideration comprises initial payment of US$11mn and a performance-related earn-out capped at US$3mn for achieving EBITDA of US$2.92mn in 2015. Universal is a pharmaceuticals manufacturing as well as marketing company in East Africa with front-end business and access to supply contracts from key donor agencies. Universal reported revenues of US$22.4mn for CY15. SSL is currently present in West and French Africa, but with this acquisition the company gets an opportunity to enter East African market. The acquisition enables the company to expand its current institutional business. Universal owns one of the two WHO pre-qualified sites in Sub-Saharan Africa. This site has the facility to produce tablets, capsules, creams, ointments and liquids. With this facility, SSL gets a ready platform for WHO contracts and plans to transfer some of its ARV and anti-malarial drug production to this facility so as to get more business from donor agencies.

Sovaldi can provide incremental benefits

Gilead out-licensed its Hepatitis-C drug Sovaldi (Sofosbuvir) to seven companies - SAL, Natco Pharma, Hetero Drugs, Mylan, Cadila Healthcare, Cipla and Ranbaxy-in 2014 for manufacture and distribution in 91 emerging markets including India. According to Gilead, there are over 100mn people with Hepatitis-C disease in these markets. SAL has launched the drug in India under the brand name Virso. As regards emerging markets, SAL has started selling Sofosbuvir in a couple of them in FY16. We currently have not factored in any revenues from Sovaldi and any incremental revenues will have a positive impact on our earnings estimates.

http://en.wikipedia.org/wiki/President%27s_Emergency_Plan_for_AIDS_Relief


10 Strides Shasun

PSAI segment

The PSAI segment now includes legacy business of SPL comprising API and CRAMS. SPL has strong API capabilities and it is among the global leaders in Ibuprofen and a key supplier of Ranitidine (stomach ulcer) and Gabapentin (anti-seizure compound) worldwide. The company has a portfolio of 43 DMFs (drug master files) and around 23 are under development. The main focus post integration is on backward integration. SPL does have some interesting DMFs like Sevelemar Hydrochloride and Sevelemar Carbonate (combined brand size of around US$1bn), Welchol and Lyrica. In addition to API revenues, there could be possible upside if SPL becomes the formulation supplier for any of these products. We have not factored in any formulation revenues from these opportunities.

Although the API business was flat, the margins improved by over 400bps in FY16 mainly on account of portfolio maximisation, sales rationalisation, and moving away from commoditsed to more niche products. API will be a flat growth business for the company as its major focus will be on formulations and a large part of APIs will be used for captive consumption.

Exit from CRAMS business (from acquired portfolio of SPL)

SSL sold this business for an enterprise value of £25mn. This is in line with the guidance which the management highlighted at the time of SPL’s acquisition and had also stated that it is looking to sell this business.

CRAMS business was loss-making for the previous three years and turned around in FY16. The business was acquired by SPL from Rhodia in 2006. In FY14, one of its key product products called Incivek (Telaprevir), (SPL was supplying to Vertex Pharmaceuticals or VPL) had a black box warning which impacted SPL’s margins significantly.

In FY16, CRAMS business garnered revenues of £33.27mn with EBITDA of £3.94mn (the sustainable EBITDA is only £2.7mn as the balance pertains to certain one-off service contracts). The proceeds from the sale of this business will be used to repay debt.

Biotech business

SAL also has a biotech business under its subsidiary Stelis Biopharma, (earlier Inbiopro). In September 2014, GMS Pharma (Singapore) invested US$21.9mn in Stelis Biopharma for a 25.1% stake, valuing the company at around US$88mn. Currently, the company spends ~US$2mn-US$3mn on R&D (in FY15, it was Rs80mn and in FY16 it was Rs197mn). SAL intends to spin off biotech business into a separate listed entity and retain up to 20% stake in the demerged entity. The company had commenced construction of its biologics facility in Johor, Malaysia, but the facility is now being set up in Doddaballapur, Bangalore. We have not assigned any value to biotech business in SSL’s valuation and any listing of this business in future is expected to unlock its value.

Further optionality comes from treasury investment in Oncobiologics

SSL has invested in Oncobiologics, a biopharmaceutical company engaged in development of biosimilars and next-generation bio-therapeutics. The total investment amounted to US$11mn (6mn units at an average cost of US$1.8). Oncobiologics was recently listed (May 2016) on Nasdaq, whose stock trades around US$4.6 as a result of which the investment grew 2.5 times. The company has an option to divest its treasury investment in Oncobiologics and raise cash if needed. We have not assigned any value to the investment made in this company.

QIP issue

In 3QFY16, SSL raised US$167mn through the Qualified Institutional Placement or QIP route by issuing additional 8.63mn equity shares at Rs1,278/share. A sum of US$100mn from the proceeds of this issue has been earmarked for making further acquisitions and for organic expansion. The remaining proceeds will be utilised for debt repayment.


11 Strides Shasun

Valuation

Historically, SAL’s stock price has been significantly influenced by corporate developments (sale of Agila to Mylan, sale of Ascent Pharma to Watson, announcement of special dividends, merger etc) owing to which the past P/E trend is very erratic. However, the base business has started gathering pace and it is likely to continue with the company strengthening its position in various niche businesses that it created over the past couple of years.

Valuation to catch up with RoE/RoCE expansion

Driven by a better product mix (higher regulated markets (led by Australia and US), Africa revenues, lower ARV), high-margin product launches in the US (Lovaza) and vertical integration benefits, we expect SAL’s margins to improve. SPL’s margins, on the other hand, are likely to benefit from a better product mix. Given that SAL is largely done with capex and SPL’s facilities are under-exploited, we do not expect major capex going forward. Coupled with a strong base business growth, we expect RoE/RoCE to improve from 12.3%/8.6%, respectively, in FY16 to 17.0%/11.8%, respectively, in FY18. Consequently, we expect SSL’s valuation gap with peers to narrow down. We have valued SSL stock at 18xFY18E EPS of Rs68.6 to arrive at a target price of Rs1,234, implying a 17% upside from the current market price.

Exhibit 10: Significant scope for margin expansion

16.7

19.1

16.5

20.4 20.8

0

5

10

15

20

25

FY14 (15mths) FY15 FY16 FY17E FY18E

(%)


Exhibit 11: Return ratios to scale higher

9.6

12.3

17.3 17.0

8.9 8.6

10.6 11.8

0

2

4

6

8

10

12

14

16

18

20

FY15 FY16 FY17E FY18E

RoE (%) RoCE (%)

(%)



12 Strides Shasun

Exhibit 12: Valuation table

P/E (x) EV/EBITDA (x) P/BV (x) RoE (%) RoCE (%)

Company name FY16 FY17E FY18E FY16 FY17E FY18E FY16 FY17E FY18E FY16 FY17E FY18E FY16 FY17E FY18E

Aurobindo Pharma 20.7 16.7 14.0 14.2 11.5 9.4 5.8 4.3 3.3 32.5 29.7 26.9 25.4 26.3 27.6

Cipla 25.4 21.9 17.4 17.0 14.5 11.7 3.2 2.9 2.5 13.3 13.8 15.3 12.8 12.9 14.8

Cadila 21.3 20.0 16.3 14.2 14.0 11.9 6.1 4.9 3.4 31.7 26.6 26.4 15.9 17.5 18.6

Divis Labs 26.4 23.9 19.7 20.9 17.9 14.9 13.6 11.5 9.7 28.4 26.1 26.8 31.4 30.2 31.0

Glenmark Pharma 28.3 15.5 13.0 15.3 9.9 8.4 4.5 3.5 2.8 19.0 25.0 23.3 18.5 26.5 27.6

Lupin 29.0 22.3 18.9 19.3 15.3 12.8 6.0 4.9 4.1 22.9 24.3 23.6 23.5 21.7 25.2

Natco Pharma 64.5 50.7 44.5 37.3 32.5 28.6 7.7 6.8 6.0 14.5 14.3 14.4 17.2 16.6 16.8

Sun Pharma 41.8 25.9 21.5 23.0 17.1 14.7 6.3 4.9 4.1 16.5 20.3 20.6 9.1 15.8 15.9

SSL 38.5 18.1 15.4 24.2 15.2 13.0 3.6 3.1 2.6 12.3 17.3 17.0 8.6 10.6 11.8

Source: Bloomberg, Nirmal Bang Institutional Equities Research

Company background

Incorporated in 1990, SAL was initially set up by first generation entrepreneur Mr. Arun Kumar as Strides Pharmaceuticals Pvt Ltd, a trading entity that exported pharmaceutical products to African countries. Thereafter, to pare its debt, the company divested its entire stake in Ascent Pharmaceuticals to Watson Pharmaceuticals (now Actavis) for US$393mn in 2012 and its Agila operations to Mylan for US$ 1.5bn in 2013. After the sale of these businesses, the residual business of SAL can be broadly classified into four business verticals - regulated markets (34% contribution to revenues in FY16), emerging business (14% contribution to revenues in FY16), institutional business (19% contribution to revenues in FY16) and PSAI (33% contribution to revenues in FY16). Post SPL acquisition, SSL (the combined entity) is currently a fringe player in India, but it is among the largest pan-African players with a local manufacturing set-up. The company has two USFDA-approved manufacturing plants in Bangalore and Italy each, and recently set up three manufacturing facilities and two packing units in Africa.


13 Strides Shasun

Financials

Exhibit 13: Income statement

Y/E March (Rsmn) FY14(*) FY15E FY16P FY17E FY18E

Net sales (incl. other oper. income) 13,410 11,958 31,564 42,957 47,828

% growth 39.4 (10.8) 163.9 36.1 11.3

Raw material costs (7,147) (5,605) (15,293) (20,190) (22,120)

Manufacturing expenses (940) (957) (2,525) (2,577) (2,870)

Staff costs (1,572) (1,721) (4,988) (6,014) (6,696)

Other expenses (1,517) (1,388) (3,545) (5,413) (6,218)

Total expenditure (11,175) (9,670) (26,351) (34,194) (37,904)

EBITDA 2,234 2,289 5,213 8,763 9,924

% growth 122.1 2.4 127.8 68.1 13.3

EBITDA margin (%) 16.7 19.1 16.5 20.4 20.8

Other income 602 386 1212 1160 1196

Interest costs (1,089) (474) (1,803) (1,668) (1,734)

Gross profit 1,748 2,200 4,622 8,255 9,386

% growth 215.9 25.9 110.1 78.6 13.7

Depreciation (565) (640) (1,573) (1,864) (1,960)

Profit before tax 1,183 1,560 3,049 6,391 7,425

% growth 383.3 31.8 95.5 109.6 16.2

Exceptional item (266) (74) (474) - -

Tax (3,245) (1,476) (715) (1,150) (1,299)

Effective tax rate (%) 353.7 99.3 27.8 18.0 17.5

Minority interest 0.1 5.6 126.6 - -

Discontinued operations 19,995.3 8,434.3 102.7 0.0 0.0

Net profit 17,667 8,450 2,089 5,241 6,127

% growth 108.8 (52.2) (75.3) 150.8 16.9

Adjusted net profit (2,062) 1,624 2,460 5,241 6,127

% growth (1,780.2) (178.7) 51.5 113.0 16.9

(*)15months


Exhibit 15: Balance sheet


Equity 596 596 893 893 893

Reserves 9,473 10,853 27,791 33,066 39,186

Net worth 10,068 11,449 28,684 33,960 40,080

Short-term loans 2,246 2,030 7,015 7,015 7,015

Long-term loans 3,221 7,052 27,455 24,455 20,955

Total loans 5,466 9,082 34,470 31,470 27,970

Deferred tax liability 17 (55) 150 (211) (211)

Minority interest 757 187 428 428 428

Liabilities 16,308 20,838 63,918 66,194 68,815

Gross block 8,039 10,863 40,219 41,419 42,619

Depreciation 3,528 4,168 5,741 7,605 9,565

Net block 4,511 6,695 34,477 33,814 33,053

Capital work-in-progress 995 995 - - -

Goodwill 1,034 1,034 1,768 1,768 1,768

Long-term investments 4,430 6,300 13,040 13,040 13,040

Inventories 1,760 2,077 6,131 7,061 7,862

Debtors 3,640 3,899 10,965 14,123 15,724

Cash 2,311 1,469 3,108 1,615 2,491

Other current assets 2,281 2,351 6,890 8,846 9,847

Total current assets 9,992 9,796 27,095 31,645 35,924

Creditors 2,679 2,345 7,793 9,403 10,303

Other current liabilities 1,976 1,637 4,669 4,669 4,669

Total current liabilities 4,655 3,982 12,462 14,072 14,971

Net current assets 5,338 5,814 14,633 17,573 20,953

Total assets 16,308 20,838 63,918 66,194 68,815

(*)15months


Exhibit 14: Cash flow


EBIT 1,669 1,648 3,640 6,899 7,964

(Inc.)/dec. in working capital (89) (1,098) (7,261) (4,433) (2,504)

Cash flow from operations 1,580 551 (3,621) 2,467 5,460

Other income 602 386 1,212 1,160 1,196

Depreciation 565 640 1,573 1,864 1,960

Interest paid (-) (1,089) (474) (1,803) (1,668) (1,734)

Tax paid (-) (3,245) (1,476) (715) (1,150) (1,299)

Dividends paid (-) (137) (348) (139) (157) (157)

Extraordinary items (34,846) (6,830) 0 0 0

Net cash from operations (36,569) (7,552) (3,494) 2,707 5,574

Capital expenditure (-) 27,489 (2,824) (29,094) (1,200) (1,200)

Net cash after capex (9,080) (10,376) (32,588) 1,507 4,374

Inc./(dec.) in short-term borrowing (3,753) (215) 4,985 - -

Inc./(dec.) in long-term borrowing (6,725) 3,831 20,403 (3,000) (3,500)

Inc./(dec.) in borrowings (10,478) 3,616 25,388 (3,000) (3,500)

(Inc.)/dec. in investments (4,430) (1,870) (6,740) - -

Equity issue/(Buyback) (1) - 11,238 - -

Cash from financial activities (14,909) 1,746 29,886 (3,000) (3,500)

Others 24,650 7,787 4,341 - -

Opening cash 1,657 2,311 1,469 3,108 1,615

Closing cash 2,311 1,469 3,108 1,615 2,489

Change in cash 654 (843) 1,639 (1,493) 874

(*)15months


Exhibit 16: Key ratios

Y/E March FY14(*) FY15E FY16P FY17E FY18E

Per share (Rs)

Reported EPS 296.6 141.9 23.4 58.7 68.6

Adjusted EPS (34.6) 27.3 27.5 58.7 68.6

DPS 505.0 107.0 1.5 1.5 1.5

BV/share 169.0 192.2 321.0 380.1 448.6

Dividend payout (%) 199.2 82.5 7.5 3.0 2.6

Performance ratios (%)

RoE (13.6) 9.6 12.3 17.3 17.0

RoCE 6.2 8.9 8.6 10.6 11.8

Valuation ratios (x)

P/E (30.6) 38.8 38.5 18.1 15.4

P/BV 6.3 6.0 3.6 3.1 2.6

EV/net sales 4.9 6.4 4.0 3.1 2.7

EV/EBITDA 29.6 33.5 24.2 15.2 13.0

Efficiency ratios

Asset turnover (x) 1.5 1.0 0.8 1.0 1.1

Working capital/sales (x) 0.4 0.5 0.5 0.5 0.5

Receivable days 99 119 127 120 120

Inventory days 48 63 71 60 60

Payable days 137 153 186 170 170

(*)15months



14 Strides Shasun

Disclaimer

Stock Ratings Absolute Returns

BUY > 15%

ACCUMULATE -5% to15%

SELL < -5%

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