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Cipla to undeperform – Macquarie Research

December 24, 2008

Cipla employs a partnership model where it undertakes product development and manufacturing for international partners, without investing in building frontend presence. This will limit profit expansion over the long run. Nine out of the top 15 global players in 2001 have been acquired by now and ongoing consolidation appears inevitable. Cipla faces the risk of its partners getting acquired and the acquirer not being willing to source products. Also, given the fierce competition, its partners have substantial bargaining power.

Cipla’s Margins are Sensitive to HIV
Africa is the biggest export market for Cipla, constituting 34% of exports. With its growing HIV product portfolio, margins could come under pressure due to the low profitability of these products. Technology know/how income booked by Cipla is highly volatile and can cause wide swings in the EBITDA margins. In FY3/08A technology know-how income doubled to Rs1.5bn, impacting the margin by 300bp. The income is unlikely to sustain at these levels.

Domestic sales constitute 51.4% of overall sales and are the most lucrative segment due to superior profitability. Dominance in the respiratory segment is a key strength, as Cipla has ~70% market share of the anti-asthma therapy. However, we expect the domestic sales contribution to decline slowly to ~48% by FY 03/11E due to the larger contribution by exports, going forward.

The National Pharmaceutical Pricing Authority (NPPA) has charged Cipla for overcharging on some drugs that are under price control and has sent demand notices for payment of Rs10bn in penalties. Cipla is contesting the matter in courts and it is still sub-judice. Failure to win the lawsuit would be a double blow for Cipla, as it would require a reduction in the prices of these drugs along with the required cash outflow for the penalty imposed.

Cipla is expected to report an EPS of Rs 8.05 and Rs 10 for FY09 and FY 10 respectively. Macquarie maintains an UNDERPERFORM rating on the stock.

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