Ajanta Pharma Sapna Jhawar [email protected] 022-4031 7130 Prepared for [email protected] - Sent on Thursday, September 07, 2017 5:57:54 PM Outperformer Ajanta Pharma 07 September 2017 INITIATING COVERAGE Risk reward favorable post sharp correction Ajanta has corrected ~38% YoY, with shares now trading at 16x FY20E (down from peak of MIDCAP 30x). Afteraspectaculargrowth during FY10-16, itreported moderateperformance inkey Share Data business markets of Africa and Asia (59% of sales) in FY17. While India business faces a MarketCap. Rs10.5 bn(US$1,644mn) near term hiccup (31% of sales;temporary in nature), US has now become 10% of sales in Price Rs1,193 FY17. Slowdown in Africa (tender business), Asia (repatriation issues) and higher Target Price Rs1,350 BSE Sensex AJANTPHARM investments towards US will keep its sales and EBITDA growth in check in near term. We Reuters Code AJPH.BO expect FY18E to be a muted year based on challenges highlighted above, but pencil in Bloomberg code AJP IN rampupfromFY19Eonwardsasbusinessesstabilize.WebelieveAjantapresentsaunique 6m avg. daily turnover 4.2 business model offering a hybrid of growing domestic formulations, solid EM franchise 52-weekHigh/Low (Rs) 2,150/1,106 Issued Shares 88 with strong cash flows, debt-free balance sheet and reasonable valuations along with an emergingUSformulationsbusiness.InitiatewithanOutperformer. ValuationRatios Yrto 31 Mar FY 17 FY 18E FY 19E Reboundingrowthpostchallengingphase:WithAfricatenderbusinessshrinkinginmarket EPS (Rs.) 57.3 51.0 61.2 and volumes and Asia suffering from volatile economies, FY17/18 will be challenging years. +/-(%) 21.9 (11.0) 19.9 However, strong chronic led growth in India, stability in Asia and US (small base, improved PER (x) 30.7 23.4 19.0 filing)shouldaidin12%salesCAGRoverFY17-20E. PBV (x) 9.9 5.7 4.7 Dividend/Yield (%) 0.7 1.3 1.3 EBITDA margin to pick up in FY19E: Over FY15-17, growth in Asia was flattish, this coupled EV/Sales (x) 7.9 5.0 4.4 with 300bps jump in R&D expense led to stagnancy at operating level (40bps increase). EV/EBITDA (x) 22.3 16.6 13.6 Challenging business environment would depress margins in FY18E (expect 29.6% EBITDA Shareholding Pattern (%) margin,down490bpsinFY18E).However,reboundinIndia,stabilityinAsiaandaswiftramp Promoters 71 upinUStoaidmarginsat31.5% byFY19E. FIIs 12 MFs 4 RoCE-moderating but better than peers: With quality becoming of paramount issue (US is BFSI's 0 now10%ofsales),higheropexwilllowerRoCE,butgivenlesserexposuretogenericmarket, Public & Others 13 weexpectittobebetterthanpeersat30%+. Relative Performance Adjusted Shareholders' Total Adjusted RoE RoCE 2,500 (Rsmn) Revenues EBITDA Pat Funds Assets EPS (Rs) (%) (%) 2,000 1,500 FY17 19,326 6,890 5,068 15,677 18,227 57.3 36.7 45.3 1,000 FY18E 20,470 6,217 4,515 18,600 21,253 51.0 26.3 33.1 500 0 FY19E 22,956 7,395 5,413 22,421 25,377 61.2 26.4 32.6 2 2 3 3 4 4 5 5 6 6 7 1 1 1 1 1 1 1 1 1 1 1 pr- ct- pr- ct- pr- ct- pr- ct- pr- ct- pr- FY20E 26,396 8,911 6,578 27,407 31,710 74.4 26.4 32.6 A O A O A O A O A O A CAGR (%) 12.0 9.0 9.1 Ajanta Pharma (Actual) Sensex Prepared for [email protected] - Sent on Thursday, September 07, 2017 5:57:54 PM 2 Index Page No. Investment Arguments 4 Financial Outlook 8 Outlook and Valuation 12 Key Risks 14 Business Model 15 Company Overview 32 Comparative Case Study (Ajanta vs. Torrent) 35 Financial Analysis 38 Detailed Financials 40 Prepared for [email protected] - Sent on Thursday, September 07, 2017 5:57:54 PM Investment Arguments Prepared for [email protected] - Sent on Thursday, September 07, 2017 5:57:54 PM Investment Arguments Rebound in growth post challenging phase : After a superlative performance from FY11-15 (31% sales CAGR, 57% PAT CAGR), Ajanta has shownsignsofmoderationfromFY15-17(15%salesCAGR,28%PATCAGR).WebelieveslowdowninAsia,baseeffectinIndiaandAfricaled tomoderation.WithAfrica tenderbusinessshrinkinginmarketandvolumes,Asiasufferingfromvolatile economiesandIndiaformulations impacted by GST (1H), we reckon FY17/18 will be challenging years. However, strong chronic led growth in India, stability in Asia brand businessandUS(smallbase,improvedfiling)shouldaidgrowthinthemediumterm. Expect rebound in FY19E led by growth resumption in India Branded formulations reported 34% CAGR (FY11-15) with3 key chronic therapies: Derma, Cardiac, Ophthalmic. Slowdown in industry restricted 26,000 45 growth to 19% CAGR in FY15-17,with derma segment getting impacted most 40 Africa reported 33% CAGR duringFY11-15 as Ajanta recorded higher growth 21,000 35 in the malarial tender business (43% CAGR). Growth contracted to 19% CAGR 30 due to volatility in crude sensitive geographies in branded segment , thereby 16,000 at 16% CAGR in FY15-17 mn 25 % Rs 20 11,000 Asia, the third pillar of growth for Ajanta reported 30%CAGR during FY11-15 15 until repatriation issues in select geographies hampered growth to -1% in FY15-17 10 6,000 5 In the meanwhile, US emerged as low base high growth market for Ajanta, surging to US$28mn in FY17 from US$0.5mn in FY15 with 12 products in 1,000 0 the market 11 12 13 14 15 16 17 8E 9E Y Y Y Y Y Y Y 1 1 F F F F F F F Y Y F F India US Africa Asia % YoY We expect Ajanta to report 12% CAGR over FY17-20E led by slowdown in Africa as India, Asia and US offer sustainability India is expected to grow ahead of IPM as new product launches and price hikes in selectportfoliooffsetlowervolumegrowth.StabilityincurrencywillaidgrowthinAsian markets.Wepegin14%CAGRoverFY17-20Eforeachsegment We build in 35% growth CAGR for the US segment over FY17-20E factoring in 12 filings and 8-10 launches p.a. Our assumptions factor in continued price erosion given the generic portfolio Prepared for [email protected] - Sent on Thursday, September 07, 2017 5:57:54 PM 5 Investment Arguments EBITDA margin to pick up in FY19E: Ajanta reported astonishing growth at operating level with margins scaling higher from 19.4% in FY11 to 34% in FY15 largely attributed to the branded business across India, Asia and Africa, supported by institutional tender business (43% CAGR over FY11-15). Over FY15-17, growth in Asia was flattish owing to currency devaluation in crude sensitive countries. This coupled with 300bps jump in R&D expense led to stagnancy at operating level (40bps increase). We believe, challenging business environmentwoulddepressmarginsinFY18E(expect29.6%EBITDAmargin,down490bpsinFY18E).However,reboundinIndia,stability inAsiaandaswiftrampupinUStoaidmarginsat31.5% byFY19E. High margins trajectory (FY11-15)... EM branded business led to high value margins in past 13,000 35 High margin led chronic Step by step acceleration Low base growth in the 11,000 30 India play in Africa tender business US starting FY15 n) Rs m 9,000 25% ( ...stabilized during FY15-17... 7,000 20 5,000 15 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E ...& reduced supplies to India continues to remain ...slowdown in Africa Asia due to repatriation EM branded business EBITDA margin high marginsegment... branded market... issues To be offset by growth in India, Asia & US in the medium term 7,700 35 ...to rebound in FY19E post a challenging FY18E 5,800 30 n % m3,900 25 Rs ...lower procurement ...& ramp up in the US Price hikes and new and donor funding in 2,000 20 to result in improved launches offset volume Africa tender business business mix, resetting decline in India... would be offset by stability in Asia... 30%+ margin profile 100 15 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E India Africa Asia US EBITDA margin Prepared for [email protected] - Sent on Thursday, September 07, 2017 5:57:54 PM 6 Investment Arguments RoCE-moderating but still better than peers: Ajanta has one of the best in class RoCE credited to its high margin branded business in India, Asia and Africa coupled with low capex and higher third party manufacturing (peak at 55.4% in FY15). However, with quality becomingofparamountissue(USis now 10% of sales),higheropex isexpectedto moderateRoCE,butgivenlesserexposuretogeneric marketunlikethebrandedbusinesslegacyofAjanta,weexpectittobebetterthanpeersat30%+. RoCE-moderating but still better than peers 60 RoCE • Launch of First-to- RoCE-peak at 55% 50 market products in India in FY15 for Ajanta and EM led to high RoCE 40 • Increasing capexfor % 30 Moderated to future growth led to 45% in FY17 lower R0CE 20 • Expect RoCEto stabilize at 30%+ levels 10 To stabilize at 32- as capacity utilization 33% over the increases from newly medium term commissioned Dahej 0 and Guwahati from FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20 onwards Prepared for [email protected] - Sent on Thursday, September 07, 2017 5:57:54 PM 7 Financial Outlook  We compare Ajanta with peer group companies both which has near similar business model (Torrent, Alembic, Cipla, Natco) and companies which have proven track record across parameters (Sun, Lupin, Cadila). We observe that Ajanta has been beating the bestoftheleagueonquiteafewparametersconsistentlyforpast10yearsnow.  What:Acombinationofgeographicalspread,segments,FTMcontribution,blockbusterslikeMetXL,Atorfit,Melcare,etcdrivehome afavorablepoint.  How:AjantahasshownexemplarygrowthoverFY12-17withitsEBITDAmarginssurgingto34.4%inFY17from18%inFY10.While Indiaisachronicledhighmarginplay,thetopproductswereintroducedasearlyorevenbefore2010,implyingthatFTMdoesnot meanforevermarketmonopoly.SothenextlogicalanswerisAfricabusiness,withcustomizedportfolioAjantarecorded27%sales CAGR over FY11-17 in the branded segment. Key notable is the institutional tender business which contributed ~4% of total sales in FY10 and accounted for ~24% of sales in FY16 before contracting to 20% in FY17. Higher market share through continued new launchescoupledwithoperatingefficiencyledtophenomenalriseattheoperatinglevel. Growth Revenue growth CAGR (%) Operating income growth CAGR (%) Net income growth CAGR (%) Company 3 Year 5 Year 10 Year 3 Year 5 Year 10 Year 3 Year 5 Year 10 Year Ajanta 16.7 23.3 21.9 22.7 38.1 31.4 29.4 45.7 13.2 Alembic 19.7 16.8 16.6 24.5 26.3 20.4 26.5 30.8 22.2 Torrent 12.3 17.1 16.3 11.6 24.0 19.7 12.0 26.9 18.5 Cipla 13.4 15.3 15.3 5.1 5.1 12.0 -9.3 -4.3 4.5 Sun 23.4 30.3 30.6 10.3 23.8 30.0 29.3 20.6 24.1 Lupin 9.4 13.9 18.3 13.7 25.5 30.3 11.7 24.1 29.4 Cadila 9.3 12.6 17.8 17.8 13.2 18.6 22.8 17.9 20.3 Natco 40.9 31.6 23.9 56.2 44.1 36.7 67.8 51.8 31.9 Ajanta has dominated the 5 year growth chart across parameters through its USP: Introducing first-to-market (60% branded formulations) and targeted marketing approach (company/geography specific go to market approach) However, post challenging FY17/18E, macroeconomic indicators hint towards stability in EM. Coupled with sustenance in India and low base growth in the US, we expect rebound in growth from FY19E onwards With top-line traction moderating, we expect PAT CAGR of 9% over FY17-20E Prepared for [email protected] - Sent on Thursday, September 07, 2017 5:57:54 PM 8 Financial Outlook Margins Gross Margins (%) Operating Margins (%) Net Margins (%) Company FY11 FY14 FY17 FY11 FY14 FY17 FY11 FY14 FY17 Ajanta 63.2 71.6 78.5 17.8 30.3 32.1 10.2 19.2 26.2 Alembic 50.1 60.9 72.6 12.0 17.5 19.7 5.9 10.9 12.9 Torrent 67.1 69.3 68.6 14.4 22.0 21.6 12.8 16.4 16.3 Cipla 56.1 60.5 62.8 21.7 18.7 14.9 18.9 14.2 7.3 Sun 74.5 82.6 77.1 34.2 43.3 30.9 31.7 19.6 22.6 Lupin 60.8 65.6 70.8 18.7 25.3 24.1 15.1 16.6 14.9 Cadila 67.0 61.6 62.6 19.3 14.7 18.4 15.9 11.4 16.1 Natco 59.5 68.4 71.0 19.7 24.3 33.1 11.3 13.3 23.5 EBITDA margins to stabilize at ~29-30% for FY18E on the back of adverse currency and higher opexfor new facilities at Dahejand Guwahati. With investments fructifying from FY19E onwards, we expect steady performance Gross margins have been consistently climbing up, even better than peers. We expect gross margins to remain above 75% over the next 4 years as businesses scale up Ajanta has pricing power by virtue of first-to market strategy and has gained significant operational efficiency across each possible step. While further squeezing looks difficult, improving business mix shall aid in margin sustenance Prepared for [email protected] - Sent on Thursday, September 07, 2017 5:57:54 PM 9 Financial Outlook Cash Flow Operating Cash Flow growth YoY(%) Free Cash Flow/Sales (%) Capex(% of sales) Company FY15 FY16 FY17 FY15 FY16 FY17 FY15 FY16 FY17 Ajanta 9.9 20.2 81.0 9.8 1.9 10.4 9.3 16.1 15.5 Alembic 9.0 453.2 -59.2 7.0 20.7 4.8 9.7 9.5 15.3 Torrent 75.8 166.7 -62.1 -30.3 23.3 7.1 46.4 10.2 10.1 Cipla -46.0 112.0 -13.2 -9.7 -6.3 6.4 20.5 24.4 7.5 Sun -37.7 126.1 37.9 -14.0 13.7 12.8 23.5 12.1 13.4 Lupin 67.9 -115.7 925.3 5.6 -31.8 -3.2 4.3 35.5 13.5 Cadila -0.7 146.9 -31.7 6.1 16.0 8.9 5.0 10.3 11.0 Natco -29.9 -15.9 322.7 -3.3 -7.0 4.5 15.2 12.7 13.7 Far ahead of Liquidity Current Ratio Net Debt/Equity Financial Leverage peers in return ratios Company FY15 FY16 FY17 FY15 FY16 FY17 FY15 FY16 FY17 (excluding Ajanta 3.4 2.9 3.8 -0.1 0.0 -0.1 1.4 1.3 1.2 the gAbilify Alembic 1.6 2.0 1.9 0.2 -0.2 0.0 1.7 1.6 1.5 effect from Torrent 1.5 1.4 1.7 0.7 0.3 0.2 2.9 2.8 2.4 Torrent and Cipla 2.0 1.1 2.7 0.1 0.3 0.2 1.4 1.7 1.7 Alembic in Sun 1.8 2.3 2.4 -0.1 -0.2 -0.2 1.7 1.7 1.6 FY16) Lupin 2.3 2.0 2.0 -0.2 0.6 0.4 1.4 1.7 2.0 Cadila 1.3 1.3 1.4 0.4 0.3 0.1 2.2 2.0 1.8 Natco 1.2 1.7 1.8 0.3 0.0 0.0 1.6 1.5 1.4 Profitability RoA(%) RoE (%) RoIC(%) Company FY15 FY16 FY17 FY15 FY16 FY17 FY15 FY16 FY17 Ajanta 45.0 42.9 39.4 41.4 39.7 36.7 46.1 43.5 40.4 Alembic 25.4 46.5 20.9 34.1 56.2 23.1 29.4 60.7 26.6 Torrent 17.2 32.0 13.5 32.9 62.8 23.8 25.1 43.3 22.0 Cipla 12.6 10.6 6.6 11.4 12.5 8.6 14.4 12.6 8.5 Sun 19.2 16.0 17.8 21.5 16.5 20.1 37.1 29.9 30.1 Lupin 29.6 19.2 15.2 29.8 22.2 20.7 38.9 20.8 16.1 Cadila 17.9 22.6 15.6 31.1 40.3 25.1 20.4 28.9 20.6 Natco 14.0 Prepared1 f4o.3r [email protected] - Sent on1 5T.3hursday, S3e1p.7tember 07,1 22.0817 5:57:541 4P.5M 31.8 10