June 5, 2013

COMPANY COMPANY

REPORT REPORT
Analyst Nishith K. Sanghvi +91-22-4322 1355 nishith.sanghvi@idbicapital.com

Indoco Remedies Ltd.

Good prospects

BUY

Summary
Indoco Remedies (Indocos) growth outperformance during FY13 in the domestic business (15% YoY) despite an acute heavy portfolio inspires confidence on the strength of the franchise (albeit on a lower base). Supplies of high margin ophthalmic products (~5 products) of market size US$638 mn in FY14 and similar number of launches in FY15 will be the next growth engine. We believe continued momentum in domestic business and beginning of supplies to the US, will address investor concerns on margins. We initiate coverage with BUY.

Nifty: 5,924; Sensex: 19,568

CMP Target Price Potential Upside/Downside Rs64 Rs80 +25%

Investment Highlights
Domestic business: Acute therapy outperformance; 15% CAGR over FY13-FY15E
Indocos domestic business has witnessed healthy growth on a sustained basis since Q1FY12 despite the company having a acute:chronic mix (90:10). The company has reported 12.9% YoY growth in Q4FY13 and 15.4% in FY13. Outperformance in Anti-infectives and GI space coupled with stomatological products have driven the growth for FY13. Indocos carving of cardio and diabeto (CND) products into a new CND division which includes sartan, statins and glyclazide with 245 MRs is a step in the right direction. The domestic business size at Rs3.4 bn/Rs3.9 bn in FY12/FY13 is expected to grow at 15% CAGR over the next two years.

Key Stock Data Sector Pharmaceuticals Bloomberg / Reuters INDR IN / INRM.BO Shares o/s (mn) 92 Market cap. (Rs mn) 5,898 Market cap. (US$ mn) 104 3-m daily average vol. 10,774

International business: Opthal launches in US to address US$638 mn market in FY14

Indoco is expected to launch 5 products with cumulative market size of US$638 mn in FY14 in partnership with a large US generic company. We believe the strength of Indocos partner in gaining market share coupled with low competition can present a substantial upside as the company has a profit sharing model in the same. We have conservatively factored US$5 mn in FY14E and US$11 mn in FY15E from the partnership.

Price Performance 52-week high/low Absolute (%) Rel to Sensex (%) -1m 2 3 Rs83/52 -3m -12m 1 18 (1) (4)

Operational parameters to witness improvement: Capex set to decline

Indocos EBITDA margin improvement from 13.7% in FY10 to 14.2%/14.7% in FY12/FY13 is mainly due to high growth in the domestic business. With high margin supplies to US partner along with continued momentum in the domestic business, the EBITDA margin will improve going ahead. The company does not envisage any major capex over the next 2 years. Indocos RoE/RoCE is expected to witness an improvement from 10.8%/12.8% in FY13 to 17.3%/16.9% in FY15E.

Shareholding Pattern (%) Promoters FIIs/NRIs/OCBs/GDR MFs/Banks/FIs Non Promoter Corporate Public & Others Relative to Sensex
140 130 120 110 100 90 Nov-12 Dec-12 May-13 Oct-12 Jun-12 Jan-13 Apr-13 Jul-12 Feb-13 Aug-12 Sep-12 Mar-13 Jun-13

59.2 2.9 14.1 2.9 20.9

Outlook and Valuation

The stock has underperformed the Sensex over the last 6 months mainly on back of investor concerns on operating margins and delay in supplies of ophthalmic products to its US partner. The stock currently trades at 6.7x on our FY15E EPS, which is cheaper than its peer set. Indoco looks set for promising growth prospects over the next couple of years led by strength in domestic business and likely trigger from its US launches. We initiate coverage with a BUY rating, with a TP of Rs80 (8.4x FY15E EPS). Table: Financial snapshot (Standalone)
Year FY12 FY13 FY14E FY15E Revenue EBITDA EBITDA (%) Adj. PAT EPS (Rs) 5,643 6,295 7,384 8,653 801 922 1,091 1,315 14.2 14.7 14.8 15.2 464* 432* 678* 878* 5.0 4.7 7.4 9.5 12.7 13.7 8.7 6.7 8.3 7.1 5.8 4.5 12.6 10.8 15.3 17.3

(Rs mn)
P/E (x) EV/EBITDA (x) RoE (%) RoCE (%) 12.3 12.8 14.6 16.9

Source: Capitaline

INDR

Sensex

* Includes forex loss in lieu of ECB.

Source: Company; IDBI Capital Research

Company Report Indoco Remedies Ltd.

Investment Arguments
Domestic business: Acute therapy outperformance; gradual increase in productivity
Indocos domestic business (65% of revenue) currently has 8 marketing divisions with 2,300 MRs. The current acute:chronic mix stands at 90:10. Indocos domestic business has been witnessing higher than market growth since Q1FY12. Key therapies in domestic market include Respiratory (21% of DF revenues), Anti-Infectives (18%), Stomatologicals (15%), Gastro Intestinal (15%) and Gynaecology (6%). The Top-5 therapies contribute 74% to the total domestic formulations revenues of the Company. According to the companys management, Acute/Chronic mix which is currently at 90:10 is expected change to 80:20 (management comments) in the next two years, due to strong growth in chronic portfolio (upwards of 20%). Its chronic portfolio has products in Cardiac-Diabetes and Multi-vitamin segments. Table: Domestic growth performance
Q1FY12 H1FY12 Q3FY12 Q4FY12 Q1FY13 Q2FY13 H1FY13 Q3FY13 9MFY13 Q4FY13 Total IPM Secondary Growth Primary Growth 13.0 8.8 7.7 14.1 5.5 6.4 17.2 7.7 14.8 19.0 18.7 13.5 17.3 23.0 20.2 13.9 12.2 17.6 15.0 17.0 18.8 9.1 7.1 11.0 12.0 13.6 16.2 8.1 0.3 12.9

(%)
FY13 11.8 10.0 15.4

Source: Company; Industry; IDBI Capital Research

We observe that the companys has been growing in-line with market growth and secondary growth over the 7-8 quarters. The company has outperformed the domestic IPM growth during FY13 on primary basis. Table: Key therapy growth performance vis--vis IPM
Q1FY12 Respiratory IPM Respiratory Indoco Anti-Infectives IPM Anti-Infectives Indoco Gastrointestinal IPM Gastro Intestinal Indoco 9.8 5.3 9.7 (1.2) 11.1 12.8 H1FY12 10.4 3.2 9.3 (4.1) 10.8 8.1 Q3FY12 18.5 12.5 12.6 3.6 14.4 (0.9) Q4FY12 15.6 20.9 14.8 7.2 16.6 17.3 Q1FY13 11.5 12.8 13.9 12.7 17.4 25.4 Q2FY13 9.4 7.4 12.4 11.9 15.8 34.3 Q3FY13 8.0 5.7 8.0 16.8 14.8 16.3 Q4FY13 6.6 5.2 4.9 5.4 7.9 13.5

(%)
FY13 8.3 7.8 9.8 11.7 13.4 22.4

Source: Company; Industry; IDBI Capital Research

The growth in the anti-infectives and GI has been higher than industry over the last 3 quarters while respiratory segment has been impacted owing to seasonality. For FY13, anti-infectives and GI have outperformed the market while respiratory segment has grown in-line with the market. Table: Growth in Lifestyle segment over the last 4 qtrs
Q1FY13 Lifestyle segment growth
Source: Company; IDBI Capital Research

(%)
Q2FY13 20.0 Q3FY13 20.2 Q4FY13 13.5 7.0

The lifestyle segment has been growing upwards of 20% in Q2FY13 and Q3FY13 and 13.5% in Q4FY13. Table: Products reporting strong quarterly growth
Q1FY13 Cyclopam Tab Sensodent-K 100 Gms Cital liquid-100 ML
Source: Company; IDBI Capital Research

(%)
Q2FY13 27.9 21.7 14.1 Q3FY13 16.9 11.2 6.8 Q4FY13 22.7 16.1 10.9 27.6 30.9 31.6

Company Report Indoco Remedies Ltd.

Gradual improvement in MR productivity

Indoco had created a new division i.e. Cardio & Diabeto (CND) with 6-7 products and 245 Medical Representatives (MRs) in Feb-12. The company has added brands like Telmicheck (Telmisartan), Rosuvastatin & Glychek (Gliclazide). Indocos MR productivity is one of the lowest in the industry due to its acute heavy portfolio. This we think will continue to improve gradually as the portfolio mix changes. Table: Domestic business to continue growth momentum
FY10 Domestic Formulations YoY (%) MR MR productivity
Source: Company; IDBI Capital Research

(Rs mn)
FY12 3,382 10.1 2,200 1.5 FY13 3,904 15.4 2,300 1.7 FY14E 4,490 15.0 2,300 2.0 FY15E 5,163 15.0 2,300 2.2

FY11 3,073 13.5 1,800 1.7

2,707 1,500 1.7

International Market Shift in Focus to Partnership Model from Contract Manufacturing

Indocos key markets in the EU include the UK and Germany. The supply partnerships are more of contract manufacturing in nature and hence there is a cap on margin upside. Indoco is in process of filing its own product dossiers in the EU market, which will aid the company in commanding better pricing.

Product launches from Watson: A key event

The Watson portfolio currently has 21 products with cumulative market size of US$3 bn in the US out of which 10 have been filed. The company plans to launch 4-5 products with cumulative market size of US$638 mn. The company expects a similar number of launches in FY15 which we have not factored in our estimates. Table: Market size for product launches in US of US$638 mn
Products Product I (plain + combination) Product II (combination) Product III
Source: Company; IDBI Capital Research

Market Size (US$) 250 200 188

Launch Q2FY14 Q4FY14 Q4FY14

No. of competitors 4-5 4-5 4-5

We have factored in US$5 mn coming from Watson supplies in FY14 and US$11 mn in FY15. Given that the products have lower competition and are sterile, we believe that price erosion is likely to be lower and may present a high margin profile. Table: Indocos Export formulations business
FY10 Regulated Markets (includes Watson) YoY (%) Semi-Regulated markets (includes Aspen) YoY (%) Total
Source: Company; IDBI Capital Research

(Rs mn)
FY11 1,111 23 305 60 1,416 FY12 1,495 34 360 18 1,855 FY13 1,814 21 195 (46) 2,009 FY14E 2,208 22 245 26 2,453 FY15E 2,685 22 295 20 2,980 900 19 191 0 1,091

Contracts with DSM and Aspen may give additional kicker

In Mar10, Indoco entered into a dossier licensing and supply deal with Aspen for the supply of 7 ophthalmic products to 30 emerging countries including BRICS. Over the last 2 years the deal has been expanded to include 50 products which include both steriles and solid dosages. The company has also signed an agreement with DSM, Austria, for marketing eight of Indocos Active Pharmaceutical Ingredient in various geographies.

Company Report Indoco Remedies Ltd.

Financial Outlook and Valuation

With strong focus on high growth domestic segment and improving operating parameters, we expect Indoco to report 17.2% revenue and 43.0% earnings CAGR over FY13-FY15E. We expect significant improvement in EBITDA margin from 14.7% in FY13 to 15.2% in FY15 owing to scale up in domestic formulations business and beginning of high margin opthal supplies to Watson. The companys RoCE is likely to improve from 13.1% in FY13 to 1 6.9% in FY15E with companys capex declining from Rs587 mn in FY12 to Rs250 mn in FY15. Indocos earnings are growing at fastest pace among peers (see Peer Table). We value the company at a P/E multiple of 8.4x, translating to TP of Rs80. Initiate with a BUY rating.

Declining Capex leading to improving return ratios

Indocos capex is expected to decline from Rs803 mn in FY11 to Rs250 mn in FY15 which will aid expansion in the return ratios. Going forward, the company does not envisage any major capex as expansion of its Goa and Patalganga facilities has been expensed. These capacities can aid revenue growth for the next 3 years. Table: Lower capex leading to higher operating performance
FY10 Capex EBITDA margin (%) RoCE (%)
Source: Company; IDBI Capital Research

(Rs mn)
FY12 (587) 14.2 12.3 FY13 (487) 14.7 12.8 FY14 (200) 14.8 14.6 FY15 (250) 15.2 16.9

FY11 (803) 13.9 12.1

(478) 13.8 11.3

With declining capex and improving EBITDA margin we expect the companys return ratios to improve from 11.3% in FY10 to 16.9% in FY15.

Historically EBITDA margin improvement lags material cost : Set to change going forward
Indocos material costs have reduced from peak of 45.8% in Q2FY12 to 39.8% in Q4FY13. However, we have not factored in any improvement in the material cost going ahead Table: Material cost improvement on a consistent basis.
Q1FY12 Domestic formulations Total revenues Material cost % of sales EBITDA margin (%)
Source: Company; IDBI Capital Research

(Rs mn)
Q4FY12 820 1477 648 43.9 14.5 Q1FY13 940 1512 661 43.7 16.4 Q2FY13 1096 1645 685 41.6 14.1 Q3FY13 943 1503 635 42.2 12.5 Q4FY13 925 1605 639 39.8 16

Q2FY12 932 1447 663 45.8 13.8

Q3FY12 850 1415 639 45.2 11.5

782 1256 540 43.0 14.6

We expect the companys EBITDA margin to improve to 14.8% in FY14E and 15.2% in FY15E.

Company Report Indoco Remedies Ltd. Figure: EBITDA margin performance broadly in range of 1416%
20

(%)

18 16
14

12
10

8
Q1FY12 Q2FY12 Q3FY12 Q4FY12 Q1FY13 Q2FY13 Q3FY13 Q4FY13 EBITDA margin (%)
Source: Company; IDBI Capital Research

The operating performance of the company has witnessed gyrations in Q3 of FY12 & FY13. Broadly it has been in the range of 14-16% over the last 8 quarters. We have factored in 14.8% EBITDA margin in FY14 and 15.2% in FY15.

Strong growth profile in revenue and earnings but trading at very low multiples
Indoco is expected to witness a CAGR of 17.2% in revenue during FY13-FY15 (albeit on a lower base) only lower than Alembic Pharma. The earnings growth is highest amongst all the companies in our coverage space. Indoco is trading at 6.7x FY15E, lower than any company in our coverage space. This is also because its return ratios are lowest in our coverage space. Table: Peer Valuation
Revenues Market cap Indoco Remedies Torrent Pharma Unichem Alembic Pharma FY14E 7,384 35,333 12,531 18,228 FY15E CAGR (%) 8,653 40,204 14,015 22,070 17.2 13.3 13.9 20.6 FY14E 7.4 50.1 16.0 10 EPS (Rs) FY15E CAGR (%) 9.5 57.2 18.7 13.6 43.0 13.6 22.3 31.2 RoCE (%) FY14E 14.7 25.9 21.5 27.4

(Rs mn)
P/E (x) FY15E 6.7 14.5 8.8 10.1

Source: Company; IDBI Capital Research

Though the scale of the operations for Indoco are lower than its competitors we believe that with the continued ramp up in the business, its valuation will improve as return ratios start expanding.

Company Report Indoco Remedies Ltd. Figure: Trading at an average PE of 7.1x over the last 5 years
120.0 100.0 80.0
(Rs)

60.0 40.0
20.0
Mar-06 Jun-06 Aug-06 Oct-06 Dec-06 Feb-07 Apr-07 Jun-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Aug-11 Oct-11 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Jan-13 Mar-13 May-13

0.0

Prices
Source: Bloomberg; IDBI Capital Research

3.4

7.1

10.5

13.9

During the period Aug-10 to Dec-12 the stock has traded at a multiple of 10.5x factoring in the turnaround happening in the domestic formulations space. However, the multiple started declining over the last 1.5 years with investors shifting to companies which offer them growth prospects. We believe the beginning of opthal supplies to Watson is a key trigger for the stock. Post the start of supplies the stock can be re-rated to 8.4x multiple or higher. We value the company at 8.4x FY15E with TP of Rs80 and have a BUY rating on the stock.

Company Report Indoco Remedies Ltd.

Financial Summary (Standalone)

Profit & Loss Account
Year-end: March Net sales Growth (%) Operating expenses EBITDA Growth (%) Depreciation EBIT Interest paid Other income Pre-tax profit Tax Effective tax rate (%) Adjusted net profit FY12 5,643 17.5 (4,842) 801 20.8 (192) 609 (68) (28) 513 (49) 9.6 464* FY13 6,295 11.6 (5,373) 922 15.1 (237) 685 (91) (111) 484 (54) 11.2 432* FY14E 7,384 17.3 (6,293) 1,091 18.3 (260) 831 (72) 11 770 (92) 12.0 678

(Rs mn)
FY15E 8,653 17.2 (7,338) 1,315 20.5 (280) 1,035 (54) 17 998 (120) 12.0 878

Cash Flow Statement

Year-end: March Pre-tax profit Depreciation Tax paid Chg in working capital Other operating activities Cash flow from operations (a) Capital expenditure Chg in investments Other investing activities Cash flow from investing (b) Equity raised/(repaid) Debt raised/(repaid) Dividend (incl. tax) Chg in minorities Other financing activities Cash flow from financing (c) Net chg in cash (a+b+c) FY12 513 187 4 (124) 580 (581) (1) (582) 0 (25) (119) (111) (114) FY13 484 237 (17) (109) 596 (487) (3) (490) 61 112 (119) 27 132 FY14E 770 260 (92) (349) 589 (200) (200) (286) (119) (405) (16)

(Rs mn)
FY15E 998 280 (120) (404) 754 (250) (250) (200) (119) (319) 186

* Includes forex loss of Rs96 mn in FY12 and Rs128 mn in FY13.

Balance Sheet
Year-end: March Net fixed assets Investments Current assets Inventories Sundry Debtors Cash and Bank Loans and advances Total assets Shareholders funds Share capital Reserves & surplus Total Debt Secured loans Other liabilities Curr Liab & prov Current liabilities Total liabilities Total equity & liabilities Book Value (Rs)
Source: Company; IDBI Capital Research

(Rs mn)
FY12 3,342 1 3,220 1,019 1,137 105 907 6,564 3,848 123 3,725 974 974 294 1,448 1,448 2,716 6,564 42 FY13 3,592 4 3,389 928 1,271 210 980 6,985 4,140 184 3,956 1,086 1,086 348 1,411 1,411 2,845 6,985 45 FY14E 3,532 4 3,923 1,088 1,491 194 1,150 7,459 4,700 184 4,515 800 800 348 1,611 1,611 2,759 7,459 51 FY15E 3,503 4 4,749 1,275 1,747 379 1,348 8,256 5,459 184 5,275 600 600 348 1,848 1,848 2,796 8,256 59

Financial Ratios
Year-end: March Adj. EPS (Rs) Adj. EPS growth (%) EBITDA margin (%) Pre-tax margin (%) RoE (%) RoCE (%) Turnover & Leverage ratios (x) Asset turnover (x) Leverage factor (x) Net margin (%) WC & Liquidity ratio Inventory days Receivable days Payable days FY12 5.0 (9.1) 14.2 9.1 12.6 12.3 0.9 1.7 8.2 66 74 58 FY13 4.7 (6.7) 14.7 7.7 10.8 12.8 0.9 1.7 6.9 54 74 46 FY14E 7.4 56.8 14.8 10.4 15.3 14.6 1.0 1.6 9.2 54 74 46 FY15E 9.5 29.6 15.2 11.5 17.3 16.9 1.1 1.5 10.2 54 74 46

Valuation
Year-end: March PER (x) Price/Book value (x) EV/EBITDA (x) Dividend Yield (%) FY12 12.7 1.5 8.3 1.7 FY13 13.7 1.4 7.1 1.7 FY14E 8.7 1.3 5.8 1.7 FY15E 6.7 1.1 4.5 1.7

Company Report Indoco Remedies Ltd.

Notes

Sonam H. Udasi Head Research Dealing

(91-22) 4322 1375 (91-22) 6637 1150

sonam.udasi@idbicapital.com dealing@idbicapital.com

Key to Ratings Stocks: BUY: Absolute return of 15% and above; ACCUMULATE: 5% to 15%; HOLD: Upto 5%; REDUCE: -5% to -15%; SELL: -15% and below. IDBI Capital Market Services Ltd. (A wholly owned subsidiary of IDBI Ltd.) Equity Research Desk 3rd Floor, Mafatlal Centre, Nariman Point, Mumbai 400 021. Phones: (91-22) 4322 1212; Fax: (91-22) 2285 0785; Email: info@idbicapital.com SEBI Registration: NSE CM INB230706631, NSE F&O INF230706631, BSE CM INB010706639, BSE F&O INF010706639, NSDL IN-DP-NSDL-12-96 Compliance Officer: Christina Fernandes; Email: compliance@idbicapital.com; Telephone: (91-22) 4322 1212
Disclaimer This document has been prepared by IDBI Capital Market Services Ltd (IDBI Capital) and is meant for the recipient only for use as intended and not for circulation. This document should not be reproduced or copied or made available to others. No person associated with IDBI Capital is obligated to call or initiate contact with you for the purposes of elaborating or following up on the information contained in this document. Recipients may not receive this report at the same time as other recipients. IDBI Capital will not treat recipients as customers by virtue of their receiving this report. The information contained herein is from the public domain or sources believed to be reliable. While reasonable care has been taken to ensure that information given is at the time believed to be fair and correct and opinions based thereupon are reasonable, due to the very nature of research it cannot be warranted or represented that it is accurate or complete and it should not be relied upon as such. In so far as this report includes current or historical information, it is believed to be reliable, although its accuracy and completeness cannot be guaranteed. Opinions expressed are current opinions as of the date appearing on this material only. While we endeavor to update on a reasonable basis, the information discussed in this material, IDBI Capital, its directors, employees are under no obligation to update or keep the information current. Further there may be regulatory, compliance, or other reasons that prevent us from doing so. Prospective investors and others are cautioned that any forward-looking statements are not predictions and may be subject to change without notice. IDBI Capital, its directors and employees and any person connected with it, will not in any way be responsible for the contents of this report or for any losses, costs, expenses, charges, including notional losses/lost opportunities incurred by a recipient as a result of acting or non acting on any information/material contained in the report. This is not an offer to sell or a solicitation to buy any securities or an attempt to influence the opinion or behaviour of investors or recipients or provide any investment/tax advice. This report is for information only and has not been prepared based on specific investment objectives. The securities discussed in this report may not be suitable for all investors. Investors must make their own investment decision based on their own investment objectives, goals and financial position and based on their own analysis. Trading in stocks, stock derivatives, and other securities is inherently risky and the recipient agrees to assume complete and full responsibility for the outcomes of all trading decisions that the recipient makes, including but not limited to loss of capital. Opinions, projections and estimates in this report solely constitute the current judgment of the author of this report as of the date of this report and do not in any way reflect the views of IDBI Capital, its directors, officers, or employees. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject IDBI Capital and affiliates to any registration or licensing requirement within such jurisdiction. The securities described herein may or may not be eligible for sale in all jurisdictions or to certain category of investors. Persons in whose possession this document may come are required to inform themselves of and to observe such restriction. IDBI Capital, its directors or employees or affiliates, may from time to time, have positions in, or options on, and buy and sell securities referred to herein. IDBI Capital or its affiliates, during the normal course of business, from time to time, may solicit from or perform investment banking or other services for any company mentioned in this document or their connected persons or be engaged in any other transaction involving such securities and earn brokerage or other compensation or act as a market maker in the financial instruments of the company(ies) discussed herein or their affiliate companies or act as advisor or lender / borrower to such company(ies)/affiliate companies or have other potential conflict of interest. This report may provide hyperlinks to other websites. Except to the extent to which the report refers to the website of IDBI Capital, IDBI Capital states that it has not reviewed the linked site and takes no responsibility for the content contained in such other websites. Accessing such websites shall be at recipient's own risk. E-mail is not a secure method of communication. IDBI Capital Market Services Limited cannot accept responsibility for the accuracy or completeness of any e-mail message or any attachment(s). This transmission could contain viruses, be corrupted, destroyed, incomplete, intercepted, lost or arrive late. IDBI Capital, its directors or employees or affiliates accept no liability for any damage caused, directly or indirectly, by this email.