Ranbaxy Labs

Company Update
Multiple triggers ahead; Upgrade to Hold

September 21, 2010

¾ Worst is behind; Multiple triggers ahead

¾ These triggers present potential upsides of Rs120

HOLD
¾ Factored in only triggers like - hive-off of NCE R&D and
Price Target Price monetization of Aricept FTF- which have already kicked in
Rs 562 Rs 520
¾ Upgrade to ‘Hold’ and raise target price to Rs520. Have a
Sensex 20,002 positive bias on the stock but will factor in upsides only on
occurrence of triggers
Price Performance
The worst is behind; Multiple triggers ahead
(%) 1M 3M 6M 12M
After a prolonged crisis management phase, we are of the view that the worst is behind
Absolute 14 26 19 56
for Ranbaxy and one can expect only positive news-flows over the next 6-9 months.
Rel. to Sensex 5 12 4 31 Some of the positive triggers such as a) hiving off NCE R&D and b) Monetization of
Source: Bloomberg Aricept FTF have already kicked in.
Further potential triggers waiting to pan out are

Stock Details § Resolution of FDA issue,

Sector Pharmaceuticals § Monetization of other Para IV opportunities such as Lipitor and Nexium,
Reuters RANB.BO
§ Supply of Nexium API and formulation to AstraZeneca,
Bloomberg RBXY@IN
Equity Capital (Rs mn) 2104 § Launch of Carbapenem in US and Europe, and
Face Value (Rs) 5 § Cost savings on account of - manufacturing shift from Ohm Laboratories to India and
No of shares o/s (mn) 421 legal and consultancy costs with regard to FDA-DOJ issue.
52 Week H/L (Rs) 566/359
In our numbers, we have already factored in the upsides from recent triggers (our
Market Cap (Rs bn/USD mn) 236/5,166
recurring EPS for CY11E has moved from Rs13.7 to Rs16.7). However, our estimates
Daily Avg Vol (No of shares) 1073353 do not take into account the earnings upside from the aforementioned potential triggers,
Daily Avg Turnover (US$ mn) 11.2 given the inability to ascertain a definite time frame for their occurrence. We are of the
view that these potential triggers can provide upside potential of Rs6 per share on
recurring basis (35% of our CY11E EPS) plus NPV of Rs20/ share for Carbapenem
Shareholding Pattern (%)
(assuming limited competition for next 3 years).
J’10 M’10 D’09
Promoters 63.9 63.9 63.9 Developments factored in our earning estimates
FII/NRI 8.3 8.9 8.2
Hiving off drug discovery unit will add Rs1.6/share to recurring business
Institutions 11.6 11.6 11.8
Ranbaxy is transferring its New Drug Discovery Research (NDDR) unit to Daiichi
Private Corp 3.7 3.1 3.5 Sankyo India Pharma Private Ltd. Ranbaxy spends ~US$25mn on NDDR. We believe
Public 12.5 12.5 12.6 Ranbaxy will retain a small portion of these expenses for independently developing its
Source: Capitaline Malaria molecule (currently in Phase III) and development programs in the GSK
collaboration. Barring this small portion, the hive off is likely to add Rs1.6 to our CY11E
estimates.

Financials Rs (mn)
YE- Net EBITDA EPS EPS RoE EV/
Mar Sales (Core) (%) APAT (Rs) % chg (%) P/E EBITDA P/BV
FY09 74,214 5,001 6.7 2,231 5.3 (71.2) 6.3 105.8 44.5 5.5
FY10 74,529 6,107 8.2 2,882 6.9 29.2 6.6 81.9 41.2 5.3
Manoj Garg
FY11E 88,113 18,605 21.1 11,409 27.1 295.8 23.3 20.7 13.3 4.5
manoj.garg@emkayglobal.com
FY12E 94,006 19,679 20.9 12,330 29.3 8.1 22.1 19.2 12.6 4.0
+91 22 6612 1257

Ashish Thavkar
ashish.thavkar@emkayglobal.com
+91 22 6612 1254

Emkay Global Financial Services Ltd 1

 Ranbaxy Labs Ltd Company Update

Aricept launch to add US$230mn and US$110mn to revenues and PAT

during exclusivity; Recurring revenue can be US$25-30mn from CY11
onwards
With US FDA approval of generic version of Aricept, Ranbaxy will be able to launch generic
version of Aricept (US$2.2bn revenue for CY09) with 180days exclusivity. Assuming 30%
price erosion and 30% MS, Ranbaxy will be able to generate US$230mn revenue and
US$110mn PAT (NPV of Rs18/share) during exclusivity. Even, post exclusivity, we expect
Ranbaxy to generate recurring revenue of US$25-30mn (assuming 95% price erosion and
25% MS) from CY11E onwards, which will boost the overall contribution of the US base
business. This is the 4th Para IV opportunity, which Ranbaxy has been able to monetize,
thus enhancing confidence on Ranbaxy’s ability to monetize other Para IV opportunities.

Potential triggers- Not yet factored in

Resolution of DOJ-FDA issue
In our recent meeting with the company, Ranbaxy has highlighted that they are reasonably
confident of resolving the ongoing FDA-DOJ issue within this year. Even in their Q2CY10
concall , Mr. Atul Sobti (Ex CMD) had indicated that composite resolution with FDA was just
a few months away, possibly in 2010 itself. Though they have also highlighted that there
would be some pain in terms of one time penalty (quantum is not known), we believe that
complete resolution of the FDA issue is a long term positive for the company.
Monetization of other Para IV opportunities
In the last 12 months, Ranbaxy has been able to monetize all four Para IV opportunities
(Imitrex, Valtrex, Flomax and now Aricept). In case of Flomax, Ranbaxy has smartly
monetized its FTF status by striking a deal with the innovators. We believe that this reflects
the ability of the company to monetize its highly lucrative Para IV pipeline. Though there is
still some uncertainty associated with FTF filings made out of Paonta Sahib such as Lipitor
and Nexium, management remains confident of monetizing all its Para IV opportunities,
going forward. We believe the resolution of the FDA issue will lift the cloud of uncertainity
from Para IV product launches. Ranbaxy has some very large and interesting opportunities
such as Lipitor (US$5.5bn revenue), Nexium (US$2.7bn), Diovan (US$2bn) and Actos
(US$1bn). Timely monetization of these opportunities will not only add over US$1.7bn
revenue during six months exclusivity but also enable Ranbaxy to retain leadership status,
post exclusivity also. Moreover, significant cash flows accruing from these opportunities will
also enable Ranbaxy to repay its debt and save on interest cost. The NPV of Para IV
pipeline stands at Rs170/share.
Commencement of Nexium supply will further add momentum to earnings
Management has indicated that commercial API supply of Nexium to AstraZeneca (AZ) is
likely to commence from Q4CY10E and formulation supply from Q1CY11E. Though
originally, this supply was supposed to commence from May 2009 onwards, Ranbaxy was
unable to do so on account of the FDA import alert on its Paonta Sahib facility. In our recent
interaction, management has indicated that the supply of Nexium API will commence from
Q4CY10 and that the initial batch of the same has already been supplied to AZ. With API
supply to AZ beginning from Q4CY10E and formulation supply from Q1CY11E, the revenue
contribution in CY11E can be Rs6bn (EPS of Rs4.3).

Nexium opportunity CY2011E CY2012E CY2013E

Revenues
Nexium (Formulations) 71.7 114.7 143.4
Nexium (API) 57.3 76.5 76.5
Total Revenues (US$ mn) 129.0 191.2 219.8

EPS
Nexium (Formulations) 2.7 4.3 5.4
Nexium (API) 1.6 2.0 2.0
Total EPS (Rs) 4.3 6.3 7.4

Emkay Research 21 September 2010 2

 Ranbaxy Labs Ltd Company Update

Carbapenem launch can add US$ 100-120mn revenue for Ranbaxy

Carbapenems, which are a class of beta-lactam antibiotics, are large opportunities within
the US (US$530mn opportunity) and EU (US$470mn opportunity). Ranbaxy is the second
generic company (first being Orchid Pharma) to file ANDAs for both Imipenem (base patent
expired in Sep’09 in US; no generic approval) and Meropenem (base patent will expire in
Sep’10 in US). Each of these products have global sales in the range of US$760mn and
belong to the Carbapenems’ segment. Overall, there are just 4 players, who have filed
DMFs for both these products, making it a limited generic competition market for these
products.
We believe that, post the resolution of the Dewas issue and FDA approval for penems,
Ranbaxy will be able to launch these products in the market. Orchid is yet to receive its
approval for Imipenem, patent for which, has already expired. This clearly indicates that
Carbapenems are difficult to manufacture generic products and if Ranbaxy is able to launch
it successfully, it may enjoy a significant period of limited competition on this US$1bn
opportunity (at least 2-3 years). Though we believe that because of Devas issue, Ranbaxy
would have lost initial upside opportunity; however it can still generate significant upside in
the long term because of limited competition. We are of the view that Carbapenem launch
can add US$100-120mn revenue for Ranbaxy within first year of launch. The NPV of
Carbapenem opportunity works out to be Rs20 per share (assuming limited competition for
next three years).

Carbapenem portfolio CY11E CY12E CY13E

Meropenem (US) 36.3 30.8 27.7
Imipenem (US) 30.0 25.5 23.0
Mero (EU) 28.8 24.4 22.0
Imip(EU) 30.0 25.5 23.0
Total Revenue (USD) 125.0 106.3 95.6
PAT (USD mn) 75.0 63.8 57.4
INR/USD 46.0 45.0 45.0
Revenue (Rs mn) 5750.0 4781.3 4303.1
PAT (Rs mn) 3450.0 2868.8 2581.9
EPS 8.2 6.8 6.1

Recovery in base business and margin expansion on account of

manufacturing shift and saving on legal cost
DOJ-FDA resolution will not only enable Ranbaxy to cover lost ground on recurring
business but will also enable company to optimize its cost matrix in the US. Post FDA ban
and import alert, Ranbaxy’s US business plummeted from US$106mn in Q2CY08 to
US$44mn in Q4CY09 (ex one-offs). Though we believe that the recovery in the US
business will be gradual, it will definitely improve the profitability of the US business.
Ranbaxy is currently manufacturing products out of Ohm facility (where manufacturing cost
is higher than India) and spending lot of money on consultants and legal recourses to
resolve the FDA-DOJ issue. Moreover, retaining market share post exclusivity in FTF
opportunities (can add US$180-200mn recurring revenue from these opportunities post
CY11E onwards) and increased launches (on the back of more filings), can result in the US
base business increasing from US$198mn in CY10 to ~US$500mn in CY12E.

Focus on profitable growth; operating margins are likely to expand by

950bps to 14% by CY11E
Over the last 5 quarters, we have witnessed a marked improvement in the base business
operating margins. Operating margins have improved from 3% in Q2CY09 to 8.8% in
Q2CY10, largely driven by a) increased contribution from high margin emerging markets, b)
cost optimization and c) closure of non-profitable business. Moreover, its recent initiatives
such as expanding the field force in India (most profitable franchises) as well as launching
of Daiichi’s patented products in other emerging markets coupled with scaling down the
operations in non-profitable markets will further boost the profitability of the company. Going
forward, we expect its base business operating margins to expand further by 950bps to
14%.

Emkay Research 21 September 2010 3

 Ranbaxy Labs Ltd Company Update

Successful resolution of FDA issue will lead to 10x rise in profit; Base
business earnings to grow 28x over CY09-11
Resolution of FDA issue and successful launch of penems and other Para IV opportunities
will lead to 10x rise in profit driven by a) Rs20.4bn of PAT from FTF opportunity, b)
Rs900mn interest income (significant cash generation by monetizing Para IV opportunities),
c) Rs960mn savings on account of reduction in NCE R&D expenditures and d) sharp
recovery in the base business. Base business EPS is likely to grow from Rs0.6 in CY09 to
Rs16.7 in CY11E on the back of a) 12% revenue CAGR and b) 950bps expansion in base
business margins.

Revised estimates and upgrade to Hold

We have revised our base business earnings estimates of CY11E from Rs13.7 to Rs16.7
on account of a) Rs1.64 savings from NCE R&D, b) Rs0.90 on account of interest earned
from US$110mn cash flow during Aricept exclusivity (Rs0.45 per share) and c) Recurring
earnings of US$20mn from Aricept in CY11E (0.65 per share). Owing to upward revision in
base business earnings, we upgrade our target price from Rs395 to Rs520 and upgrade our
rating one notch from ‘Reduce’ to ‘Hold’. We have valued the company on its CY11E base
business earnings on account of it fully reflecting the benefits of revival in its base business,
strong earnings traction in the domestic market and strong operating performance.

Aggressive valuations leave limited room for upside

Given the inability to ascertain a definite time frame for the occurrence of potential triggers,
we have not factored the same in our estimates. These triggers present potential upsides of
Rs120 per share (recurring EPS of Rs6/per share). The recent run up of 14% in last one
month indicates that market has already started factoring these upsides. Thereby, we
believe actual occurrence of these triggers is likely to have limited upside potential.
Though we believe that Ranbaxy’s base business has already bottomed out and are
positive on the long term prospects of the company, the outcome of DoJ/ FDA issue will be
most critical to stock performance.

Positive out come of DoJ- FDA can lead to earning upside of Rs 6 in the base business (Rs)

Lipitor Total
70 + EPS
Carbapenams 62.1
60 Interest Para
income IV NPV
Recurring
Interest from 39.4
50 EPS from Cost 26.8
income Lipitor
Lipitor post savings
Recurring cash flow
from excl in US
40 EPS from during
Aricept
Aricept post excl. Incremental EPS post
cash flow 12.6 1.4
30 excl. USFDA resolution
during excl. 2.8
1.8
Para 6
0.9 16.7
20 13.7 1.64 0.5 IV
Base
10 Base R&D Total Base
business
business benefit business
16.7
0

Emkay Research 21 September 2010 4

 Ranbaxy Labs Ltd Company Update

Financial

Income Statement Balance Sheet

Y/E, Mar (Rs. mn) CY08 CY09 CY10E CY11E Y/E, Mar (Rs. mn) CY08 CY09 CY10E CY11E
Net Sales 74,214 74,529 88,113 94,006 Equity share capital 2,102 2,102 2,102 2,102
Growth (%) 9.4 0.4 18.2 6.7 Reserves & surplus 40,861 42,815 50,889 56,675
Expenditure 69,213 68,423 69,508 74,327 Net worth 42,962 44,917 52,991 58,777
Raw Materials 27,704 31,657 30,772 35,060 Minority Interest 675 816 967 1,090
SGA 21,011 22,591 16,792 16,359 Secured Loans 33,639 32,639 28,639 11,259
Employee Cost 9,670 14,175 15,975 17,163 Unsecured Loans 9,476 4,476 3,476 1,976
Other Exp 10,828 0 5,969 5,745 Loan Funds 43,114 37,114 32,114 13,235
EBITDA 5,001 6,107 18,605 19,679 Net deferred tax liability -12,229 -12,229 -12,229 -12,229
Growth (%) -45.3 22.1 204.7 5.8 Total Liabilities 74,522 70,618 73,843 60,873
EBITDA margin (%) 6.7 8.2 21.1 20.9
Depreciation 2,825 2,676 2,931 3,119 Gross Block 61,942 66,761 71,351 75,938
EBIT 2,176 3,430 15,674 16,560 Less: Depreciation 17,042 18,628 21,328 24,215
EBIT margin (%) 2.9 4.6 17.8 17.6 Net block 44,900 48,133 50,023 51,723
Other Income 2,706 1,398 1,590 706 Capital work in progress 4,707 3,185 2,930 2,931
Interest expenses 2,055 710 751 662 Investment 5,432 5,432 5,432 5,432
PBT -15,000 10,098 16,513 12,684 Current Assets 66,922 65,221 67,955 51,308
Tax -5,648 6,991 4,954 3,171 Inventories 19,643 19,643 21,440 22,486
Effective tax rate (%) 37.7 69.2 30.0 25.0 Sundry debtors 13,310 13,397 14,559 15,893
Adjusted PAT 2,071 2,741 11,259 12,206 Cash & bank balance 23,956 21,836 21,687 1,835
(Profit)/loss from JV's/Ass/MI -160 -142 -150 -124 Other current assets 10,012 10,345 10,270 11,094
Adjusted PAT after MI 2,231 2,882 11,409 12,330 Current lia & Prov 47,438 51,352 52,497 50,521
Growth (%) -71.2 29.2 295.8 8.1 Current liabilities 39,719 40,912 40,647 40,881
Net Margin (%) 3.0 3.9 12.9 13.1 Provisions 7,720 10,440 11,850 9,639
E/O items -17,827 5,980 0 -3,920 Net current assets 19,484 13,869 15,458 787
Reported PAT -9,512 2,965 11,409 9,389 Misc. exp & Def. Assets 0 0 0 0
Growth (%) -222.8 -131.2 284.8 -17.7 Total Assets 74,522 70,618 73,843 60,873

Cash Flow Key ratios

Y/E, Mar (Rs. mn) CY08 CY09 CY10E CY11E Y/E, Mar CY08 CY09 CY10E CY11E
PBT (Ex-Other income) -17,706 8,700 14,923 11,978 Profitability (%)
Depreciation 2,825 2,676 2,931 3,119 EBITDA Margin 6.7 8.2 21.1 20.9
Interest Provided 2,055 710 751 662 Net Margin 3.0 3.9 12.9 13.1
Other Non-Cash items 0 0 0 0 ROCE 3 4 19 21
Chg in working cap -3,234 3,494 -1,739 -5,180 ROE 6.3 6.6 23.3 22.1
Tax paid 5,648 -6,991 -4,954 -3,171 RoIC 3.9 6.6 29.0 27.9
Operating Cashflow -10,413 8,590 11,912 7,408 Per Share Data (Rs)
Capital expenditure -6,813 -4,387 -4,566 -4,820 EPS 5.3 6.9 27.1 29.3
Free Cash Flow -17,226 4,203 7,346 2,588 CEPS 12.0 13.2 34.1 36.8
Other income 2,706 1,398 1,590 706 BVPS 102.2 106.9 126.1 139.8
Investments -3,028 0 0 0 DPS 0.0 2.1 6.8 7.3
Investing Cashflow -7,135 -2,989 -2,975 -4,114 Valuations (x)
Equity Capital Raised 34,949 0 0 0 PER 105.8 81.9 20.7 19.2
Loans Taken / (Repaid) 1,699 -6,000 -5,000 -18,880 P/CEPS 46.7 42.5 16.5 15.3
Interest Paid -2,055 -710 -751 -662 P/BV 5.5 5.3 4.5 4.0
Dividend paid (incl tax) 0 -1,011 -3,334 -3,603 EV / Sales 3.1 3.4 2.9 2.7
Income from investments 0 0 0 0 EV / EBITDA 44.5 41.2 13.3 12.6
Others 2,533 0 0 -1 Dividend Yield (%) 0.0% 0.4% 1.2% 1.3%
Financing Cashflow 37,125 -7,721 -9,086 -23,146 Gearing Ratio (x)
Net chg in cash 19,577 -2,120 -149 -19,851 Net Debt/ Equity 0.4 0.3 0.2 0.2
Opening cash position 4,379 23,956 21,836 21,687 Net Debt/EBIDTA 2.5 2.0 0.5 0.6
Closing cash position 23,956 21,836 21,687 1,835 Working Cap Cycle (days) 16 12 23 33

Emkay Research 21 September 2010 5

 Ranbaxy Labs Ltd Company Update

Recommendation History: Ranbaxy Labs – RBXY IN

Date Reports Reco CMP Target

13.08.2010 Ranbaxy Q2CY10 Result Update Reduce 445 395

12.05.2010 Ranbaxy Q1CY10 Result Update Reduce 458 395

10.03.2010 Generic Pharma Sector Report Accumulate 314 366

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Date Reports Reco CMP Target

11.08.2010 Piramal Healthcare Q1FY11 Result Update Hold 482 531

02.08.2010 Torrent Pharma Q1FY11 Result Update Buy 565 650

29.07.2010 Sun Pharma Q1FY11 Result Update Hold 1,775 1,866

29.07.2010 Lupin Pharma Q1FY11 Result Update Accumulate 1,920 2,111

Emkay Global Financial Services Ltd.

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Emkay Research 21 September 2010 6