Investors looking for long-term additions to their portfolios can use the ongoing market correction to accumulate Cipla. With an extensive domestic distribution and sales network, regulation-compliant manufacturing facilities and a strong portfolio of generic inhalers, this blue-chip makes for an attractive investment bet at this juncture.

At the current market price of Rs 308, the stock trades at about 20 times its likely FY12 per share earnings. This seems justified considering the company's strong generic pipeline, entry into biosimilars and the likely commercialisation of its CFC-free inhalers which, put together, offer it good long-term growth potential.

The only limiting factors could be the lack of exclusivity revenues and the possibility of continued margin pressure from increased overheads (new facility at Indore SEZ). These, again, only pose temporary constraints, as the Indore facility is expected to become a significant revenue contributor by the end of FY12. In the meantime, positive developments in forging supply agreements with MNC pharma majors, could be a trigger for stock price appreciation.

Long-term triggers

Cipla has up its sleeve many niche growth opportunities. For one, it is developing eight CFC-free inhalers for the US and European markets. While these have to pass through the regulatory litmus test (it expects regulatory approval for its first combination inhaler in key EU markets by FY12-13), the management hopes to launch the inhalers in Europe in the next three-four years.

These products present a high-margin growth opportunity as only a handful of players are expected in each product category. It has already launched some of its inhalers (Salbutamol and Budesonide) in the UK, Spain and Portugal. It has also commenced supplies of Seroflo inhalers in South Africa and expects to do the same in Russia over the next few quarters. Though a big opportunity, it may take a while before it begins to enjoy the revenues from it.

Second, the setting up of the new SEZ facility at Indore, Madhya Pradesh, too is expected to aid the company's exports further. The facility, so far, has only added to its cost overheads, with staff costs and depreciation eating into the company's margins in the just-ended quarter. This, however, is expected to change in the coming quarters, as the facility has received approvals from the UK's MHRA, the WHO and the South African and Australian regulatory bodies.

Cipla will now start utilising the facility to cater to these markets immediately. It can also shift the manufacturing of some of its existing products to this facility. Approval from the US FDA, however, will be the real game-changer. Increasing utilisation of the facility would release the pressure on its margins too. The management expects the facility to contribute to about 10 per cent of its sales by the fourth quarter of next year.

A strong domestic sales network, entrenched presence in inhalers and in acute and chronic therapies also add to its strengths. The likely launch of its first biosimilar by late 2011 or early 2102 will be another growth trigger. Cipla recently made an entry into the biotechnology space, by investing about $65 million (staggered over three years) in two ventures, one in India and the other with China's Desano Group.

Earnings scorecard

For the nine months ended December 2010, Cipla reported 11.6 per cent growth in revenues. While the domestic business grew by about 11.5 per cent, exports (including formulations and APIs) registered a growth of 11.3 per cent. Fall in high-margin tech fees and increased costs due to the commissioning of the Indore facility dented margins. Operating profit margins at 22.3 per cent contracted by 3.6 percentage points. As a result, profits fell by about 7 per cent.

While this may leave the company's FY11 numbers somewhat capped, it is the growth potential over the next few years that beckons attention. Delay in US FDA approval and unanticipated regulatory hurdles for its combination inhalers pose a risk to our recommendation.

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