July 17, 2009 | Pharmaceuticals

July 17, 2009 | Pharmaceuticals

Initiating Coverage

Current Price Rs 1221 Potential upside 10 %

Sun Pharmaceuticals (SUNPHA) In the pit stop…

Target Price Rs 1344 Time Frame 12-15 months

PERFORMER

ƒ Clean & debt-free balance sheet with strong fundamentals – a safe bet The balance sheet of SPIL carries almost zero debt. Moreover, SPIL has robust return ratios despite expanding balance sheet, which indicates that the reinvestment of incremental cash flows is generating better return. A debt-free balance sheet with strong fundamentals provides a safe investment bet in the volatile markets

Valuations SPIL has consistently outperformed most industry peers on parameters such as revenue growth, export growth and margins. Given strong formulation focus on chronic ailments, cost containment and robust pipeline for US generics, we believe the stock is well on track for long-term secular growth. Exclusivity opportunities in the US may bring mid-way spikes. Moreover, a cash balance of US$550 million enhances the chances of SPIL’s participation in the global consolidation wave. We estimate the fair value of SPIL to be in the range of Rs 1344, ~10% higher than CMP. We are initiating coverage on SPIL with a PEFORMER rating.

EPS (Rs)

120

4000

80

2000

40

FY11E

0 FY10E

0 FY09

SPIL generates one of the highest EBITDA margins (GC ~70-75%) in the industry. This is on account of its strong foothold in niche therapies such as CNS, CVS, diabetes, etc, which contribute ~75-80% of its domestic formulations revenue

Sales (Rs cr)

6000

FY08

ƒ Strong foothold in domestic chronic segment earns highest margins

Sales & EPS trend

FY07

SPIL’s US strategy places the company among one of the highest margin earners in the industry. We estimate SPIL’s US revenue to degrow ~27% on account of recent seizure of 33 Caraco products. However, speedy approval from its portfolio of 108 ANDAs (mostly differentiated ANDAs) pending approval will likely cushion steeper fall in US revenues (we have not factored such revenue in our estimates). Such approvals will likely help maintain margins and US revenue

Raghvendra Kumar [email protected] Ashish Thavkar [email protected]

FY06

ƒ Selective strategy for regulated markets prevents margin contraction

Analysts’ Name

FY05

Sun Pharma (SPIL) is a leading player in the Indian pharma space. Strong focus on cost control, impressive pipeline for the US, strong foothold in domestic markets and a clean & strong balance sheet are the major investment planks of SPIL. We also like its strategy of buying distressed assets and turning it around via strong management bandwidth. We are initiating coverage on SPIL with a PERFORMER rating.

Stock Metrics Bloomberg Code Face Value (Rs) Promoter holding (%) Market Cap (Rs Cr) 52W - H/L Sensex Average Volume

SUNP@IN 5.0 63.7 25,289 1600/953 14253 48,321

Comparative return metrics 3M 14.1 46.1 47.4 -1.7

Cipla Dr Reddy Piramal Heathcare Sun Pharma

6M 49.5 71.7 45.8 10.2

12M 30.4 21.4 7.0 -6.6

zzStock price movement 1800

Exhibit 1: Key Financials Year to March 31 Net Sales Net Profit (Rs crore) Shares in issue (Crore) EPS (Rs) % Growth PE (x) Price / Book (x) EV/EBITDA (x) RoE (%) RoCE (%)

Rs Crore FY07 2135.9 784.3 19.3 40.6 31.5 32.1 4.5 36.9 28.3 21.1

FY08 3356.7 1487.1 20.7 71.8 77.0 17.0 2.5 15.4 29.8 30.4

FY09A 4271.4 1824.1 20.7 88.1 22.7 13.9 1.9 13.5 28.1 28.2

FY10E 4108.7 1698.8 20.7 82.0 -6.9 14.9 1.6 14.2 21.6 21.9

FY11E 4426.9 1733.4 20.7 83.7 2.0 14.6 1.4 13.8 18.6 18.9

Target Price

1500 1200

Absolute buy

900 600 300 0

Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09

Source: Company, ICICIdirect.com Research ICICIdirect | Equity Research

1 | Page

Company Background Promoted by Dilip Shanghvi, Sun Pharmaceuticals (SPIL) was formed as a partnership firm in 1982 to manufacture drugs at Vapi in Gujarat. It was incorporated as a limited company in 1993 and renamed as Sun Pharmaceutical Industries Ltd.

Shareholding pattern (Q4FY09) Shareholder Indian Promoters Financial Institutions / Banks Foreign Institutional Investors MFs/Insurance Companies Non-promoters(non-institution)

% holding 63.7 3.1 17.1 4.3 11.8

Business profile SPIL is primarily engaged in the formulation business. The key therapeutic segments of the company in the formulation business in India are CNS, gastrointestinal (GI) and cardiac care. The company also has a presence in antidiabetics, orthopaedics, paediatrics, oncology and ophthalmology. Domestic revenue contributes ~45% to the overall FY09 revenue of the company.

Manufacturing and R&D facilities The company has 17 drug manufacturing plants, seven of which are API plants while the remaining 10 are formulation ones. The company’s API plants at Ahmednagar and Panoli enjoy USFDA and UKMHRA regulatory approval. On the US generic front, between Sun Pharma and all subsidiaries the company had a stock of 71 ANDA approvals until March 2009. The company filed 37 ANDAs in 2008-09. The company has a cumulative 129 DMF filings until March 2009.

100 80

63.7

63.7

63.7

63.7

60 40

25.3

25.0

25.1

24.5

20 0 Q2FY09

Promoters (%)

Q3FY09

Q4FY09

Q1FY10

Institutional Holding (%)

The erstwhile TDPL division was renamed Spectra while a new division, Arian, targeting cardiologists/physicians and diabetologists was launched during 2001. The formulation site in Halol, India (the erstwhile MJ Pharma site) received approval from USFDA, UKMHRA, South African MCC, Brazilian ANVISA and Columbian INVIMA. In the same year 2004, the first joint venture manufacturing unit in Dhaka, Bangladesh was commissioned.

Market position in domestic formulations market

Sun Pharma maintained its sixth position in the domestic formulation market with a market share of 3.46% in December 2008. The company has about 507 brands and 14 of its brands were among list of the top 300 industry brands. The leading brands are Glucored, Pantocid, Susten Aztor, and Monotrate. CNS, cardiac and anti-diabetic are the top three therapeutic categories for SPIL contributing ~61% to the total revenues. In branded markets, SPIL’s products are prescribed in chronic therapies like CVS, psychiatry, neurology, gastroenterology, diabetology and respiratory. It makes speciality formulations across a range of dosage forms, viz., oral, injectable and delivery based system. Sun Pharma began international acquisitions during 1997.

Acquisitions SPIL has a vast history of acquisitions. It took stake in MJ Pharma, which has several manufacturing lines for fixed dosage formulation and UKMHRA approved manufacturing line for Cephalexin capsules. SPIL acquired TDPL (which has extensive product offering in therapies such as oncology, fertility, anaesthetics and pain management), brands in respiratory and asthma therapy area from Natco Pharma, Cephalexin API manufacturer and Gujarat Lyka Organics. Moreover, SPIL acquired common stocks and options from two large shareholders of Caraco, thereby increasing its stake to more than 60% from 44% at a total outlay of ~$42 million. In May 2007, SPIL signed a definitive agreement to acquire Taro Pharma, an MNC generic manufacturer with established subsidiaries and manufacturing across the US, Israel and Canada for $454 million.

2 | Page

Exhibit 1: Major acquisitions done by SPIL Acquired Entity Name Year MJ Pharma Ltd Equity stake 1996. Merged with Sun Pharma in 2003

Benefit MJ Pharma had USFDA approval for Cephalexin capsules and UKMHRA approvals for oral dosage form. Sun upgraded the plant across dosage form lines (sterile dry powder injections, small volume injections, nasal sprays, tablets, capsules, soft gelatin caps, aerosols, ophthalmics). This site now has seven manufacturing lines spread over 36,000 sqft Tamil Nadu Dadha 1997 Enabled a quick entry into high-growth therapy areas of interest: fertility, anticancer, anaesthesiology, Pharma gynaecology, pain management. Trusted brands, processes for difficult-to-make oncology products such as Cisplatin and Carboplatin, and a field force with existing relationships were advantages. In the subsequent years, this portfolio was totally revamped to bring new products to market, doctor coverage was improved, and a swift increase in customer rankings was seen. The company revamped the product list with new products based on complex technologies, like Susten and Lupride, to earn the trust of doctors in India and world markets Caraco Pharma Iniital stake 1997. Sun increased its stake in Caraco from 49% to 63% in FY04. Current stake stands at ~76% on a diluted Larger stake basis. With this Sun got an access to the front end in the US. The US generic opportunity is immense, buyout in 2004 with products worth $40 billion likely to go off patent in the next few years Gujarat Lyka Organics 1999 The manufacturing site for Cephalexin and 7 ADCA actives has since been converted into a ISO 9002 certified, intermediates and API manufacturing site for India and traditional markets Brands from Natco Pharma

1998

A basket of brands in the respiratory/chest therapy area and brands in gastroenterology, orthopedics, anti-infectives and pediatrics were acquired. In line with the company's strategy of reorienting brands so that they can offer the best value. These brands were shifted into different divisions, doctor calllists were reworked and new products added backed by strong promotional programmes

Milmet Labs

1999

Pradeep Drug Co

2000

Milmet's presence in ophthalmology with well-trusted brands like Viscomet (used in major eye surgeries) and Timolet (for glaucoma) made it an attractive acquisition candidate. New products were brought in, several of which used complex delivery technologies such as gel forming systems. The portfolio was revamped and coverage improved for a move in rankings to No. 1 based on prescription share with this high-growth specialist group This WHO cGMP approved API manufacturing site for India and neighbouring markets was upgraded and has subsequently received ISO 9002 and 14001 certification Phlox manufactures cephalosporins and has a European Drug Master File for cefuroxime axetil. This acquisition is an attractive proposition as a result of the international approval and the plant's compliance with international regulatory standards. The acquisition gave Sun Pharma a quick entry into the market. Additionally, the company has a number of products that were scaled up at the facility

Phlox Pharma

Women's First Healthcare

2004

Acquired three brands : gynaecological Ortho-Est® (estropipate), and the antimigraine preparation Midrin® for less then $4 million. This was Sun's first step in the branded generic space in the US at a reasonable cost

ICN, Hungary

2005

Able Labs

2005

Sun bought a plant in Hungary (known as Alkoladia). It was one of the few sites globally that had an authorisation to make controlled substances APIs. This has helped Sun to make filings in the controlled substances space in developed markets Dosage form manufacturing facilities spanning 2,50,000 sq ft with specifically designed areas to handle the manufacture of controlled substance dosage forms, were acquired for $23.15 million, from the US Bankruptcy Court of the District of New Jersey. This deal also includes the rights to product dossiers that were being marketed by Able

Chattem Chemicals

2008

Sun along with its subsidiaries, acquired 100% ownership of Chattem Chemicals, Inc.,a narcotic raw material importer and manufacturer of controlled substances with a facility in Tennessee. With this acquisition, it has been possible for Sun Pharma to augment its preseence in controlled substances. Chattem is a US registered palyer for narcotic importer and producer. This has helped Sun Pharma to be more active in the pain management segment in the US

Source: Company, ICICIdirect.com Research

3 | Page

Restructuring During 2006, the company announced a de-merger of the innovative business and completed the de-merger in 2007. SPARC Ltd, the new company, was listed on the stock exchanges in India, the first pure research company to be so listed. Exhibit 2: SPIL’s business model BUSINESS

INDIA

DISTRIBUTION

OWN

CARACO PHARMA SUN PHARMA BUSINESS MODEL

COMMENTS

Focus on chronic therapies Fastest growing Indian Pharma company

stake in caraco 72% Turned around the operations Markets own as well as Sun Pharma's products

US GENERICS OWN

Rest of World (RoW)

PARTNERSHIP/OWN

Marketing/ ANDA Filings

Replicating India strategy Focussing on chronic therapies

Source: Company, ICICIdirect.com Research

4 | Page

Exhibit 3: Revenue break-up for FY08-09 SUN PHARMA (FY09) Rev: Rs 4374.1 crores Rev contribution: 100%

FORMULATIONS

API (BULK) + OTHERS

Rev: Rs 3885.1 crores Rev contribution: 88.8%

DOMESTIC MARKET Rev: Rs 1959.7 crores Rev contribution: 50.4%

Rev: Rs 487.9 crores Rev contribution: 11.2%

EXPORT MARKET Rev: Rs 1925.4 crores Rev contribution: 49.6%

CHRONIC SEGMENT

US MARKET

Rev: Rs 1371.8 crores Rev contribution: 66.4%

Rev: Rs 1589.5 crores Rev contribution: 83.0%

ACUTE SEGMENT

NON-US MARKET

Rev: Rs 587.9 crores Rev contribution: 33.6%

Rev: Rs 335.9 crores Rev contribution: 17.4%

DOMESTIC MARKET Rev: Rs 104.2 crores Rev contribution: 21.4%

EXPORT MARKET Rev: Rs 379.6 crores Rev contribution: 77.8%

Source: Company, ICICIdirect.com Research

5 | Page

Investment rationale SPIL has been one of the best performers in the Indian pharma space during the last few years on account of its superior product mix. The company differentiates itself from most of its Indian peers on account of its strong foothold in niche therapies in the domestic market, robust product pipeline in the US markets and cost leadership. Thereby, it generates one of the best EBITDA margins in the Indian pharma space. Recent ‘at risk’ launch of generics pantoprazole (Protonix) and exclusivity on generics Ethyol and Trileptal led SPIL to achieve lifetime growth in the US business.

Strong foothold in niche therapies, robust pipeline of filings for US markets, superior product mix and lean cost structure makes Sun one of the best performers in the Indian pharma space

However, SPIL suffered a setback on the Effexor XR opportunity. We believe its formidable market share in niche therapies in domestic markets and strong pipeline of 108 pending ANDA approvals in the US market will keep its growth momentum upbeat in the longer run. Recent seizure of 33 drugs by USFDA from Caraco’s Michigan facility will hamper the revenue flow from the US market. We estimate the base US business (other than exclusivity opportunity on Ethyol, Protonix & Trileptal) will likely significantly de-grow at a CAGR of 30% over FY09-11E on account of the seizure from Caraco’s plant. The Lexapro opportunity may provide some respite.

Lexapro opportunity may provide respite Recently, SPIL entered into a litigation settlement with Forest Lab regarding Lexapro, which is a blockbuster anti-depressant drug with annual sales of US$2.3 billion on innovator price. The settlement may bring positives to SPIL but the USFDA issues with Caraco may cast cloud over this opportunity. The major contours of SPIL (along with Caraco) - Forest Labs agreement regarding the settlement of the legal proceedings related to Lexapro (escitalopram oxalate) tablets are: •

SPIL will license out to Lundbeck certain patent applications related to the synthesis of escitalopram and citalopram in exchange for an upfront payment. If such technology is used SPIL will also get royalties on sales.

Sun will benefit from out-licensing income and royalties on sales

Comment: SPIL may get out-licensing income on licensing out the technology and also royalties on sales, if the transferred technology is utilised for manufacturing of the drug •

Forest will provide licenses to Caraco for any patents related to Lexapro and with respect to the marketing of Caraco’s generic version of the product. This will happen as of the date that any third party generic that has received final approval from the FDA enters the market other than an authorised generic (AG) or the first filer.

Caraco’s entry into the Lexapro market will be triggered by the entry of another generic after the FTF holder and it’s authorized generic

Comment: Caraco gets litigation risk-free rights to sell generics version of Lexapro, if any third party (having approval from USFDA) enters the Lexapro market other than the first filer or the authorised generics (AG). This will enable Caraco to enter the markets as a fourth generic player after the FTF opportunity holder, AG and any third party entering the market triggering entry of Caraco.

6 | Page

•

Caraco will take over the commercialisation and sale of several other products from Forest’s Inwood business in return for royalty payment on the sales of these products. Comment: Caraco would get rights to commercialise various products of Forest in the US markets, on which Caraco will pay royalties on sales of these products.

Caraco will also undertake commercialisation and sale of several products from Inwood Labs product basket

Exhibit 4: Inwood Labs Product List Category Depression Angina Angina Hypertension Asthma Asthma Cough Suppression

Brand Celexa® Tiazac® Isochron™ Tiazac® Theochron™ TheoCap™ Tessalon®

Generic Citalopram HBr Diltiazem HCl Isosorbide Dinitrate Diltiazem HCl Theophylline Tablets Theophylline Capsules Benzonatate

Source: Company, ICICIdirect.com Research

•

Forest will reimburse Caraco for a portion of their costs related to this litigation. Comment: The reimbursement of the certain part of the litigation cost will likely to improve cash flow slightly.

US generics – key to drive exports revenue In a quest to excel in the export market and generate higher margins, SPIL accorded top priority to the US markets. SPIL follows a different strategy in the US market, which gives it stability in earnings. The major contours of the strategy are: •

SPIL enters a product wherein it can remain competitive for a longer period

•

SPIL prefers to enter into the market of a product, which is difficult to manufacture

•

SPIL selects products, which includes filings with Para-IV certification, complex products, controlled substances, extended release products, blockbusters and some plain vanilla ANDA on old molecules. The clever blend of the filings provides stability to the earnings

•

Moreover, SPIL follows a multi-pronged strategy in the US markets

This strategy seems to fetch SPIL one of the best margins on generics in the US. We believe US revenues will de-grow ~27% on account of recent actions by the USFDA on the company’s US subsidiary. This will hamper the revenue flow from key US market. However, speedy approval from its portfolio of 108 ANDAs (~20-25% differentiated ANDAs) pending approval, including seven tentative approvals, and few filings under ParaIV will likely act as a cushion for the company. The US fixed dosage business is one of the significant growth drivers of SPIL’s overall business

SPIL follows a multi-pronged strategy in the US markets wherein it targets difficult to manufacture products through a blend of superior product filings

A 27% de-growth in revenues from the US market will be cushioned by speedy approvals of 108 pending ANDA approvals

7 | Page

while the US fixed dosage business per se is dependent upon the composition of (ANDA) filings for the market. Filing under exclusivity provide for the best revenue and profits growth as there is almost nil generics competition while technologically differentiated products generate better and sustainable margins due to limited competition. Plain vanilla products have highest competition and the margins are not very high. A major risk in the US markets arises from price erosion once the patent on a product expires. However, SPIL has an edge over other Indian players because of its front-end Caraco (which has a presence in the US market) and backward integration into own bulk for many of its products.

8 | Page

US revenue will likely de-grow at 27% CAGR through FY09-11E We believe the US continuing business revenue will likely de-grow at a CAGR of ~27% to ~US$180 million on account of recent actions by the USFDA at the Caraco’s Michigan facility and generics competition on generics pantoprazole. In the short-to-medium term (until July 2010), new approvals and contribution from generic pentoprazole will likely prevent a steep deterioration in US sales. SPIL is still in the generic pentoprazole (Protonix) market. However, it is selling at a certain price point without diluting the price. We estimate the base US business (other than exclusivity & generics pantoprazole sales) of SPIL to de-grow at ~31% CAGR over FY09-11E and revenue from generics pantoprazole (protonix) to decline by ~22% CAGR over FY09-11E.

Recent USFDA action at Caraco’s Michigan facility will likely cause fall in revenues by ~27% to US$ 180 million. However, in the short to medium term new approvals and enhanced product filings will prevent a steep deterioration in US revenues.

Exhibit 5: US base business will likely de-grow at ~31% CAGR over FY09-11E 850.7

900 800

724.1

700 600

511.1

500 343.2

400

399.2

300 200 100 0 FY07

FY08

FY09

FY10E

FY11E

US (base business) Source: Company, ICICIdirect.com Research

Protonix (Generics Pentaprazole) – A brief background Protonix (generic name Pantoprazole) is a heartburn proprietary drug of Wyeth. It prevents the production of acid in the stomach. It is used to treat gastroesophageal reflux disease (GERD) and inflammation of the oesophagus. Protonix is Wyeth’s drug with annual sales revenues of US$2.3 billion in the US at innovator price. In September 2007, SPIL’s ANDA with Para IV certification got USFDA approval with few other players such as Israeli player Teva. Out of the companies that got approval, Teva launched the generic version of the drug in December 2007. On January 29, 2008, Wyeth launched the generic version of Protonix by authorising Prasco Labs of the US. Following this authorised generic launch by Wyeth, SPIL launched the generic Protonix at risk on January 29, 2008.

Protonix Statistics: Developer: Atlanta US development & marketing rights: Wyeth Annual Sales: ~ US$ 2.3 bn Patent expiry: July 19, 2010 Generic Launch: Teva (22nd Dec 2007) Authorized generic: Prasco (29th Jan 2008) At risk Generics launch by Sun Pharma (30th Jan 2008)

Generic Pentaprazole – a lifetime opportunity for SPIL Generic Pentaprazole (Protonix) is probably the largest-ever product in terms of revenue and profit launched by any Indian pharma company in the US. SPIL launched generic Protonix at risk on January 29, 2008 after Teva & Wyeth’s authorised generics Prasco. We believe the company clocked revenues of ~US$300 million at a gross margin of ~90% till date from generics pantoprazole. We believe SPIL earned exceptionally good EBITDA margin of 75-85% on it. Further, we believe SPIL is still in the US market with generic pantoprazole but selling at a certain price point without diluting the overall price of the product. We believe SPIL may rake in ~US$120-150 million in the topline until protonix goes off patent in July 2010. Also, we believe the competition in the generics

We believe SPIL clocked estimated revenues of ~US$300 million till date from Protonix at gross margin of ~90% and estimated EBITDA margin of ~7585%. Sun may rake in ~US$120150 million in revenues till the time Protonix patent expires

9 | Page

pantoprazole market is low with around three to four players – innovator Wyeth, authorised generics Prasco, Teva & SPIL. Kudco is another generics company, which filed ANDA for pantoprazole. With its 30-month stay becoming complete in December 2008, it has probably not entered the market. Kudco is also SPIL’s potential competitor. It has Para IV ANDA whose 30-month stay expired in December 2008.

Lower claim probability on SPIL in Protonix issue Teva launched generic Protonix in December 2007. Thereby, it became the first generic company to dilute the price. This may trigger triple damage claims on the quantity on launch. Just to put a check on the quantity exposed for potential triple damage control, we believe Teva is unlikely to re-launch the product in the US once the inventory in the market is depleted. However, it is not known whether Teva is there in the market or not. If Teva is not in the market, it is a positive for SPIL as it would be the only generic company in the market. Also, if Wyeth goes for damage claims on SPIL, it is likely to be a single damage claim.

In case of patent litigation turning against SPIL, probable damage claim on Sun will likely be lesser

Effexor XR – a lost opportunity SPIL received a ‘not to sue’ covenant from Wyeth over SPIL’s ANDA for generic venlafaxine extended release (generic version of Effexor XR) with multiple Para IV certifications in October 2007. The three strengths (for which ANDA has been approved) have annual sales of ~US$2.6 billion in the US. In April 2007, Wyeth filed suit against Osmotica Pharma of US for 505b (2) application filed by Osmotica for generic tablet version of Effexor XR. However, later they settled the patent litigation, wherein Wyeth granted Osmotica a royalty-bearing licence. Osmotica got an approval in May 2008.

Sun Pharma lost the opportunity to market Effexor XR after Osmotica filed for citizen’s petition requesting the USFDA to make all the subsequent filers to resubmit their application with Osmotica’s product as the Reference Listed Drug (RLD)

Moreover, Teva settled the patent litigation with Wyeth and will launch generic Effexor XR capsules in July 2010. Subsequently, Osmotica filed a citizen’s petition in May 2008, requesting the USFDA to ask all subsequent filers for the generic tablet version of Effexor XR to resubmit their ANDA applications with its drug being the reference listed drug (RLD) as its product is NDA. Responding to the citizen’s petition, USFDA granted CP to Osmotica. Thereby, it has not given approval to SPIL’s generic tablet version of EffexorXR (venlafaxine extended release) capsules. Post this development, SPIL needed to re-file the ANDA using Osmotica’s venlafaxine extended release tablets as the RLD. SPIL has filed for the ANDA for Effexor XR with Osmotica’s drug as RLD. It expects to launch the drug on approval. If it is successful in launching the drug by the end of CY09, then SPIL will benefit from the exclusive marketing of Effexor XR until July 2010, when Teva is expected to launch the drug.

10 | Page

Robust pipeline of filings – key to US revenue growth SPIL, along with Caraco, has ~108 ANDAs (which includes seven tentative approvals and some filings with Para-IV certification) pending approvals. Approvals will likely be significant growth drivers for the topline & bottomline and to maintain margins. The growth will likely be fuelled on account of the company’s focus on filing for technologically differentiated products such as new drug delivery systems, extended releases, controlled substances, filings with para IV certification, etc. We believe currently differentiated ANDAs account for 20-25% of the filings.

Sun Pharma’s robust R&D pipeline of 108 pending ANDA approvals will be the key growth driver for the US business.

Exhibit 6: ANDA pipeline 200

170

160

142

120 80 40

103

94 59

48

53

15

20

2005 Mar

2006 Mar

29

0 2007 Mar

Cummulative product filings

2008 Mar

2008 Dec

Cummulative product approvals

Source: Company, ICICIdirect.com Research

We believe while product sales under exclusivity (with FTF opportunity) will likely bring midterm spikes in the performance, the filings under new drug delivery systems (NDDS), extended releases, or controlled substances, etc. will likely provide for a sustainable medium to long term growth. It will also prevent margins erosion on account of less competition in differentiated products. We believe SPIL has an edge over its Indian peers because of its frontend Caraco and backward integration into own APIs for many of its products. For the US markets, SPIL selects products, which includes filings with Para-IV certification, complex products, extended release products, blockbusters and some plain vanilla ANDA filings on old molecules. The clever blend of the filings provides stability to the earnings. •

The plain vanilla ANDA filings on old molecules gives SPIL a steady stream of revenue for few years, thereby enabling the company to corner decent market share on the product

•

On products under exclusivity period (on filings with Para IV certification), the competition is likely to be low during the exclusivity period (if the company launches the product)

•

For complex molecules such as extended release or controlled substances, there is less competition and price erosion, so the margins and markets are sustainable

11 | Page

Changing business mix – delivers superior margin The product mix and US revenue contribution has a major bearing on the EBITDA margin. Revenue mix from the US has increased to ~36% in FY09 from ~25% in FY04 while the EBITDA margin expanded to ~44% in FY09 from ~31% in FY04, indicating a positive relationship of EBITDA margin with US revenue contribution. However, SPIL has shown significantly higher margins historically. Contribution from exclusivity on Trileptal & Ethyol and at risk launch of generics pantoprazole on January 29, 2008 contributed significantly to the topline & EBITDA margin. Super normal EBITDA margin on products during the exclusivity period lead the overall EBITDA margin to be very high. Post FY09, revenues from the US market will likely decline on account of expiry of exclusivity period, declining contribution from generic pantoprazole and decline in sales revenue of Caraco on account of product withdrawal and USFDA action against its Michigan plant. However, we believe the US strategy of the company of prudent productselection, lean cost structure and strong cash flows to finance the R&D activity for the US business are the three mainstays to manage a robust and consistent growth rate in the US & overall margins.

SPIL’s US strategy of prudent product-mix in the US, lean cost structure and strong cash flows to finance the R&D activity for the US business are the three mainstays to manage a robust and consistent growth rate in the US

Exhibit 7: Changing business mix delivers superior margins 60

US (% contribution)

46.2 45 30 15

30.6

35.2

30.0

31.5

43.6

40.6

43.5

36.9

30

36.3 24.9

0 FY04

6.3 FY05

24.9

22.8

FY06

FY07

45

23.8

18.7

EBITDA %

60

15 0

EBITDA (%)

FY08

FY09

FY10E

FY11E

US (% to total sales)

Source: Company, ICICIdirect.com Research

12 | Page

Domestic market – niche focus, high margins SPIL has superior margins via its strong focus on niche therapies in the domestic market. The extensive product mix and exposure to growing niche therapy areas of cardiovascular (CVS), central nervous system (CNS), gastrointestinal (GI), respiratory, ophthalmology, orthopaedics, etc. enables SPIL to grow faster than the industry growth rate. The company generates ~75-80% of domestic formulation revenues from the niche therapies. During FY09, the domestic formulations business registered a healthy growth of 32% vis-à-vis industry growth of ~13%. The company has been ranked No. 1 in six specialty therapies. SPIL has demonstrated significantly good results in domestic markets. Its domestic formulations revenue grew at a CAGR of ~28% to Rs 1960 crore over FY04-09. With continued focus on niche therapies and new product launches, we expect SPIL to sustain the domestic growth of ~15% over FY09-FY11E.

Extensive product mix and exposure to growing niche therapy areas lead to ~28% CAGR growth in the domestic business over FY04-09. With continued focus on niche therapies and new product launches, we expect SPIL to sustain the domestic growth of ~15% over FY09-FY11E.

Exhibit 8: Specialty-wise ranking in the domestic market Speciality Psychiatrist Neurologist Cardiologist Opthalmologist Diabetologist Orthopedicians Cgastro-enterologist Nephrologist Oncologist Consulting Physician Chest Physicians Gynaecologist

1998 1 1 5 NA 6 31 6 NA 20 8 16 NA

Current Ranking 1 1 1 1 1 1 2 4 6 5 4 6

Source: Company, ICICIdirect.com Research

30% 20%

8%

7%

6%

Antiasthamatic & Antiallergic

Musculo-skeletol & Pain

Gynaec & Urology

Gastroenterology

0%

Diabetology

2%

4% NeuroPsychiatry

10%

14%

Others

11%

Optholmology

20%

28%

Cardiology

Therapy-wise revenue contribution

Exhibit 9: Therapy-wise revenue contribution

Source: Company, ICICIdirect.com Research

13 | Page

Strong focus on niche therapies SPIL exhibited robust domestic revenue growth on account of its strong focus on chronic therapeutic areas. These require prolonged treatment as the illness tends to be more chronic such as neuropsychiatry, CVS, diabetology, etc. The segment accounts for ~75-80% of SPIL’s domestic formulations revenue. Due to prolonged nature of treatment, we believe the prescription life of the medicine is higher and is not readily changeable. Also, due to company’s ranking over the last five years, the brand value is higher. This will likely help SPIL to maintain superior margin.

A total of 70% of SPIL’s domestic revenues come from high margin chronic segment. We expect this segment to grow at a higher rate of ~21-22%

With rising stress levels, lifestyle changes and rising affluence, we believe chronic therapy areas such as CNS, CVS and diabetes will likely grow faster (~21-22%) than the industry growth rate of 12-13%. Historically also the chronic segment has grown faster than the acute segment due to changes in lifestyle. SPIL generates ~15% of its revenue from specialty segments of ophthalmology and diabetology. In this therapeutic segment, it has maintained its top ranking in the industry. Exhibit 10: Break-up of chronic therapies in the domestic market Chronic Therapies CVS 29% Nephro 39%

Opthal 6%

Gynaec 10%

Diabetes 16%

Source: Company, ICICIdirect.com Research

14 | Page

R&D expenditure fetching robust returns SPIL increased its stake from 56.5% to 76% i.e. 19.5% in Caraco via technology transfer (technology developed by SPIL’s R&D) during the last five years. Thereby, the company made expenditure on R&D to the tune of ~Rs 1129 crore. The current market cap of Caraco (Caraco is a listed entity) is ~Rs 765 crore implying that the expenditure on R&D has generated ~Rs 150 crore via stake increase in Caraco and generated EBITDA of ~Rs 1120 crore on sale of products in the US markets developed by the R&D team. Strong organic revenue and profit growth has enabled SPIL to increase its spending on R&D while maintaining profit margins. SPIL spends ~9% of its annual sales on R&D, which is one of the highest in the Indian pharma space. The R&D of the company is focused on generics research and has developed a number of products ranging from ANDA with Para IV certification to controlled substance and plain vanilla products. In the recent past, a major fillip to its US business was provided by the successful FTF applications (Protonix, Ethyol and Trileptal). During H2FY09, SPIL received four ANDA approvals out of which one is the company’s first controlled substance release.

SPIL’s strong focus on R&D led to successful FTF applications (Protonix, Ethyol and Trileptal). During H2FY09, SPIL received four ANDA approvals which have an estimated market size of US$ 650 million.

Exhibit 11: Increased R&D effort translating into higher product filings 160

142

120

94

80 40

59

53

40

29

20

15

0 FY05

FY06

Cummulative products filed

FY07

FY08

Cummulative products approved

Source: Company, ICICIdirect.com Research

15 | Page

Leanest cost structure SPIL has one of the leanest cost structures in the industry, translating into highest margins and superior RoEs. SPIL’s lean cost structure, strong organic growth and value-accretive acquisitions have enabled it to maintain high return ratios. Average RoE for the last five years has been consistently above 30% despite a worsening environment for global generics and increasing shareholders fund. However, going forward, we expect RoE to decline on expanded balance sheet largely financed via shareholders’ fund.

SPIL has one of the leanest cost structures in the industry, translating into one of the highest margins and superior RoEs

In FY05, Sun issued FCCBs to the tune of US$350 million at an initial conversion rate of Rs 729 per share and at a fixed exchange rate of Rs 45.01 per dollar. During FY08, the entire outstanding FCCBs were converted into equity leading to an increase in shareholders fund. With all the FCCBs getting converted, Sun’s net worth will rise significantly, lowering the reported RoEs. Exhibit 12: Cost comparison Cost Structure

Rs crore Sun Pharma

Cipla

3357.1 722.6

4230.9 2071.6

Net Sales Raw material RM as % to sales Employee cost Emp. Cost as % to sales R&D expenses R&D as % to sales SGA SGA as % to sales Other expenses Other exp as % to sales

DRL Ranbaxy 4991.7 1813.3

6982.2 2721.6

21.5

49.0

36.3

39.0

304.3

255.5

731.1

891.8

9.1

6.0

14.6

12.8

300.1

-

-

428.0

-

874.3

1690.7

17.5

24.2

8.9

290.3

6.1

8.6

188.7

1042.2

734.1

335.3

5.6

24.6

14.7

4.8

Source: Company, ICICIdirect.com Research

16 | Page

A clean balance sheet with strong fundamentals SPIL enjoys a strong balance sheet with over Rs 2000 crore in cash & liquid investments, an important asset in tough business cycles. With huge cash and attractive valuations in the market, we believe SPIL can participate in the consolidation wave in the industry. SPIL’s strategy has always been to focus on acquiring high potential yet underperforming assets and create value out of such buy outs. SPIL has been utilising its strong operating cash flow to step up investments in manufacturing to meet the requirements of rapidly expanding revenues. A significant portion of the fixed asset base expansion is because of the multiple capacity acquisitions Sun has done in the past. Although there has been a rapid expansion in the fixed asset base, fixed asset turnover has improved from 1.6 in FY04 to 3.2 in FY08, signifying rapid upgradation and turning around the acquisitions.

Although there has been a rapid expansion in the fixed asset base, fixed asset turnover has improved from 1.6 in FY04 to 3.2 in FY08, signifying rapid up-gradation and turning around the acquisitions.

Exhibit 13: Improving asset utilisation

892.4

900 613.0

3.2

725.7

600 300

951.4

1035.4

1.6

FY04

FY05

3.0 2.0

2.2 1.6

4.0

1.8

1.0

0

Fixed Asset T/o

Net Fixed Assets (Rs

1200

0.0 FY06

Net Fixed Asset

FY07

FY08

Fixed Asset T/o

Source: Company, ICICIdirect.com Research

17 | Page

Taro acquisition: On May 20 2007, SPIL announced the acquisition of Taro Pharma for US$454 million. The deal was agreed at $7.75 per share implying the equity value of the transaction to be ~$230 million and debt refinance of ~$224 million. The total EV of the transaction works out to ~$454 million. In May 2007, Franklin Advisers and Templeton Assets Management, having beneficial ownership of ~9% in Taro, filed a motion in the court to prevent the proposed merger on the grounds of discrimination against minority shareholders.

Taro – breaching the agreement A year after signing the deal with SPIL, Taro sent a notice to SPIL to terminate the merger agreement on the grounds the price of US$7.75 per share does not reflect the financial turnaround that the company achieved in CY07. However, SPIL claims the turnaround happened on account of the help that SPIL extended to Taro in the form of cash injection of US$60 million. SPIL currently holds a 36% stake in Taro and has the option to buy 5 million shares of promoters at US$7.75 per share. It also has a warrant to buy additional 3.8 million shares at US$6 per share. Exercising all these options may take SPIL’s shareholding in Taro to 52%.

Promoters’ effort to raise the agreed price In June 2008, SPIL exercised the option to acquire the promoters’ share, subsequent to which Taro filed a motion seeking a declaratory judgment on the tender offer in the Tel Aviv court. Responding to the motion the Court ruled in favour of SPIL. Now Taro is appealing to the lower court seeking declaratory judgment on the tender offer in the Israeli Supreme Court. The Supreme Court of Israel will decide whether a tender offer or a special tender offer is required. The Taro promoters may not tender their stake. Hence, SPIL is pleading in the Supreme Court of the state of New York to order the promoters and directors of Taro to honour the promise.

Taro acquisition, an attractive opportunity for value creation If the Taro acquisition happens, it will be EPS accretive in the first year. As per unaudited results, Taro reported profit of US$50 million on sales of US$339 million in CY08 as against a profit of US$29 million on sales of US$315 million in CY07. The acquisition is likely to help SPIL penetrate deeper into the US as Taro gets ~85% revenue from the US. In FY08, SPIL generated ~45% of revenue from the US on account of FTF opportunities and at risk launches. However, we believe that the US revenue contribution should stabilise at ~30-35% (without acquisition of SPIL). On Taro acquisition, US revenues may move up to ~45-50%. If SPIL does not succeed in acquisition of Taro, it should be construed as an opportunity lost rather than a real loss. Exhibit 14: Taro financials (un-audited numbers) Sales EBITDA Net Profit Rs/$ assumed at 47 *includes an investment loss of Rs 82 crore

Rs crore CY07 1471.1 210.5 169.3

CY08 1607.1 278.7 77.6*

YoY Gr. (%) 9.2 32.4 -54.2

Source: Company, ICICIdirect.com Research

18 | Page

Risks & concerns Near-term risks could be in the form of uncertainty surrounding SPIL’s Taro Pharma acquisition, which we believe, will be a long drawn affair unless both parties quickly agree on the issue. During October 2008, Caraco’s Detroit facility was issued a warning letter by USFDA. Although the FDA warning letter would not impact sales of currently marketed products, it would halt any further approval of ANDAs from that facility. If the issue is not resolved quickly, revenues from US would be impacted. Heightened competition in key therapy areas of the domestic market and greater vulnerability to currency fluctuations (with international business now accounting for ~50% sales) remain the key concern. Sun continues to ship generic pantoprazole but in substantially lower quantities. Sun intends to selectively sell pantoprazole with a certain price point and mitigate risk – particularly before potential entry of a generic competitor (UCB) in the near term. The generic pantoprazole was launched at-risk. Hence, Sun may be liable for damage claims.

19 | Page

Financials Organic growth to remain subdued Having grown at a CAGR of ~40% during FY07-09, SPIL’s CAGR is likely to decline on a higher base in the next two years due to loss of exclusivity on some of its products, loss of revenue from the US post USFDA action and increasing competition in at-risk launched pantoprazole (Protonix), which generated estimated revenue of ~US$200 million for SPIL from the day it was launched till date. We estimate the FY09-11E revenue CAGR of 2% at Rs 4427 crore. SPIL has exhibited excellent growth track record in the past on account of extensive product mix in niche therapies and clever product selection for the US market. Higher base and loss revenue from Caraco post USFDA action seems to keep revenue growth flat. Exhibit 15: Net sales to witness flat growth 5000 4500 4000 3500 3000 2500 2000 1500 1000 500 0

SPIL’s FY09-11E CAGR is likely to decline on a higher base in the next two years due to loss of exclusivity on some of its products, loss of revenue from the US post USFDA action and increasing competition in at-risk launched pantoprazole

Rs Crore Organic growth without exlusivity 4426.9 4271.4 4108.7

Marketing exlusivity led growth

3356.7

2135.9 984.7

FY04

1185.3

FY05

1636.8

FY06

FY07

FY08

FY09

FY10E

FY11E

Source: Company, ICICIdirect.com Research

During FY07-09, the net profit of SPIL grew by ~52% to Rs 1824 crore due to super normal margins on product under exclusivity in the US markets and generic Protonix. We believe rising competition on generic Protonix will keep margins under pressure. We estimate net profit will degrow at a CAGR of ~2.5% to Rs 1733 crore over FY09-11E. Exhibit 16: Profits to decline @2.5% CAGR over FY09-11 2000 1800 1600 1400 1200 1000 800 600 400 200 0

Rs Crore 1824.1

1698.8

1733.4

FY10E

FY11E

1487.1

784.3 345.9

404.6

FY04

FY05

573.3

FY06

FY07

FY08

FY09

Source: Company, ICICIdirect.com Research

20 | Page

Margins will likely stabilise in FY11E but remain robust

Given SPIL’s lean cost structure and strong focus on cost control, at risk launch of generics pentoprazole (protonix) and exclusivity on Trileptal and ethyol lead to SPIL’s super normal EBITDA margin in the range of over ~43% during FY08 & 09. We believe SPIL’s EBITDA margin will likely show declining trend over FY09-11E before normalising in FY11E in the range of ~37%. During FY10E, we believe the EBITDA margin will likely be in the range of ~40% as SPIL is still marketing generics pentoprazole at certain price level with very few competitors. This will likely keep margins higher. In FY11E, we have assumed the margins will normalise in the range of ~3640% on account of better product mix and higher contribution from controlled substances from US markets.

We believe SPIL’s EBITDA margin will likely show declining trend over FY0911E before normalising in FY11E in the range of ~37%

SPIL is likely to maintain its operating margin at over ~37% in the longer run on account of its strategy of remaining focused on technologically difficult products for the US markets, superior product mix in niche therapy areas in domestic markets and lean cost structure. We believe increase in SPIL’s revenue from core generic business of US would also help in keeping margins high. Exhibit 17: Operating and net profit margins to stabilise

NPM, OPM (%)

50% 40% 30% 20% 10% 0% FY04

FY05

FY06

FY07 EBITDA (%)

FY08

FY09

FY10E

FY11E

NPM (%)

Source: Company, ICICIdirect.com Research

21 | Page

Return ratios – to stabilise after a spike Given strong cost discipline, robust organic growth and value-accretive acquisitions, SPIL has maintained better return ratios. However, over the last five years, the RoNW & RoCE has shown a declining trend due to increasing balance sheet size, mostly financed by reserves. Exhibit 18: Return ratios to stabilise 40%

Over the last five years, the RoNW & RoCE has shown a declining trend due to increasing balance sheet size, mostly financed by reserves.

40%

ROCE & RoNW stabilizing after a fall

30%

30%

20%

20%

10%

10% 0%

0% FY '04

FY '05

FY '06

FY '07E

RONW

FY '08E

FY09E

FY10E

FY11E

ROCE

Source: Company, ICICIdirect.com Research

Exhibit 19: Balance sheet size expanding at 33% CAGR with net worth at 42% over FY04-11E 12000

Expanding balance sheet largely financed by reserves

10000 8000 6000 4000 2000 0 FY '04

FY '05

FY '06

FY '07E Networth

FY '08

FY '09E

FY10E

FY11E

BS Total

Source: Company, ICICIdirect.com Research

Exhibit 20: Du -Pont ratio analysis ROE (%) PAT/PBT PBT/PBIT PBIT/Sales Sales/Assets Assets/Equity

FY04 43.2 0.9 1.0 0.4 0.5 1.1

FY05 35.8 0.9 1.0 0.4 0.5 1.1

FY06 36.1 0.9 1.0 0.5 0.6 1.1

FY07 28.3 0.9 1.0 0.5 0.6 1.1

FY08 29.8 0.9 1.0 0.4 0.5 1.5

FY09E 28.1 1.0 1.0 0.4 0.5 2.3

FY10E 21.6 1.0 1.0 0.4 0.4 2.7

Source: Company, ICICIdirect.com Research

22 | Page

FY11E 18.6 0.9 1.0 0.4 0.8 1.6

Rising RoIC – indicating superior re-investment rate Following the trend of RoNW & RoCE, RoIC is likely to show an increasing trend from FY10E onwards. Looking at the historical trend, RoIC increased suddenly during FY08. During the period between FY04 and FY07, the RoIC declined from ~39% to ~27% and later peaked in FY08 at ~53% due to supernormal returns from generic Pentoprazole, Ethyol and Trileptal. Continued return from generic Pentoprazole in FY09 is likely to keep RoIC at higher levels. As Pentoprazole is going off patent in July 2010, we expect a sudden decline from pentoprazole revenue to impact return ratios. In FY11E, we expect technologically differentiated molecules to generate higher revenues in US markets post ANDA approval over FY10. This would likely improve the RoIC in FY11E. With increasing RoIC and incremental cash flows being reinvested at higher rates (at the rate of RoIC), we can expect healthy cash flows in future years.

Continued return from generic Pantoprazole in FY09 is likely to keep RoIC at higher levels. Sudden decline from pantoprazole revenue will impact return ratios post patent expiry on it in July 2010

Exhibit 21: Return on invested capital to stabilise after spike in FY08 60%

53.1% 47.5%

50% 40%

40.4%

39.5% 37.0% 30.0%

30%

26.9%

37.6%

ROIC likely to increase after a slight decline over FY08 to FY09E

20% 10% 0% FY '04

FY '05

FY '06

FY '07E

FY '08E

FY09E

FY10E

FY11E

Source: Company, ICICIdirect.com Research

23 | Page

Valuations SPIL has been one of the best performers in the Indian pharma space on account of extensive and superior product mix. The company differentiates itself from most of its Indian peers on account of strong foothold in niche therapies in Indian markets, robust pipeline of products in the US markets and cost leadership, thereby generating one of the best EBITDA margins in the Indian pharma space. Recent ‘at risk’ launch of generic pantoprazole and exclusivity on Ethyol and Trileptal lead it to achieve lifetime growth rate in the US. However, SPIL suffered a setback on its Effexor XR opportunity. We believe its formidable market share in niche therapies in domestic markets and strong pipeline of 108 pending ANDAs approvals in the US market will likely keep its growth momentum upbeat. SPIL accorded top priority to the US markets to excel in the exports market and follows a differentiated strategy in US markets, which generates stabile earnings. We believe US revenues will likely de-grow ~27% due to recent USFDA actions on the Caraco’s Michigan facility. However, speedy approval from its portfolio of 108 ANDAs (~20-25% differentiated ANDAs) pending approval will likely protect further deterioration of US revenues. SPIL has an edge over other Indian players because of its front-end Caraco and backward integration into own bulk for many of its products. In the domestic market, SPIL generates superior margins via its strong focus on niche therapies. The extensive product mix and exposure to growing niche therapy areas of CVS, CNS, GI, respiratory, ophthalmology, orthopaedics, etc. will likely lead SPIL to grow faster than the industry growth rate. The company generates ~75-80% of domestic revenue from niche therapies. During FY08-09, the domestic formulations business registered a healthy growth of 33% vis-à-vis industry growth of ~13% while the domestic formulations revenue growth was at a CAGR of ~25% to Rs 1565 crore over FY04-09. With continued focus on niche therapies and new product launches, we expect SPIL to sustain the domestic growth of ~15% over FY09-FY11E. Moreover, the company has a long history of acquisitions. The company is currently making efforts to acquire Israel based Taro Pharma. If the Taro acquisition happens, it will be EPS accretive in the first year. Taro reported unaudited profit of US$50 million on the sales of US$339 million in CY08 as against a profit of US$29 million on sales of US$315 million in CY07. The acquisition is likely to help SPIL to penetrate deeper into the US as Taro gets ~85% revenue from the US. In FY08, SPIL generated ~45% of revenue from the US on account of FTF opportunities and at risk launches. However, we believe the US revenue contribution should stabilise at ~30-35% (standalone SPIL). On the Taro acquisition, US revenues may move up to ~45-50%.

With continued focus on niche therapies and new product launches, we expect SPIL to sustain the domestic growth of ~15% over FY09-FY11E

On the Taro acquisition, US revenues may move up to ~45-50%

24 | Page

Is the high P/E viable? •

SPIL generates a very strong EBITDA margin, which is probably one of India’s best margins. Superior product mix gives better visibility on the earnings

•

Neat and clean balance sheet with almost nil debt on the books reduces risk

•

Strong fundamentals and better return ratios augur well

•

SPIL has been one of the best performers in the Indian pharma space during the last few years on account of extensive and superior product mix

•

If the Taro acquisition happens, it will be EPS accretive in the first year. Taro reported unaudited profit of US$50 million on the sales of US$339 million in CY08 as against a profit of US$29 million on sales of US$315 million in CY07. The acquisition will lead SPIL to penetrate deeper into the US market

•

SPIL has a very strong pipeline of filings for the US market, which may again generate some interesting launch

•

SPIL has a superior and extensive product line in the niche chronic therapy areas in the domestic market, which generate consistent and better revenue and margin

•

Lesser competition in the SPIL’s niche chronic therapy areas gives better earning visibility

•

SPIL invests aggressively in building a strong proprietary product pipeline for the US market. It has demonstrated this by making R&D expenditure of ~9% of sales

We believe SPIL deserves a premium over other players in terms of target PE, as we believe: 1) There is better visibility on revenues and earnings momentum 2) The company can maintain its margin due to its superior product mix in the domestic market and robust pipeline for the US market 3) Lower risk due to strong fundamentals, almost debt free and clean balance sheet 4) Better RoIC, indicating higher reinvestment rate

25 | Page

We estimate the fair value of SPIL to be in the range of Rs 1344 (16x FY11E EPS), ~10% higher than CMP. We are initiating coverage on SPIL with a PERFORMER rating. Exhibit 22: P/E band

Exhibit 23: EV to EBITDA band 18x

1500

16x

1200

12x

900

40000 20x

32000

16x

24000

8x

12x

600

16000

300

8000

0

0

Apr-03 Sep-03 Feb-04 Jul-04 Dec-04 May-05 Oct-05 Mar-06 Aug-06 Jan-07 Jun-07 Nov-07 Apr-08 Sep-08 Feb-09 Jul-09

Jul-09

Feb-09

Apr-08

Sep-08

Nov-07

Jan-07

Jun-07

Aug-06

Mar-06

Oct-05

May-05

Jul-04

Dec-04

Feb-04

Apr-03

Sep-03

8x

Source: Company, ICICIdirect.com Research

Source: Company, ICICIdirect.com Research

Exhibit 24: Market cap to sales band

Exhibit 25: Price to book band 4000

45000 10x

40000 35000

8x

30000

4x

3500 3000

3x

2500 2000

1000

Source: Company, ICICIdirect.com Research

Source: Company, ICICIdirect.com Research

26 | Page

Feb-09

Apr-08

Sep-08

Jun-07

Nov-07

Jan-07

Aug-06

Oct-05

Mar-06

0

May-05

0

1x

Jul-04

500

Apr-03 Aug-03 Dec-03 Apr-04 Aug-04 Dec-04 Apr-05 Aug-05 Dec-05 Apr-06 Aug-06 Dec-06 Apr-07 Aug-07 Dec-07 Apr-08 Aug-08 Dec-08 Apr-09

5000

Dec-04

2x

10000

1500

Feb-04

15000

2x

Sep-03

5x

Apr-03

20000

Jul-09

25000

Exhibit 26: P&L account

Rs crore FY '06 1636.8 167.4 529.5 32.4 141.6 8.7 321.8 19.7 0.0 0.0 153.4 9.4 490.5 30.0 61.0 596.9 23.9 573.0 -0.3 573.3

FY '07 2135.9 242.8 577.1 27.0 199.0 9.3 443.9 20.8 0.0 0.0 244.0 11.4 672.0 31.5 81.3 833.5 -6.7 840.2 55.9 784.3

FY '08 3356.7 145.1 756.4 22.5 304.1 9.1 290.3 8.6 189.8 5.7 299.0 8.9 1551.3 46.2 96.9 1599.6 48.5 1551.1 64.0 1487.1

FY09A 4271.4 86.8 950.3 22.2 439.9 10.3 388.3 9.1 391.4 9.2 332.0 7.8 1863.3 43.6 116.2 1955.6 71.2 1884.4 60.3 1824.1

FY10E 4108.7 259.0 1083.3 26.4 505.9 12.3 369.8 9.0 164.3 4.0 317.5 7.7 1668.0 40.6 106.6 1820.4 72.8 1747.6 48.8 1698.8

FY '06 92.9 1.4 1495.9 33.2 1874.5 35.6 1838.9 105.3 3603.1

FY '07 96.7 1.4 2674.7 43.8 1113.2 38.3 1074.9 89.5 4019.3

FY '08 103.6 0.0 4887.3 188.6 143.6 36.8 106.8 9.2 5332.2

FY '09E 103.6 0.0 6383.1 248.9 236.5 129.6 106.8 9.0 6981.0

FY10E 103.6 0.0 7776.1 297.7 135.6 28.8 106.8 9.0 8321.9

FY11E 103.6 0.0 9197.5 335.8 135.9 29.1 106.8 9.0 9781.7

1284.9 392.5 892.4 41.4 354.1

1425.2 473.8 951.4 60.8 254.3

1596.0 560.7 1035.4 68.6 656.5

1940.6 676.9 1263.7 42.0 2500.0

2163.0 783.5 1379.5 0.0 2500.0

2298.6 895.7 1402.9 0.0 2500.0

1546.8 360.9 247.1 511.7 2666.6 351.5 2315.1 0.0 3603.1

1448.7 678.9 265.3 664.5 3057.3 304.6 2752.8 0.0 4019.3

1510.5 1417.7 508.1 772.8 4209.1 637.3 3571.8 0.0 5332.2

380.6 1791.8 437.4 1008.0 3617.9 442.6 3175.3 0.0 6981.0

1752.1 1725.4 421.2 1048.3 4946.9 504.5 4442.4 0.0 8321.9

2962.8 1857.3 453.4 1194.5 6468.0 589.2 5878.8 0.0 9781.7

Net Sales Other Income Raw Material Raw material as % of sales Emp Expenses Emp exp as % of sales SGA Expenses SGA as % of sales Other expenses Other exp as % of sales R&Dexpenses R&D exp as % of sales EBITDA EBITDA margin (%) Depreciation PBT Taxation Net Profit before minority interest Minority Interest Net Profit after minority interest

FY11E 4426.9 332.0 1265.0 28.6 581.7 13.1 398.4 9.0 187.5 4.2 362.7 8.2 1631.5 36.9 112.2 1851.3 79.8 1771.5 38.1 1733.4

Source: Company, ICICIdirect.com Research

Exhibit 27: Balance sheet Equity Share Capital Preference capital Reserves & Surplus Minority Interest Loan Funds Secured Loans Unsecured Loans Deffered Tax Liability Total Liabilities Fixed Assets Gross Block Accumulated Depreciation Net Block Capital Work-in-progress Investments Net Current Assets Cash Trade Receivables Loans & Advances Inventory- Other Current Assets, Loans & Advances Less : Current Liabilities & Provisions Total Net Current Assets Miscellaneous expenses not written Total Assets

Rs crore

Source: Company, ICICIdirect.com Research

27 | Page

Exhibit 28: Ratio analysis FY '06 Per share data EPS Cash EPS Book Value Margins Operating Margin (%) Gross Profit Margin (%) Net Profit Margin (%) Balance sheet & Return ratios RoNW (%) ROCE (%) ROIC (%) Debt Equity Valuation ratios EV/Sales EV/EBIDTA Market Cap to sales P/BV Turnover Ratios Fixed Assets Turnover Ratio Debtors Turnover Ratio Inventory Turnover Ratio Creditors Turnover Ratio Working capital ratios Current Ratio Quick Ratio Working Capital/Sales Cash to Absolute Liabilities L& A T/o Debtor Days Inventory Days Creditor Days L&A Days Debtors to Sales Average Debtors/Sales

FY '07

FY '08

FY09E

FY10E

FY11E

30.8 34.1 171.1

40.6 47.6 286.6

71.8 79.6 481.9

88.1 96.6 626.4

82.0 89.5 760.9

83.7 90.9 898.1

30.0 36.5 31.8

31.5 38.5 35.3

46.2 48.4 44.3

43.6 47.5 43.2

40.6 44.1 40.0

36.9 41.3 37.2

36.1 16.8 30.0 1.2

28.3 21.1 26.9 0.4

29.8 30.4 53.1 0.0

28.1 28.2 47.5 0.0

21.6 21.9 40.4 0.0

18.6 18.9 37.6 0.0

12.9 42.9 12.7 6.5

9.9 31.6 10.1 3.9

6.5 14.0 6.9 2.3

5.4 12.3 5.4 1.8

5.2 12.9 5.6 1.5

4.6 12.4 5.2 1.2

1.9 4.5 3.4 2.8

2.4 3.1 3.4 4.0

3.3 2.4 4.5 2.1

3.5 2.4 4.3 4.0

3.1 2.4 4.0 3.9

3.2 2.4 3.8 3.8

7.6 6.1 1.4 4.4 6.6 80.5 107.5 129.2 55.1 0.2 0.2

10.0 7.9 1.3 4.8 8.1 116.0 108.4 91.1 45.3 0.3 0.2

6.6 5.4 1.1 2.4 6.6 154.2 81.5 172.2 55.3 0.4 0.3

8.2 5.9 0.7 0.9 9.8 153.1 84.1 90.8 37.4 0.4 0.4

9.8 7.7 1.1 3.5 9.8 153.3 90.8 94.0 37.4 0.4 0.4

11.0 9.0 1.3 5.0 9.8 153.1 96.2 95.8 37.4 0.4 0.4

FY '06 1752.1 1771.5 352.0 112.2 0.0 1571.7 230.8 964.4 1030.0 135.6 0.0 2.9 0.0 897.3 2542.6

FY '07 380.6 1747.6 301.3 106.6 0.0 1548.4 103.5 77.9 1547.0 180.4 0.0 101.9 0.0 1264.7 1645.3

FY '08 1510.5 1884.4 328.3 116.2 0.2 1672.1 194.7 538.7 938.8 318.0 1843.5 92.8 0.0 1129.9 380.6

FY09E 1448.7 1551.1 267.7 96.9 80.3 1300.0 332.8 1089.9 542.8 188.6 402.2 969.6 1079.4 61.8 1510.5

FY10E 1546.8 840.2 141.2 81.3 15.8 764.5 46.9 488.9 228.8 159.6 99.8 761.3 494.2 98.1 1448.7

Source: Company, ICICIdirect.com Research

Exhibit 29: Cash flow statement Op cash or cash equivalents Profit after Tax Less: Dividend Paid Add: Depn Add Provision for deffered tax Cash Profit Net Increase in Current Liabilities Net Increase in Current Assets Cash Flow after changes in WC Purchase of Fixed Assets (Increase) / Decrease in Investment Increase / (Decrease) in Loan Increase / (Decrease) in share cap Net Cash Inflow / Outflow Closing Cash/ Cash Equivalent

Rs crore FY11E 1180.9 573.0 102.3 61.0 15.7 547.4 92.8 406.0 234.1 219.9 294.4 51.5 5.8 365.9 1546.8

Source: Company, ICICIdirect.com Research

28 | Page

RATING RATIONALE ICICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assigns ratings to its stocks according to their notional target price vs. current market price and then categorises them as Outperformer, Performer, Hold and Underperformer. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock. Outperformer (OP): 20% or more; Performer (P): Between 10% and 20%; Hold (H): +10% return; Underperformer (U): -10% or more; Pankaj Pandey

Head – Research

[email protected]

ICICIdirect.com Research Desk, ICICI Securities Limited, 7th Floor, Akruti Centre Point, MIDC Main Road, Marol Naka, Andheri (E) Mumbai – 400 020 [email protected] ANALYST CERTIFICATION We /I, Raghvendra Kumar CFA Ashish Thavkar MBA research analysts, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our personal views about any and all of the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Analysts aren't registered as research analysts by FINRA and might not be an associated person of the ICICI Securities Inc.

Disclosures: ICICI Securities Limited (ICICI Securities) and its affiliates are a full-service, integrated investment banking, investment management and brokerage and financing group. We along with affiliates are leading underwriter of securities and participate in virtually all securities trading markets in India. We and our affiliates have investment banking and other business relationship with a significant percentage of companies covered by our Investment Research Department. Our research professionals provide important input into our investment banking and other business selection processes. ICICI Securities generally prohibits its analysts, persons reporting to analysts and their dependent family members from maintaining a financial interest in the securities or derivatives of any companies that the analysts cover. The information and opinions in this report have been prepared by ICICI Securities and are subject to change without any notice. The report and information contained herein is strictly confidential and meant solely for the selected recipient and may not be altered in any way, transmitted to, copied or distributed, in part or in whole, to any other person or to the media or reproduced in any form, without prior written consent of ICICI Securities. While we would endeavour to update the information herein on reasonable basis, ICICI Securities, its subsidiaries and associated companies, their directors and employees (“ICICI Securities and affiliates”) are under no obligation to update or keep the information current. Also, there may be regulatory, compliance or other reasons that may prevent ICICI Securities from doing so. Non-rated securities indicate that rating on a particular security has been suspended temporarily and such suspension is in compliance with applicable regulations and/or ICICI Securities policies, in circumstances where ICICI Securities is acting in an advisory capacity to this company, or in certain other circumstances. This report is based on information obtained from public sources and sources believed to be reliable, but no independent verification has been made nor is its accuracy or completeness guaranteed. This report and information herein is solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments. Though disseminated to all the customers simultaneously, not all customers may receive this report at the same time. ICICI Securities will not treat recipients as customers by virtue of their receiving this report. Nothing in this report constitutes investment, legal, accounting and tax advice or a representation that any investment or strategy is suitable or appropriate to your specific circumstances. The securities discussed and opinions expressed in this report may not be suitable for all investors, who must make their own investment decisions, based on their own investment objectives, financial positions and needs of specific recipient. This may not be taken in substitution for the exercise of independent judgement by any recipient. The recipient should independently evaluate the investment risks. The value and return of investment may vary because of changes in interest rates, foreign exchange rates or any other reason. ICICI Securities and affiliates accept no liabilities for any loss or damage of any kind arising out of the use of this report. Past performance is not necessarily a guide to future performance. Investors are advised to see Risk Disclosure Document to understand the risks associated before investing in the securities markets. Actual results may differ materially from those set forth in projections. Forward-looking statements are not predictions and may be subject to change without notice. ICICI Securities and its affiliates might have managed or co-managed a public offering for the subject company in the preceding twelve months. ICICI Securities and affiliates might have received compensation from the companies mentioned in the report during the period preceding twelve months from the date of this report for services in respect of public offerings, corporate finance, investment banking or other advisory services in a merger or specific transaction. ICICI Securities and affiliates expect to receive compensation from the companies mentioned in the report within a period of three months following the date of publication of the research report for services in respect of public offerings, corporate finance, investment banking or other advisory services in a merger or specific transaction. It is confirmed that Raghvendra Kumar CFA Ashish Thavkar MBA research analysts and the authors of this report have not received any compensation from the companies mentioned in the report in the preceding twelve months. Our research professionals are paid in part based on the profitability of ICICI Securities, which include earnings from Investment Banking and other business. ICICI Securities or its subsidiaries collectively do not own 1% or more of the equity securities of the Company mentioned in the report as of the last day of the month preceding the publication of the research report. It is confirmed that Raghvendra Kumar CFA Ashish Thavkar MBA research analysts and the authors of this report or any of their family members does not serve as an officer, director or advisory board member of the companies mentioned in the report. ICICI Securities may have issued other reports that are inconsistent with and reach different conclusion from the information presented in this report. ICICI Securities and affiliates may act upon or make use of information contained in the report prior to the publication thereof. 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 ICICI Securities 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. This report has not been prepared by ICICI Securities, Inc. However, ICICI Securities, Inc. has reviewed the report and, in so far as it includes current or historical information, it is believed to be reliable, although its accuracy and completeness cannot be guaranteed.

29 | Page