Cadila Healthcare - US business robust: Potential upside exceeds risks - Avendus

While a rebound in CDH's US generic business and the company's ability to put the segment back on track are crucial to earnings and valuations, we now attempt to quantify the impact resulting from a deep slide in US generic sales, away from estimates. We estimate that a potential disappointment in US generic sales, falling short between USD70mn and USD190mn over FY14f–FY15f, and maintaining profitability in other business heads constant, could pull down net earnings by 8%/14% for FY14f/FY15f from our estimates. The challenge to attain scale in this segment could also impact CDH's valuations. The CMP reflects this extreme scenario, in our view; the realistic scenario points to a Mar14 TP of INR928, a potential 26% upside over the 12 months. We note that the near term may remain challenging with signs of stability likely to be felt only from 1QFY14. Raise rating to Buy.

US generics vital to earnings growth

Our estimates for CDH factor in a rebound in US revenues with a steady flow of approvals settling in. Just how crucial is the return of scale in the US generic segment to the company's earnings? Our current estimates build in revenues of USD281mn for FY13f. Product flows from CDH and incremental launches from Nesher, we believe, could support an average growth of c34% annually over the next two years. The segment, contributing to c28% of consolidated sales by FY15f, in our estimate, could account for a slightly higher share in the core EBITDA on improved operating leverage.

Risk of sharp slip in US geography is built into current valuations

We believe that a substantial disappointment in US generic sales, falling short between USD70mn and USD190mn over FY14f–FY15f, and maintaining profitability in other business heads, could pull down net earnings by 8%/14% for FY14f/FY15f from our estimates. Our sensitivity assumes constancy in key variables-mainly interest outflow and other operating income-which, in practicality, also carry a flow-through on lower revenues and the company's ability to generate FCF. CDH's inability to deliver scale on its US generic business would also impact its valuations, in our view. So, a significant slip in US sales and a lower valuation multiple, provides a 21% downside risk to our rolled over Mar14 TP of INR928 to INR734. At the CMP, the fears on the company's inability to scale up the US generic business, we believe, are factored in.

Near-term pain but maintain long-term positive view; upgrade to Buy

We upgrade our rating to Buy with a rolled over Mar14 TP of INR928. The near term is likely to stay challenging, which could cumulate into pressure on the stock. The core margin weakness, as seen in the Dec12 quarter, and the pace and quantum of the capex is spreading the B/S thin, worsening of which is a threat to earnings and valuations. The pricing policy in India is also a key risk.

Source : Equity Bulls

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