Strong volume growth, pressure on profitability Cipla’s net sales grew 15% in Q2FY11 on robust performance of domestic and export formulations. Higher input prices, coupled with a jump in staff and other expenditure, translated into 2.2% rise in EBITDA (ex tech fees and forex). Commissioning of the Indore SEZ resulted in increase in depreciation cost. Adjusted PAT (ex forex net of tax) declined 10% which is below our expectation.

20% domestic growth was on lower Q1FY11

Domestic sales growth was robust at 20% in Q2FY11 which was benefited on lower 4% sales growth in Q1FY11. This growth is the highest recorded by Cipla in the past 16 quarters. The OTC business and Inhalers exhibited strong volume performance.

14% growth in export formulations was significant

Export formulation grew a significant 14% despite an adverse currency impact. Exports of API were still a challenge and degrew by 1%, tempering export growth to 11%.

Pressure on margins, should be in 20-21% range

EBITDA margins (ex tech fees and forex) declined254bps dragged by higher staff costs (240 bps) and RM costs (75bps). However, reduction in other costs by 61bps partly offset this. We believe EBITDA margin would be maintained at 20-21% over FY11e and FY12e.

Key call takeaways
1) 10% domestic formulations growth is sustainable;
2) Other expenditure includes forex gain of Rs150mn;
3) Capex of Rs9-10bn over FY11 and FY12;
4) Hedge book stands at USD250mn;
5) Indore SEZ is at Rs250mn EBITDA negative and
6) Inhaler currently consist 17% of sales and can become 25% in near future.

VALUATIONS AND RECOMMENDATION

We note that consensus estimates for Cipla have declined 7% in the past 12 months marking a 9% underperformance to the Sensex. We maintain our estimates and continue to value Cipla at 20x Dec’11e. We raise our target price to Rs337 compared to Rs323. With a limited 2% upside, we maintain ‘HOLD’.