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Striving for a place in Innovators’ club

* We upgrade Cadila to Buy from Hold and raise the TP to Rs655 from Rs430. Our bullish view is based on 1) consistent double-digit revenue growth in the core business, coupled with 200bps EBITDA margin expansion during FY20-23E; 2) upside from Saroglitazar in PBC and NASH; and 3) potential success of Covid-19 vaccine, ZyCoV-D.

* In our view, the current share price ascribes NIL success probability to innovation efforts due to the lack of precedents for in-house new chemical entity (NCE) and vaccine development, and also in view of Sun Pharma’s initial challenges in specialty.

* In our SOTP, the core business contributes 80% (Rs520/share, valued by us at 20x forward P/E), PBC/NASH add 14% (Rs90, NPV) and ZyCov-D accounts for the remaining 7% (Rs45, NPV). Our bull case scenario yields a fair value of Rs835/share, assuming higher market share in PBC and NASH, favorable gRevlimid settlement and Covid-19 vaccine becoming an annual shot.

* Key downside risks are: 1) Higher-than-expected competition in Mesalamine franchise; 2) Adverse regulatory outcome on plants; 3) Failure to get FDA approval for Saroglitazar.

Innovative medicines and vaccine efforts underappreciated: Saroglitazar, the company’s lead NCE, offers a significant opportunity (USD30bn market size) as competitors are small development-stage companies and PBC is a rare disease offering good pricing dynamics. The company has successfully completed the Phase-2 trial for PBC and Phase-2 proof of concept trial for NASH. However, current valuations ascribe nil success probability to these developments. Our NPV analysis suggests a base case upside of Rs50/share for PBC and Rs40/share for NASH. Similarly, ZyCoV-D offers a base case upside of Rs45/share, assuming it is a three-year opportunity (Exhibits 4-17).

Well positioned to sustain multi-year growth in the core business: The one-off bump in US revenues in FY18 driven by Mesalamine, Sentynl and Tamiflu has since moderated. Hereon, we expect US revenues to grow at a 10% CAGR through FY23E, backed by a strong product pipeline (110 ANDAs + 154 products under development plus nine 505(b)2 products), and launch of 25-30 products annually. We expect the India formulations business (25% of revenue) to grow at a 12% CAGR over FY20-23E, thus outperforming the market after several years of underperformance; this we believe would be driven by renewed focus on ‘mandate brands’, comprising new product launches and resource redeployment (Exhibits 18-36).

Improving FCF and profitability: We forecast consol. FCFE to grow to Rs33.6bn by FY23E from Rs16.1bn in FY20, driven by Rs7bn FCF increase in the core business. Further, with likely improvement in asset-turns (1.1 to 1.4 in FY23E) and expansion of 300bps in EBIT margin, we expect core ROIC to improve well above the cost of capital to ~19% in FY23E from 11% in FY20.

Compelling valuation: The stock is trading at a 1-year forward P/E of 16.4x on our consolidated forecast, and 21x on core earnings in line with the historical average. Our Rs655 TP includes core business value of Rs520 (20x forward P/E), Saroglitazar NPV of Rs90 and ZyCoV-D upside of Rs45.

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