We are closing our overweight rating on Cipla and downgrade the stock to equal-weight in view of slowing growth prospects, trailing outperformance and full valuations. We also reduce our target price to R414 (R437 earlier). We apply an 18x P/E multiple (broadly in line with large-cap industry average) to our FY2015e EPS of R22.97.
The price target change is largely driven by earnings estimate cuts, marginally lower P/E multiple (to 18x from 19x to account for slower growth), and rolling forward our target to FY15. We estimate FY14-15 EPS CAGR of 8% versus 28% over last two years (FY12-13). Excluding Lexapro upside in FY13, we estimate the above growth rates to be 14% and 21%, respectively, implying a slowdown in the base business. This is being driven by lower operating margins (higher staff costs and up-front SG&A for building international front end) and higher effective tax rate (21% in FY12 moving to 24-25% in FY13/14).
Cipla is up 15% over last one year (compared with over 11% returns for the Sensex) and up 32% over last 24 months (against 6% for Sensex). This was driven by strong earnings, commercialisation of the Indore facility, and a couple of niche launches in the US (eg, Lexapro, olanzapine). In our view, Dymista appears to be off to a slow start with less than 3% market share in the US since its launch in FY12. We remain unsure of monetisation of generic Truvada in 2013.
Based on our revised estimates, Ciplas P/Es are 20.5x for FY13e and 19.8x for FY14e, respectively. Thats broadly in line with its longer-term average multiple and a premium of approximately 5% to the Indian large-cap pharma average. However, the earnings growth we project over the next 12 months (3.4%) is significantly lower than the five-year EPS CAGR of 18%, which makes the stock vulnerable to de-rating.
Lower OPM and higher tax-rate drive EPS estimate cuts. For FY13, our EPS estimates are down 7.3% largely driven by higher staff costs based on increase in manpower and annual increments (higher base set in nine months of FY13), increase in SG&A expenses driven by up-front costs towards building international front end, and higher effective tax rates (21% in FY12 moving to 24-25% in FY13/14). For FY14 and FY15, our EPS estimates are down 11.2% and 11.6%, respectively largely driven by higher cost base in FY13.