Zydus Lifesciences Ltd - Stock Valuation and Financial Performance

About the Company:

Zydus Lifesciences Limited, formerly known as Cadila Healthcare Limited, is an Indian multinational pharmaceutical company and is primarily engaged in the manufacture of generic drugs. It is also the parent company of Zydus Wellness, where the company maintains a 69.62% controlling stake. The company derives 47% of its revenue from the United States, 26% from India, 14% from Wellness (India), 9% from Emerging Markets and EU, and 4% from other businesses such as APIs and Alliances.

From FY18 to FY23, the company has experienced an annual sales growth of 7.7%, while the adjusted EPS has remained flat. This trend can be attributed to a decline in net profit margins from 16% to 10.4% between FY21 and FY23, accompanied by a decrease in Return on Equity from 19.7% to 10.2% over the same period. These declines are primarily due to price erosion and fewer product launches during this timeframe.

However, in FY24, the company's net profit margin has rebounded to 19.7% and sales and profits grew by 13.4% and 97% respectively, driven by numerous new product introductions and low price erosion. The fluctuation in earnings is characteristic of the pharmaceutical industry's cyclical nature, which is heavily influenced by the launch of new products and the erosion of prices for existing ones.

What are the growth and revenue drivers for Zydus Lifesciences?

(In Rs. Crores)

The key revenue drivers for the company are its Indian formulation business and the United States generic business, which each have their own drivers.

India: The India formulations business accounted for 26% of the company’s revenues in FY24. The business consists of both acute and chronic therapies. The growth in the Indian formulations business is being led by chronic therapies. Introduction of oncology brands such as Vivitra (trastuzumab), Bryxta (bevacizumab) and Ujvira (trastuzumab emtansine), nephrology brands such as Oxemia, and Lipaglyn (Saroglitazar) for diabetes have largely led to this growth and shall contribute favourably to the future growth of this segment. Zydus Lifesciences maintains a strong competitive advantage by selling various key drugs at a fraction of the cost of innovators.

US Generics Business: The US remains the world’s largest pharmaceutical market, accounting for over 40% of the global market in 2022. This is primarily due to the high GDP, GDP per capita and high prices commanded by innovator drugs. This makes the United States extremely attractive to Indian generic manufacturers who enter the business through bioequivalence or as generic manufacturers. The United States accounted for 47% of Zydus Lifescience’s revenue in FY24. Zydus Lifescience is the 5^th largest generic company in the United States and is ranked among the top 3 in 60% of its product families. 

While the United States is an attractive market, it is prone to price erosion due to increased competition when a drug loses patent protection. Price erosion can be as high as 80% due to huge number of players and oligopolistic nature of distributors. Growth in FY23 and FY24 was due to the approval of generic versions of Revlimid and Trokendi. However, these drugs will face intense competition at launch in FY27 when the innovator drugs lose exclusivity as per settlements. Growth in the United States is expected to come from the launch of generics as well as a few new drugs with a focus on orphan drugs. The company has a robust pipeline which should aid growth over the next few years. The growth rate will vary depending on patent expiries, settlements and price erosion.

Emerging Markets and Europe: Emerging Markets and Europe accounted for 9% of Zydus Lifescience’s revenue in FY24. The company is present in various countries such as but not limited to France, Spain, South Africa, Mexico, Brazil, Australia and other markets in Africa, Middle East and Eastern Europe. While the contribution of each country may be low, the company aims to be a large player in the segments where it is present. It is the largest player in Sri Lanka, 9^th largest in the Philippines and 2^nd largest in South Africa. Over the last 5 years, this segment has grown an annualized rate of 13%.

Others: The other segments of the company include Zydus Wellness, API and Alliances.  The API business accounted for 4% of the consolidated revenue. The alliances include JVs where Zydus Lifesciences manufactures products solely for its joint venture partners. The contribution of such businesses is negligible. 

Zydus Wellness accounted for 14% of Zydus Lifescience’s revenue in FY23. This business includes brands such as Complan, Sugarfree and Glucon-D, and has grown at an annualised rate of 7% for the last 4 years (A 5 year estimate would be misleading due to the acquisition of Heinz India’s consumer wellness business in 2019). However, the earnings can be volatile due to dependence on raw material such as milk, stevia, refined palm oil, aspartame and dextrose monohydrate. Moreover, Zydus Wellness is a seasonal business with majority of the revenue generated in Q1 and Q4 of the financial year which is due to its product portfolio.

While the operating margins for Zydus Wellness have been falling and are at an all-time low, we expect the margins to improve over the future. The company expects 17-18% EBITDA margins in the following two years, primarily driven by improvements in gross margins. Furthermore, the company expects demand to recover soon leading to double digit growth. The outlook for this segment remains healthy.

What are the key risks?

Price Erosion: Price erosion is a key risk for all generic pharmaceutical companies. Loss of patent leads to 60-80% erosion in price due to increased competition and the oligopolistic nature of distribution. As a result, bulk of the profitability is made early in the off patent cycle by companies that have 180 day exclusivity. Therefore, high profit margins over the short term cannot be extrapolated without a healthy pipeline of new launches that offset the price erosion. Certain key drugs are expected to witness competitive pressures in FY27, but the extent of price erosion remains uncertain.

Stretched Cash Conversion Cycle: The cash conversion cycle may continue to remain elongated due to the consolidation of American distributors and the commoditization of generic drugs. Moreover, geopolitical problems may cause increase in shipping time.

Stellar results on back of performance across segments, margin expansion and cost control.

Cadila experienced very good growth in its US business over last 3-5 years thanks to large pipeline it had from FY15-18. Currently the margins are high and they may come down as new launches slowdown and pricing pressure will reduce gross margins. Its R&D also is expected to increase as a % of sales.

We believe that it will experience slower growth in next 1-2 years as it has large base of launches in recent past. Also its domestic business comprises of bulk of the old drugs with limited growth. So we believe current price is not good enough to justify allocation. The price can correct more as its Moriaya Plant has received USFDA observations that could lead to further escalations. This will dampen its growth as it is one of the important plants from new launch perspective.

We would wait before jumping to buy Cadila. Meanwhile, we may like to buy Lupin, Cipla as their launches are lined up in next 4-8 quarters. If you haven’t bought Lupin & Cipla already, you can add them at current prices. You can consider switching your Cadila position to either of the two.

Even if we have disclosed our valuations for ready reference, we suggest you always ask us before you buy a stock beyond our recommendations. We will highlight caveats, if any.

Cadila Healthcare Ltd. has the product portfolio of formulations, active pharmaceutical ingredients (API), intermediates, biological, animal healthcare products and consumer wellness products (Zydus Wellness Ltd.). Cadila’s historical financial performance has been good. It has clocked good sales and EPS growth rates. It is one of the few companies that have shown consistent value creation for shareholders across the years.

What are the concerns and how is Cadila addressing them?

What should investors do?

Cadila Healthcare is a fundamentally strong stock, which can have a good future growth. It is currently available at reasonable price. However, the stock may see some pain in the short term as company’s performance is expected to remain subdued in the near term. Investors can look at buying the stock in tranches, thereby averaging their buying price.