Company update: Natco Pharma (Outperformer) - Non US businesses to drive growth in the near term

This note highlights drivers for Natco’s ex-US business segments, as derived from Natco Pharma’s recent FY19 Annual Report. Management has indicated that a strong pickup in non-US business segments would drive growth over the next couple of years, given the lack of new meaningful launches in the US over FY19-21.

Non-US business – growing in salience: While US generics has been Natco’s primary growth driver over last few years, the company has been striving to increase the salience of its non-US business. A key element of this strategy is expanding its portfolio of niche products across multiple geographies. Results are beginning to show. Canada and Brazil have done well in FY19 with pick-up in new approvals and should grow faster over next 2-3 years. Despite the decline in HepC sales, domestic business is expected to grow on the back of steady growth in oncology and pick-up in CnD segment. In an interesting diversification, Natco is looking to leverage its R&D capabilities to enter the global agrochemicals segment.

Increasing R&D investments: Natco is leveraging its improved profitability to enhance R&D investments across various markets. R&D expenses increased from 7.6% of sales in FY18 to 9.4% in FY19. Despite the enhanced focus on EMs, Natco continues to successfully invest in developing complex generics for the US market. A case in point is the recent potential big-ticket FTF filing on gImbruvica tablets.

Balance sheet remains in good shape: Despite increased R&D and capex spends and muted profitability growth, Natco generated Rs1.3bn FCF in FY19, up from Rs440m in FY18 – driven by Rs6.7bn of operational cash flows during the year. Natco has invested ~Rs10bn in capex over FY18-19 as part of its future growth plans. The company also undertook Rs1.3bn buyback during FY19 and ended with ~Rs6.9bn net cash.

Valuations & view

Management continues to pursue unconventional growth strategies to create new medium-term growth engines. Recent big-ticket FTF on gImbruvica tablets further underlines Natco’s capability to generate unexpected winners. Despite near-term earnings softness, the initiatives add comfort on Natco’s ability to create new and meaningful growth drivers in the coming years. While gCopaxone scale-up will drive FY20 earnings, gNexavar and gRevlimid launches, accompanied with scale-up in India and RoW markets, will retain the earnings momentum over next several years. Maintain Outperformer rating with a target price of Rs860. Tentative approval for gRevlimid will be key near-term upside trigger.