Mumbai-based Lupin has managed to create a niche for itself, with vertical integration, and backed by a strong research and technology platform. Sustained growth in the domestic market, strong earnings visibility from the US business, and ramp-up of business in Europe, Japan and other markets will drive growth over the next few years. Though continuous growth and expansion have put pressure on margins, Kamal K Sharma, managing director, believes the forays into new verticals such as optimology and dermatology, and improved visibility in the branded generics space will keep the momentum going and ease the pressure on margins. In an interview with Saaurabh Shivshankar, Sharma talks about the challenges of growing overseas and the strategies that the company has put in place. Excerpts from an interview

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Despite the growth in top line, margins were under pressure in the second quarter. Can you tell us why?

I think it is too short a period to look at the company’s financials and the appropriate way would be to see how the company has performed over the years. The company has scaled up tremendously in the past five years with top line growing at about 30 per cent and bottom line at over 50 per cent. This, by any standards, is a robust performance in the pharmaceuticals industry. The standalone margin of the company is still 21-22 per cent.

In two years, since October 2007, we have made some smart acquisitions at a very good price and Ebitda multiples. But some acquisitions have low Ebitda margins because of country-specific dynamics. For example, in Japan, branded generics enjoy a margin of 45-48 per cent compared with 50-55 per cent in India. The reason for this is API (active pharmaceutical ingredient) buying in Japan is atypical. The agency in Japan imports the API and then distributes it to actual users. There are very few companies, and especially in branded generics which have backward integration. They don’t make their own APIs.

In Japan, quality is the most important thing. They are very particular about the quality of the API, the look and feel of it. So that entails a lot of value-add, thus, making APIs expensive. When we bought Kyowa, the margins were at 33 per cent, which in just one year has improved to 38-39 per cent as we negotiated better with suppliers and improvised some manufacturing process.

We have done six acquisitions in the past two years, and if we take the weighted average of the Ebitda, the margins come to around 19 per cent. So, on a standalone basis we are better. I would not say that we are happy with this margin, our target is to increase this to 25 per cent.

The other reason why we are not able to achieve this as rapidly as we would like to is because we are in a massive growth phase. The other thing one should consider is that when we are growing at 30 per cent or so, and are also acquiring companies, it is natural that margins will come under pressure.

Is the transformation proving costly for Lupin?

Six years ago, Lupin was just an anti-infective and anti-TB drugs maker and margins were under tremendous pressure. While we have maintained our leadership in India with a 48 per cent share in this heritage business, we have rapidly grown in the chronic illnesses (lifestyle diseases) segment. Today, in India, almost 65 per cent of our business comes from the chronic illnesses segment.

There are two ways of increasing this business. One is through M&A, and the other is to grow organically and do calibrated acquisitions

When we entered cardiology, diabetology and asthma, these businesses had well-established players. So, to make a dent in their turf, you needed some lateral well-thought out strategies, besides good quality products and a strong marketing and distribution channel. We got into tie-ups with some premiere institutes in the world to promote the cause of those therapies. Such efforts have cost us money. Besides to provide advance products, which do not have generic equivalents, we in-licensed 12-13 products from European and American companies on exclusive and semi-exclusive basis. So the creation of such a portfolio in such a short time-frame had some bearing on margins. Having said that we remain committed to improving margins.

Over the past four years, our Ebitda margins expanded by 100-150 basis points year-on-year, even as we increased our R&D expenditure from 3 per cent to 7 per cent. This has given good results. Today, in the US we are the fastest growing generic company and the ninth largest brand from the prescription point of view. Of the 23 products we have in our portfolio, nine are market leaders. Without changing the complexion of our business in India, our forays in America sucked investments, but at the same time helped us in growing the quality of our business. Many people said we were late in the game, but our strategy to create the right kind of tweaks through intellectual property management has helped us achieve what we have so far.

In India, the legacy portfolio of anti-infectives will keep us a bit compromised. TB contributes 13 per cent, compared with 40 per cent four years ago, anti-infectives contribute 24 per cent and the other is the lifestyle (diseases segment), so the first 37 per cent is low-margin business.

How has the US market played out?

We were the only Indian company in the US which was not only a pure generic player but also a branded generic company. We proved ourselves, though we felt the heat in the first year after investing huge sums in setting up a field force and not seeing adequate revenues against it. But from the second year onwards, we turned around after we learned a lot of things in the US.

Our first branded product, Suprax, an antibiotic, was dropped by erstwhile marketer Wyeth Labs two years before we bought the brand. During this period, other antibiotics such as Omnicef and Zithromax took the lead. So to get it (Suprax) back in the market was a difficult task. Moreover, the parasites which affect the flu keep on shifting with the season, so the task was not only to relaunch the product, but also to change its positioning. We did it successfully and the rest is history. We now have four brands lined up, including the recently acquired Antara, a cholesterol-lowering medication, which enjoys sales of $75 million, and Allernaze (nasal spray), which will be in the market from June 2010.

So what is your growth strategy going forward?

Size does matter in this business. There are two ways of increasing size. One is through mergers and acquisitions, and the other is to grow organically and do calibrated acquisitions. We preferred the latter way to avoid the problem of leverage.

We have established our presence in eight countries, and of these, in India, the US, South Africa and Japan we are growing at double the market growth rates. We have not grown as we would have liked to in Australia, the Philippines and Germany, but we are putting our strategies in place to grow in these markets.

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Firm Outlook

Analysts expect steady growth going forward

in Rs cr	FY09	FY10E	FY11E
Sales	378	460	539
Change (%)	40	22	17
Ebitda	76	87	106
Change (%)	19	15	21
Net profit	50	63	75
Change (%)	23	25	19
EPS (Rs)	61	71	85
Book value (Rs)	172	246	319
ROE (%)	37	35	31
P/E (x)	11	19	16
Price (Rs)	684	1,382	1,382

Source: Bloomberg

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From being a truly transnational company, we still have some geographies to explore. One of them is Latin America. That little region is an almost $44 billion market. The next one is West Asia, the Gulf states, which are high-price, high-quality markets. And the third geography where we have not done enough is the CIS (Commonwealth of Independent States). The idea is to have basic infrastructure, get more products and employ the right promotional strategies. This is the first part of the strategy for growth.

More importantly, the pharma business is going to get more competitive as the pipeline of generic products tapers off from 2011. Keeping this in mind, we have moved into specialties. One is oral contraceptives (OCs). In the US alone, which is a $6.5 billion market for oral contraceptives, we are planning 28 filings. This is very complex hormonal preparation that needs dedicated manufacturing and Lupin has the added advantage of being vertically integrated. There are only two competitors today, Watson and Teva, and we assume that by the time we launch our products there will be two more. The current manufacturers outsource their APIs. Lupin being vertically integrated, will have an edge over the competitors in terms of being cost effective. The other big markets for oral contraceptives are Brazil, which is a $1 billion-plus market, and Europe.

What are the other focus areas?

The next is optimology, which is a sophisticated segment. Again a vertically integrated model and dedicated manufacturing facility makes this a high-margin product. In optimology, though the products are going off-patent, the drugs are not genericised because some of the syntheses are very integrated and strong.

There are three more therapeutic areas we are focusing on. In asthma, though we started late in this segment, we have managed an 18 per cent market share. Asthma is a highly knowledgeable area as not only the drug, but the proponent, the valve, the design, the polymer of the valve and other parts are all patented. There is a landmine of patents around asthma. So if you can make something non-infringing, then you have great potential. We can develop these products.

Dermatology is another area for branded generic products. The sigma of all these will propel us to higher levels. Although we are happy to be $300 million-plus in America, we can easily be a $1 billion-plus company. Similarly, everyone talks about India being a $20 billion market going forward from the current $6 billion. We have our engines in place. Today we have 3,000-plus medical representatives against 900 five years ago. The reach to doctors has increased meaningfully as the same doctor is not visited by different reps with the same products.

Our product pipeline has become a key differentiator. Today, we have 100 submissions in the US, of which 35 are approved, 23 are in the market and of the rest 50 per cent are Para IV filings. So we do expect this will yield more margins, because Para IV means they are patent challenges. We believe that some specialty areas including bio-similars, which we are still working on, will help the company sustain margins. Beyond 2013, there will be a huge market for bio-similars.

By when do you see the new verticals contributing to the top line?

The OCs and opthal products will start contributing from the second half of 2011, dermatology from the beginning of 2012 and asthma after 2013. You need a combination of both generics as well as branded products. In the branded business, ramping up is a bit slow, but then it stays there for long, whereas in the generic business the ramp-up is fast but cash-flow is steady. Such cash flows are necessary to sustain in the branded generics play. Going forward, all governments will favour the generics business to cut health costs. So to sustain margins one has to come out with innovative products.

Will Lupin grow sans leverage?

There are a few disciplines that we follow and we do not compromise on that. By and large we believe that our debt-equity should not exceed 0.5 levels. Today it stands at 0.43. It can go to 0.6-0.7 and come back to 0.5, but it will not go to 1:1, however lucrative the proposal might be. When it comes to acquisitions, there are three criterias that we follow. First, the payback period should not be more than five years. In a classical acquisition the payback can go up to 12 years because you acquire the asset at an Ebitda multiple of 15. Back of the envelope calculation will tell you that the ROC will come to about 7 per cent. To make it 20-25 per cent you have to run like hell. Most of our acquisitions are in the range of 8-9 times Ebitda. The quality of management is the second consideration. In all the acquisitions that we have done, we have not changed a single manager. Finally, there has to be a sizeable revenue cost and profit synergy when we acquire a candidate.

How does the capex scene look?

This year and the next year we will be investing $100 million in capex. Our internal accruals will fund the dividend, the working capital requirement and the capex required. Only if we are buying a brand or acquiring some company then we may look for some more debt.

How is Lupin coping with currency fluctuations?

You cannot cover your entire risk in the forex market. We have some prudent strategies to hedge our foreign exchange risk through simple forward covers or simple put and call options. It is an important aspect for us, as 65 per cent of our business is in foreign currency.