We initiate coverage of The Searle Company Ltd. (SEARL ...arifhabibltd.com/.../uploads/2017/03/Initiation-Report-SEARL.pdf · The Searle Company Limited (SEARL) Page 3 March 30, 2017

Current Price as of March 29th, 2017 www.jamapunji.pk

March 30, 2017

SEARL: The Preferred Medicine

Pharmaceuticals

Hubco Company to Outperform Due to Analyst

The Searle Company Ltd. REP 300

Initiating Coverage on SEARL – BUY!

We initiate coverage of The Searle Company Ltd. (SEARL) with our Dec’17 Target Price

of PKR 816.60/share; at current price levels the scrip offers a 33% upside potential.

Our investment thesis is premised on i) significant growth expected in the topline on

the back of anticipated expansion, macroeconomic triggers, industry dynamics, and

improving outreach, ii) unsurpassed margins, and iii) expected rise in foreign interest

in the scrip amidst inclusion in MSCI EM and FTSE GEIS. Further to it, SEARL is by far

one of the safest scrips in the sector given it is relatively immune to the uncertainty

of pricing mechanism and respective regulatory outcomes.

Double Digit Growth in Topline Expected to Lead to Greener Pastures

Premised on the back of the anticipated expansion together with (i) Pakistan’s improving

macroeconomic levels, (ii) growing awareness of advantages of nutrition based

biopharmaceutical products, and (iii) country’s overall demographics with SEARL’s

growing distribution network; we expect the company’s leading chronic, analgesic, and

nutrition product mix to lift the topline north of 20% YoY in FY17E (PKR 11,435mn). Based

on our estimates, top 30 products that make up over 50% of the total revenue, are

expected to post over 13% of jump in sales during FY18 (in excess of PKR 7,000mn), while

the biopharmaceutical products that are already in production, estimated to have broken-

even, should start churning high margin sales with an anticipated growth of over 1.5x in

FY18. Incorporating this exceptional growth, our estimates point to a 5Y CAGR of 22%

(FY16-21F) translating into FY21F net revenue of PKR 26,149mn.

Concurrently, with improved margins in FY17 along with the anticipated generous

dividends from its subsidiaries, we expect SEARL to post a growth of 48% YoY in its

bottom-line in FY17E (EPS: PKR 20.04) with a 5Y CAGR of 20% (FY16-21F) taking the FY21F

net profit to PKR 5,171mn (EPS: PKR 33.59).

Industry Leader in Margins with a Promising Business Model for the LT

Recently, while stay order on hardship cases facilitated some of its competitors translating

into improved margins, SEARL made significant advances of its own. In the 2QFY17, while

SEARL successfully managed its Gross Margins at 41%, its Net Margins surged up to 29%

from an earlier 20% in FY16, providing a momentous headway compared to industry’s

average NM of 13%. Going forward, we believe, with the high-margin Bioscience’s sales

expected to post double digit growth coupled with possible enhancement of its existing

pharma facilities, SEARL may further increase its GMs up to ~43% while maintaining its

NMs at higher 20s (given the expected increase in its marketing efforts).

Preferred Pick with Largest Free Float / Foreign Inflows / Competitive Adv.

Tied to its long term growth prospects, superseding margins, and a solid business plan in

place, SEARL gets our preference in the sector based on its i) largest free float in the

industry of 62.97mn, ii) inclusion in MSCI EM and FTSE Global Equity Index Series Asia

Pacific (ex-Japan), and iii) competitive advantage over various MNCs.

Exhibit. 1 Key Financial Highlights

Year End (PKR mn) FY15 FY16 FY17E FY18F FY19F

Net Revenue 7,582 9,525 11,435 14,641 17,861

Growth (%) 25 26 20 28 22

EPS diluted (PKR) 9.32 13.57 20.04 22.83 25.49

PE (x) 34.4 39.5 30.7 27.0 24.2

DPS (PKR) 2.0 5.0 7.0 9.0 10.0

Source: Company Financials, AHL Research

BUY

816.6

615.7

32.6

Shares (mn) 154

904

3M 6M 12M

1.7 36.2 87.2

334.7 335.5 511.5

670.1 670.1 670.1

584.9 444.8 328.9

Source: Bloomberg

Analyst:

Shiraz Zaidi

F:+92 21 3242 0742

D:+92 21 3246 2589

SEARL PA

Upside (% )

Current Price

Target Price (Dec'17)

Recommendation

Market Cap. (USD mn)

www.arifhabibltd.com

E: [email protected]

UAN: +92 21 111 245 111, Ext: 248

94,771

– International Brands Ltd.

Price Performance

Major Shareholders

Price Performance

Avg. Volume (000)

High Price - PKR

Low Price - PKR

Return (% )

Market Cap. (PKR mn)

Best Domestic Equity House – 2016

Top 25 Companies

(2015, 2014 & 2012)

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http://www.jamapunji.pk/

The Searle Company Limited (SEARL) Page 2

March 30, 2017

SEARL - Pharmaceuticals

INVESTMENT THESIS

I. Double Digit Growth in Topline Expected to Lead to Greener Pastures

Keeping pace with pharmaceuticals globally, we expect Searle Company Ltd. (SEARL) to

proceed with a series of capital expenditure focused primarily on expansion of its high-

tech Biosciences (Biopharmaceutical) facility, along with enhancement of its existing

Pharmaceutical and Consumer Goods’ segments. With a CapEx of PKR 400mn already

incurred by the management during the 1HFY17, we expect another PKR 600mn in the

2HFY17, followed by PKR 550mn in the following year, taking the total expenditure in

excess of PKR ~1,500mn by end of FY18.

The anticipated phased expansion could not have been better timed, we believe, with

various drivers in place for the sector to outperform going forward. A few key factors

worth discussing in more detail are i) improving macroeconomic indicators (affordability),

ii) growing awareness of advantages of good health and healthy lifestyle (awareness), and

iii) country’s overall demographics (accessibility).

a) Key Drivers for Pharmaceuticals (to Support SEARL’s Topline) i. Rise in Income = Rise in Affordability

Pakistan has been all over the international media for its turn-around story given the

substantial improvement in its economy and law and order situation. To reiterate, we

expect the GDP to grow at 5.2% in FY17 and in excess of 7.0% from FY19 onwards which

will in turn increase not just the disposable income but is expected to also widen the

middle class, raising nation’s overall affordability. We expect this economic activity to

possibly provide some ease on pricing regulation of scheduled drugs, especially Essential

Drugs, which has remained one of the primary hurdles for the industry to operate at a

higher profitability margin, as discussed earlier. In addition, an enhanced affordability

should help create a larger market for a diverse product portfolio, especially for nutrition

based Biopharmaceuticals and Consumer Good items, which may fall under non-Essential

and Over-The-Counter drugs.

ii. Rise in Affordability Supports Awareness of Benefits of a Healthier Lifestyle

Secondly, the increase in affordability is expected to be tailed by an increased awareness

of advantages of good health and healthier lifestyles. The trend is substantiated by various

research and surveys conducted by renowned consultancies such as McKinsey (‘Unlocking

Pharma Growth’, 2012) and Streategy& (‘Pharma Emerging Markets 2.0’, 2013) in similar

emerging markets. Especially in the case of large middle-income markets such as Brazil,

India, China, Mexico, Turkey, and Russia all exhibited similar trends in their pharma

industries; that of a rise in overall spending (mainly marketing) to increase patient

awareness followed by an expanding insurance coverage, emergence of new hospital

formats, and introduction of innovative therapies and biotech solutions to lingering

epidemics.

We expect a similar trend to emerge in Pakistan that has a growing population along with

recently found triggers to economic growth. The only precaution that will need to be

considered is the lack of tailored approach to an individual market (instead of a generic

growth model) and the lack of outreach within. We believe, while various MNCs may

struggle to find efficiencies in-between their internal (foreign parent) company policies

and stringent local regulation terrain of the pharma landscape, SEARL will be well

positioned as one of the largest local manufacturers to capture and increase its existing

market share going forward. SEARL currently stands as the 5th largest pharmaceutical in

Biopharmaceuticals vs Pharmaceuticals

The primary difference between

biopharmaceuticals and traditional

pharmaceuticals is the method by which

the drugs are produced.

Contrary to pharmaceuticals, that

manufacture drugs through a series of

chemical synthesis, Biopharmaceuticals

manufacture drugs via living organisms

such as bacteria, yeast, and mammalian

cells.

Affordability: Premised primarily on the

back of anticipated pickup in GDP,

translating into higher disposable income

and growing middle and upper middle

classes.

Awareness & Acceptability: Based on

various research and surveys conducted in

other emerging markets, especially with a

similar growing middle income population,

a rise in an overall affordability of the

population paved way for a better

awareness of advantages of good health

and nutrition based treatments along with

a more holistic approach towards a

healthier lifestyle. On the ground level we

see a similar change here in Pakistan,

though at an initial stage in the upper-

middle class but expected to gradually

move down the social classes pyramid.

Accessibility: SEARL has incurred double

digit growth in selling and marketing

expenses in the last three years with a

similar growth expected going forward. The

rise in expenses, except salaries, is primarily

driven by increasing efforts in marketing

the products via both (i) obtaining new and

maintaining old contracts with hospitals,

which remain influential due to the large

proportion of prescriptions for chronic

ailments, (ii) reaching out to more remote

pharmacies and clinics; including moving

down the physician pyramid that may drive

some of SEARLs’ best sellers (Nuberol Forte,

Hydrallin, Peditral, Extor, Metrozine,

Spiromide, Sustac, Rotec, Tramal, etc) in

chronic heart diseases, common cold, and

analgesics product lines.


March 30, 2017


Pakistan with 3.63% of market share, based on Q3 2016 data obtained from Information

Medical Statistics (IMS).

iii. Demographics, demographics, demographics (Accessibility)

The third significant growth driver remains the very demographics of Pakistan’s

population. Being the sixth largest nation in the world with over 203mn natives growing

at ~2.0% annually, according to the World Population Data Sheet 2016 – issued by

Population Reference Bureau, it offers a massive potential for growth in its pharma

industry. Pakistan has a striking ~60% of total population living in rural areas, with bare

minimum facilities and drug unavailability (lack of outreach) whereas, an enormous ~60%

of total population is projected to be under 30 years of age.

To address the lack of outreach, SEARL has been determined to increase its salesforce to

over 1,750 (inclusive of factory workers) end of FY16 from an earlier 1,468 in FY15, not

only by moving down the ‘physician pyramid’ to drive growth in its chronic segments but

also to penetrate into the rural areas (lower strata) which remains a massive market still

untapped, even for the drugs treating mild illnesses. Staff salaries of PKR 602mn (FY16)

remain the largest header under the company’s marketing and distribution expenses of

PKR 2,420mn (FY16).

b) Product Portfolio Tailored to the Needs of the Local Market

Pertaining to the tailoring of product mix, SEARL has a wide range of popular brands

under its banner that provide treatment for lingering epidemics in the country. To better

analyze the effectiveness of available product portfolio, we break down the population

and leading causes into three groups; i) ‘1-14 Yrs’, ii) ’15-39 Yrs’, and ii) ‘40+ Yrs’.

Based on the data obtained from the highly renowned Institute of Health Metrics and

Evaluation (IHME), an independent population health research center – part of University

of Washington US, leading causes for deaths in Pakistan amongst ages ‘1-14’ were i) liver

diseases, ii) cardiovascular diseases, iii) malaria, and iv) respiratory diseases. For ’15-39’

group more common causes were i) HIV/TB, ii) Liver diseases, iii) Birth related diseases

and disorders (maternal), and iv) nutritional deficiencies, whereas for our last group of

‘40+’ primary causes noted were i) HIV/TB, ii) Birth related (maternal), iii) Liver diseases,

iv) digestive infections, and v) diabetes. The results indicate that some of the deadliest

diseases in Pakistan have been similar to those common in most of the markets SEARL

already operates (see graph in the following page).

Figure. 1 Leading Cause of Death (5-14 Years Age Group) Figure. 2 Leading Cause of Death (All Age Groups)

Source: Institute for Health Metrics and Evaluation (IHME), AHL Research Source: Institute for Health Metrics and Evaluation (IHME), AHL Research

4% 9%

15%

5%

12%

54%

Brain Infection Diarrheal disease Heart Disease

Malaria Respiratory infection Others

13%3%

4%

36%8%

35%

Birth infections Diabetes Diarrheal disease

Heart Disease Respiratory infection Others


March 30, 2017


Figure. 3 Massive Markets For Leading SEARL Product Mix in Both Emerging and Developed Economies (All Ages)

Source: Institute for Health Metrics and Evaluation (IHME), AHL Research

Exhibit. 2 Massive Markets For Leading SEARL Product Mix in Both Emerging and Developed Economies (All Ages)

AFG IND MYN PAK PHL SRL USA VNM

Cardiovascular 28.0% 27.0% 24.7% 32.8% 33.3% 36.7% 32.0% 35.5%

Digestive/Infection 12.9% 13.3% 8.1% 11.9% 12.3% 5.4% 3.8% 5.0%

Cancer 5.5% 6.6% 17.4% 9.0% 12.3% 11.5% 24.5% 18.1%

Diabetes 4.4% 7.4% 7.4% 5.5% 9.2% 13.1% 7.1% 8.3%

Respiratory 3.5% 11.8% 8.2% 5.2% 5.4% 9.0% 6.7% 0.0%

HIV/AIDS/TB 1.3% 5.8% 7.1% 3.4% 4.8% 0.7% 0.3% 4.1%

Liver 1.8% 2.3% 6.1% 1.5% 2.0% 3.4% 2.1% 2.9%

Birth Related 2.3% 0.6% 0.9% 1.3% 0.3% 0.1% 0.0% 0.0%

Malaria 0.0% 0.0% 0.0% 0.8% 0.0% 0.0% 0.0% 0.0%

Nutritional def. 0.3% 0.6% 0.4% 0.6% 0.6% 0.1% 0.2% 0.0%

Other 0.1% 0.3% 0.6% 0.2% 0.3% 0.3% 1.6% 0.3%

Source: IHME , AHL Research

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

AFG IND MYN PAK PHL SRL USA VNM

Cardiovascular Digestive/Infection Cancer Diabetes Respiratory HIV/AIDS/TB

Liver Birth Related Malaria Nutritional def Other


March 30, 2017


Figure. 4 Leading Cause of Deaths in PAK (Groups Defined) Figure. 5 Leading Cause of Death (All Ages Groups)

Source: IHME, AHL Research Source: IHME, AHL Research

Exhibit. 3 Leading Cause of Deaths in Pakistan (1990 - 2015)

Pakistan 1990 1995 2000 2005 2010 2015

Cardiovascular 21% 25% 28% 28% 31% 33%

Other 19% 20% 25% 26% 27% 22%

Birth Related 19% 17% 16% 14% 15% 14%

Digestive/Infection 27% 22% 19% 15% 14% 12%

Cancer 5% 6% 7% 7% 8% 9%

Diabetes 0% 0% 0% 4% 0% 6%

Respiratory 4% 5% 5% 5% 5% 5%

HIV/AIDS/TB 4% 4% 0% 0% 0% 0%

Source: IMHE, AHL Research

As shown in Exhibit 2-3 and Figure 3-5, SEARL’s broad range of product mix facilitates

treatment for leading causes of deaths in all its operational markets. Products range from

chronic heart diseases/cardiovascular; hypertension (BYSCARD | EXTOR), angina

(TENORMIN) and angina pectoris (SUSTAC | RANCARD XR | INDERAL), congestive heart

failure (SPIROMIDE), chest pain, pain palliative for chronic conditions such as joint aches

(TRAMAL | NUBEROL FORTE), arthritis, osteo and rheumatoid arthritis (ROTEC), diabetes

(JENTIN MET | HYLIXIA | CANDERAL), various respiratory, liver (METROZINE | METODINE),

and birth infections; amoebiasis, osteopenia, osteoporosis (OSTEGEM), neural tube

defects (M-FOLATE), chronic asthma, spastic form of chronic obstructive pulmonary

disease, anti-malarial, along with more common infections and diseases such as common

cold (HYDRYLLIN), allergies (XADINE), fever, and muscle ache.

0%

20%

40%

60%

80%

100%

1-14 years 15-39 years 40+ years

Birth related Cancer CardiovascularDiabetes Digestive/Infection HIV/AIDS/TBLiver Malaria Nutritional def

0%

20%

40%

60%

80%

100%

1990 1995 2000 2005 2010 2015

Birth Related Cancer CardiovascularDiabetes Digestive/Infection HIV/AIDS/TBOther Respiratory


March 30, 2017


A Few of the Leading Brands - To Provide for Growth in its Topline

c) Exports and Toll Manufacturing to Pick Up

Both exports and contracted toll manufacturing have facilitated support to the company

consistently over the years with over 10% of contribution to total sales, on average. Given

the expansion of Biopharma facility along with anticipated introduction of various new

drugs in the registration pipeline, we expect the exports and toll manufacturing to pick

up YoY in excess of historical quantum. Further, SEARL is in process of obtaining US FDA

approval which will not only help in registration of drugs going forward but will also help

in improving its exports and toll manufacturing.

On the back of all the factors discussed above, our conservative estimates signal a growth

of 20% YoY in net revenues for FY17 (PKR 11,435mn) followed by a 28% YoY growth in

FY18 (PKR 14,641mn) with a 5 Yr CAGR of 22% (FY16-21F).

Figure. 6 Category Leadership Brands


Exhibit. 4 Exports & Toll Manufacture Supporting Sales

Year End FY12 FY13 FY14 FY15 FY16

Exports 309 241 366 524 851

Toll Sales 245 237 311 271 291

% of Net Sales 11 9 11 10 12

Total Net Sales 4,936 5,150 6,072 7,582 9,525


Pakistan South AsiaEast Africa South-East AsiaMiddle East

Nuberol (Forte)

(Paracetamol + Orphenadrine Citrate)

• Treats painful muscle spasm associated with chronic low back pain, sprains, strains, prolapsed intervertebral disc, muscle injury, nonarticular rheumatism, tension headache, dysmenorrhea, and other Acute & Chronic painful muscular conditions.

Hydryllin (Syrup & Drops)

(Aminophylline + Diphenhydramine + Ammonium Chloride + Menthol)

• Treats Productive cough, Smokers cough, cough associated with Asthma, cough due to Bronchitis and other respiratory disease and infections.

Peditral (Sachet & Liquid)

(Sodium Chloride + Potassium Chloride + Sodium Citrate + Dextrose Anhydrous)

• Treats Productive cough, Smokers cough, cough associated with Asthma, cough due to Bronchitis and other respiratory disease and infections.

Extor

(Amlodipine + Valsartan)

• Treats Essential Hypertension


March 30, 2017


II. Industry Leader in Margins with a Promising Business Model for the LT

Recently, while stay order on hardship cases facilitated some of its competitors translating

into improved margins, Searle made significant advances of its own. In the 2QFY17, while

SEARL successfully managed its GM at 41%, its NM surged up to 29% from an earlier 20%

in FY16, providing a momentous headway compared to industry’s average of 13%.

With a focus on Biosciences and Consumer Goods in a growing economy (projected to

grow in excess of 8% from FY18 onwards), SEARL has over a hundred New Chemical Entities

(NCEs) in process of registration which, we expect, should provide stronger tailwinds to its

bottomline from FY18 onwards once they come in production (our estimates indicate NMs

in excess of 20% despite anticipated rise in overheads).

To add to it, while SEARL already has an extensive network of international operations

(Afghanistan, Sri Lanka, Myanmar, Vietnam, Cambodia, Philippines, etc.), the company is in

an early stage of exploring markets and registering products in some of the region’s fastest

growing economies with industries in excess of USD 1,000mn. Given the Drug Policy

exempts locally manufactured exporting medicine from price cap, an expansion in SEARL’s

Global Business Division should supplement future margins.

Going forward, we believe, with the higher-margin Bioscience’s sales expected to post

double digit growth coupled with possible enhancement of its existing pharma facilities,

SEARL may further increase its GMs up to ~42% while maintaining its NMs at current levels

(given the expected increase in its marketing efforts).

Figure. 7 Industry Margins Comparison - SEARL Leading the Pack in Net Margins


0.0

10.0

20.0

30.0

40.0

50.0

GM NM GM NM

2015 LQ

ABOT GSK SEARL FEROZ SAPL WYETH(%)


March 30, 2017


III. Preferred Pick with Largest Free Float and Anticipated Foreign Inflows

Coupled with the long term growth prospects, superseding margins, and a solid business

plan in place, SEARL gets our preference in the sector due to i) largest free float of

62.97mn in the sector, ii) inclusion in MSCI EM and FTSE Global Equity Index Series Asia

Pacific (ex-Japan), and iii) competitive advantage over various MNCs.

Having the largest free float in the pharmaceutical sector facilitates ample liquidity to the

scrip in turn enabling higher volumes and ease of trading. In fact, higher free float enabled

the stock to be included in MSCI EM and FTSE GEIS-AP due to its largest free float based

market capitalization. The inclusion is expected to bring further liquidity to the scrip via

increasing foreign interest.

In the local pharmaceutical industry a few key factors provide a competitive edge to local

manufacturers in the market. The most important factor remains the possibility of a

tailored internal policy that is in line with the regulations yet may provide endless

possibilities to the company in driving its margins. For example, while a MNC might only

run contracts via approved vendors or run lengthy QA checks through its parent to obtain

its approval, a local manufacturer can hunt cheapest available vendors meeting its quality

parameters both local and foreign.


March 30, 2017


Recommendation and Valuation

(Dec’17 TP at PKR 816.6 / share)

We value SEARL using a multiple stage DCF model with our valuation criteria as follows:

risk-free rate 8.0%, equity risk premium 6.0%, and beta factor 0.9x and a 5.2% terminal

growth (our FY17 GDP projection).

Based on our calculation, the sum of PV from discounted cash flows stands at PKR

60,216mn, along with PV from Terminal cash flow that comes at PKR 65,826mn. Our

Target Price for Dec’17 stands at PKR 816.6 /share.

Exhibit: 6 Valuation Snapshot

(PKR mn)

Sum of PV 60,216

PV Terminal CF 65,826

Net Debt (341)

Equity Value 125,701

No. of Shares (mn) 154

Total Value (Per Share) 816.6

Source: AHL Research

Exhibit. 7 Industry Snapshot

LQTD SEARL FEROZ GLAXO ABOT SAPL

GM (%) 41.00 43.40 27.50 41.20 33.70

NM (%) 28.93 13.60 10.20 19.70 7.60

ROE (%) * 31.80 20.00 19.70 31.40 18.20

ROA (%) * 22.70 17.00 12.90 23.80 7.20

Source: Company Financials, AHL Research, (*) Based on L12M Equity and PAT

Exhibit: 5 Valuation Criteria

Terminal Growth 5.2%

RfR 8.0%

Beta (Adj) 0.9

Risk Premium 6.0%

CoE 13.5%

Source: AHL Research


March 30, 2017


Risks to Estimates

Downside Risks & Mitigating Factors

The largest risk exposure to the sector comes from the lack of certainty on drug pricing

mechanism, especially in light of recent regulatory developments, as discussed earlier

under ‘Key Sector Considerations’.

With that said, unlike some of its biggest competitors in the local market, SEARL has a

much lower revenue dependency on products that may be classified as hardship cases.

It is also substantiated by documents released by DRAP from its Drug Pricing

Committee meeting held on 4th and 5th March, 2016 where no item produced by SEARL

was contested for a price hike. Secondly, another factor mitigating a possible hardship

case would be SEARL’s strong Global Business Division that could help company utilize

exemption from any local pricing cap as established under Drug Policy 2015 – discussed

earlier, and possibly export medicine at a profitable price.

Upside Risks

On the other hand, a possible upside risk to our estimates remains an exponential

growth in sales due to faster registration of pending Biopharmaceutical products, than

we anticipate.

Marketing and Selling & Distribution expenses are expected to mount going forward

while the company strives to create a sizeable market for its existing and upcoming

products. We have incorporated a double digit growth in our assumptions, while a well-

managed expenditure could pose a substantial upside risk to our estimates.


March 30, 2017


The Ever changing Pharma Landscape - Key Sector Considerations

ʘ Ministry of Health (MoH) controlled, assigned, and decided drug prices under the Drug Act of 1976. Price

Regulation Committee (PRC) worked under MoH and regularly monitored drug prices and decided ceiling

prices referred by MoH.

ʘ Drug Policy was adopted in 1992 (based on leader prices and CPI) but was deemed ineffective later due

to invalid classification of controlled and uncontrolled drugs. MoH dissolved and Drug Regulatory

Association of Pakistan (DRAP) came into existence under the DRAP Act 2012.

ʘ There were continued disagreements between Pakistan Pharmaceutical Manufacturers Association

(PPMA) and DRAP over its ineffective new drug registration and pricing mechanism that still stands in

place. PPMA’s discontent with DRAP stood on the premises that the regulatory authority made it too

difficult for the pharmaceuticals, both local and MNCs, to function with its micro monitoring of processes

while itself ignoring structural hurdles such as years long process of registration of NCEs and patenting.

ʘ From DRAPs perspective, according to various surveys conducted by private third parties, variety of

pharma products were being sold in the local market that were not only unregistered with DRAP but were

also made available at different prices. Hence, calling for stricter measures to keep the sector in check.

ʘ In 2013 DRAP decided to allow pharmaceuticals to raise prices on selected drugs up to 15% but then later

the decision was overturned. In response to which, pharmaceuticals sorted to approach the Supreme

Court and successfully obtained stay order to keep prices raised.

ʘ In 2016, DRAP’s Drug Pricing Committee (DPC) decided to increase prices by another 8% for different

drugs based on the increase in their raw materials.

ʘ In CY17TD, majority of the stay orders obtained from the Supreme Court against DRAPs decision to cap

the prices at prior levels are intact. All pharmaceuticals that have products eligible to be classified under

‘Hardship cases’ (loss making), as well as ‘Lower priced drugs’, as elaborated in 2015 Policy, are assumed

to maintain the stay orders in place.

While there remains uncertainty surrounding the outcome of the stay orders on hardship cases and

pricing of scheduled drugs, we expect the matter to either linger on until a decisive agreement is reached

between pharmaceuticals and DRAP or some concession/relief provided to both MNCs and local

manufacturers as the sector remains an essential part of the economy.


March 30, 2017


International Brands Limited – The Group

A distribution business under the banner of International Brands Limited (IBL) remains one

of the primary distributors for major FMCG labels such as Unilever Pakistan, British

American Tobacco, Bristol Myers Squibb, GlaxoSmithKline, Novartis, RJR Nabisco, Dow

Chemicals, and New Zealand Dairy Board. IBL embarked on joint ventures with Gillette,

P&G, Unisys, Dow, FMC, Pioneer, and RJ Reynolds. It acquired Gideon Daniel Searle

(originally founded in Nebraska, US in 1888) in 1993.

IBL’s core expertise lies in its ability of marketing and distribution across Pakistan which

only serves a competitive advantage to its group companies such as SEARL. With diverse

product mix and one of the largest distribution networks across the country (67 branches),

IBL's scope reaches out to all major business sections. Further, IBL functions more like a

business partner rather than the stereotypical distributor where its sub-distributors

(business partners) facilitate coverage even in the more remote areas where running

branches becomes infeasible for IBL.

Figure. 8 Strategic Organogram

Source: Company Financials, Company Profile, AHL Research

The Searle Company (SEARL) - Management

The company has been successfully steered for the past 9 years by Mr. Nadeem Ahmed –

Chief Executive Officer, a pharmaceutical and healthcare veteran with an extensive

experience of 26 years. Apart from SEARL, Mr. Ahmed is on the Board of IBL Healthcare

(IBLHC), United Distributors Ltd. (UDL), United Brands Ltd. (UBL), International Franchise

Ltd. (local partners of Dunkin Donuts), Habitt Home Store, IBL Operations, and Unisys Pvt.

Ltd. and heads the Pricing Committee of Pakistan Pharmaceutical Manufacturers

Association (PPMA) forum as its Chairman.

Working besides the CEO is Mr. Mobeen Alam serving the chair of Chief Financial Officer

and Director Finance at The Searle Company. Spanning over a decade, Mr. Alam’s

experience has been tied mostly to IBL and the company, working in various functions from

internal audit to strategic initiatives. Prior to SEARL, Mr. Alam was associated with

PricewaterhouseCoopers Pakistan. Along with the CEO and CFO, SEARL has a team of

experienced Directors, all veterans of pharmaceutical and healthcare industries.

International Brands Ltd(IBL)

IBLHC (74.19%)

Nextar Pharma(70.34%)

Searle Pharma Ltd100%

Searle Labs Pvt Ltd100%

Searle Biosciences100%

IBL Identity Pvt Ltd(Al Abid Exports)

100%

The Searle Company(55.36%)

IBL Operations(FMCG/Pharma/Dist.)

United Brands(FMCG/Dist./Mkt.)

Habitt(Home Accessories)

IFL (Dunkin Donuts)


March 30, 2017


Shareholders’ Pattern (SEARL)

Exhibit. 8 Aggregate Shares Held Figure. 9 Aggregate Shares Held

No of Shares % of Shares

IBL LTD 83,397,698 54.18%

General Public 26,706,152 17.35%

Foreign Companies 42,154,752 27.39%

Banks & Institutions 10,439,687 6.78%

Others 23,341,430 15.16%

Total 153,931,293 100.00%

Source: Company Financials, AHL Research Source: Company Financials, AHL Research

54.18%

17.35%27.39%

6.78%

15.16%

IBL LTD General Public Foreign Companies

Banks & Institutions Others


March 30, 2017


SWOT Analysis

Manufacturing Facilities

1. Pharmaceutical Plant (Karachi – S.I.T.E) – Total plant area of 5.2 acres (138,000 sqft covered area). It is

the production site for Hydryllin and Nuberol (Forte), two of Searle’s flagship brands.

2. Pharmaceutical Plant (Lahore – Block I & II) – Total plant area of 119,136 sqft (55,000 sqft covered area).

The facility has an overall capacity of 5 million bottles per month of oral liquid and ~3 million packs of

tablets. Both blocks are integrated in a manner to achieve maximum flexibility and independence of

manufacturing dedicated products.

3. IV Infusion Plant (Lahore) – State of the art plant dedicated for making, filling and sealing infusion bottles.

Management is expected to expand their line of IV Solutions going forward. Currently, the plant produces

eleven (11) different products of different sizes.

4. Biotechnology Plant (Karachi – Port Qasim) – Biosciences is what is to become the fastest growing

revenue generator for SEARL in the coming years as the management is focused on expanding the high

margin business line.

5. Consumer Plant (Karachi – Korangi) – Total plant area 3,000 sq. yards (18,000 sqft covered area). The

plant is engaged in the manufacturing of consumer brands such as Canderel, Kaplan, and Metacil.

STRENGTH

Largest distribution network of parent company

Growing global presence

Profitable multinational partners (including toll manufacturing)

One of very few technologically advanced and purpose built biosciences manufacturing plant

In process of acquiring US FDA approval for its Bio-sciences plant (to help expedite drug registration)

Larger anticipated cash generation would enable either a higher payout or further expansion

Competitive advantage over various MNCs in availing cheaper raw materials, quicker registration process, and ease in switching between suppliers

WEAKNESSES

Higher than industry-average marketing costs (negatively

impacting SEARL’s net margins)

Higher marketing/branding costs for Consumer goods and

Bioscience products due to less awareness in public

(market creation)

Rapid continuous growth required in Biosciences (high

margin products) to improve margins and counter possible

rise in overheads (industry-wide)

Costs in penetrating into potentially high growth rural

areas

OPPORTUNITIES

Expected growth in middle class and its disposable

income to lead to disproportionate growth in

nutrition based (biopharmaceutical) products and

consumer goods

Export to other rapidly growing economies besides

Pakistan (Argentina & Romania)

Mark additional affiliations with corporates, hospitals,

and health insurance companies to market both its

prescription and OTC drugs

With various MNCs struggling to cope with the

changing regulations’ landscape, SEARL has the

potential to capture the opening gap in supply and

demand for pharmaceuticals.

THREATS

Biosciences market penetration from other local and

international pharmaceuticals

Unfavorable Drug Policy implementation

Continued rise in overheads (cost of manpower and

energy)

Possible competition from market penetration from

Chinese imports

Political and law and order instability to pose challenges


March 30, 2017


Financial Highlights

Exhibit. 9 Income Statement

(PKR mn) FY15A FY16A FY17E FY18F FY19F

Net Sales 7,582 9,525 11,435 14,641 17,861

Gross Profit 3,332 3,714 4,722 6,285 7,680

Other Income 806 1,806 2,471 2,563 2,663

Financial Charges (190) (110) (108) (59) (60)

PAT 1,435 2,089 3,085 3,514 3,924

EPS PKR 9.32 13.57 20.04 22.83 25.49

DPS PKR 2.00 5.00 7.00 9.00 10.00


Exhibit. 10 Balance Sheet

(PKR mn) FY15A FY16A FY17E FY18F FY19F

Shareholders' Equity #REF! 4,548 8,180 10,495 12,932 15,471

Non-Current Liabilities #REF! 713 508 866 723 580

Current Liabilities

Trade and Other Payables #REF! 1,617 1,819 1,958 2,785 3,394

Other Current Liabilities #REF! 804 702 605 155 280

Total Liabilities and Equity #REF! 7,979 11,506 14,220 16,891 20,021

Assets

Non-Current Assets #REF! 3,730 6,001 7,022 7,485 7,698

Current Assets #REF! 4,248 5,506 7,198 9,407 12,323

Total Assets #REF! 7,979 11,506 14,220 16,891 20,021


Exhibit. 11 Ratio Analysis

FY15A FY16A FY17E FY18F FY19F

Gross Margins % 43.9 39.0 41.3 42.9 43.0

Net Margins % 18.9 21.9 27.0 24.0 22.0

ROE % 37.3 32.8 33.0 30.0 27.6

ROA % 20.1 21.4 24.0 22.6 21.3

Dividend Yield % 0.3 0.9 1.1 1.5 1.6

P/E x 73.6 42.0 30.7 27.0 24.2

P/B x 12.2 8.3 8.8 7.2 6.0



March 30, 2017


Analyst Certification: The research analyst(s), is (are) principally responsible for preparation of this report. The views expressed in this research

report accurately reflect the personal views of the analyst(s) about the subject security (ies) or sector (or economy), and no part of the

compensation of the research analyst(s) was, is, or will be directly or indirectly related to the specific recommendations and views expressed by

research analyst(s) in this report. In addition, we currently do not have any interest (financial or otherwise) in the subject security (ies).

Furthermore, compensation of the Analyst(s) is not determined nor based on any other service(s) that AHL is offering. Analyst(s) are not subject

to the supervision or control of any employee of AHL’s non-research departments, and no personal engaged in providing non-research services

have any influence or control over the compensatory evaluation of the Analyst(s).

Equity Research Ratings

Arif Habib Limited (AHL) uses three rating categories, depending upon return form current market price, with Target period as December 2015

for Target Price. In addition, return excludes all type of taxes. For more details kindly refer the following table;

Rating Description

BUY Total return of subject security(ies) is more than +10% from last closing of market price(s)

HOLD Total return of subject security(ies) is between -10% and +10% from last closing of market price(s)

SELL Total return of subject security(ies) is less than -10% from last closing of market price(s)

Equity Valuation Methodology

Following valuation technique is used to arrive at the target price of subject security (ies);

Discounted Cash Flow (DCF)

Risks

The following risks may potentially impact our valuations of subject security (ies);

Market risk

Interest Rate Risk

Exchange Rate (Currency) Risk

Disclaimer: This document has been prepared by Research analysts at Arif Habib Limited (AHL). This document does not constitute an offer or solicitation for

the purchase or sale of any security. This publication is intended only for distribution to the clients of the Company who are assumed to be reasonably sophisticated

investors that understand the risks involved in investing in equity securities. The information contained herein is based upon publicly available data and sources

believed to be reliable. While every care was taken to ensure accuracy and objectivity, AHL does not represent that it is accurate or complete and it should not be

relied on as such. In particular, the report takes no account of the investment objectives, financial situation and particular needs of investors. The information given

in this document is as of the date of this report and there can be no assurance that future results or events will be consistent with this information. This information

is subject to change without any prior notice. AHL reserves the right to make modifications and alterations to this statement as may be required from time to time.

However, AHL is under no obligation to update or keep the information current. AHL is committed to providing independent and transparent recommendation to

its client and would be happy to provide any information in response to specific client queries. Past performance is not necessarily a guide to future performance.

This document is provided for assistance only and is not intended to be and must not alone be taken as the basis for any investment decision. The user assumes

the entire risk of any use made of this information. Each recipient of this document should make such investigation as it deems necessary to arrive at an independent

evaluation of an investment in the securities of companies referred to in this document (including the merits and risks involved), and should consult his or her own

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arise to any person from any inadvertent error in the information contained in this report.

© 2017 Arif Habib Limited: Corporate Member of the Karachi, Lahore and Islamabad Stock Exchanges. No part of this publication may be copied, reproduced,

stored or disseminated in any form or by any means without the prior written consent of Arif Habib Limited.


March 30, 2017


Contact Information

Shahid Ali Habib Chief Executive Officer [email protected] +92 -21-3240-1930

Research Team

Shahbaz Ashraf, CFA Head of Research [email protected] +92-21-3246-2589

Tahir Abbas VP- Senior Investment Analyst [email protected] +92-21-3246-2589

Syed Fawad Basir AVP- Investment Analyst [email protected] +92-21-3246-2589

Rao Aamir Ali AVP- Investment Analyst [email protected] +92-21-3246-2589

Syed Shiraz Zaidi Investment Analyst [email protected] +92-21-3246-1106

Muhammad Waleed Rahmani Investment Analyst [email protected] +92-21-3246-1106

Misha Zahid Investment Analyst [email protected] +92-21-3246-1106

Arsalan M. Hanif Investment Analyst [email protected] +92-21-3246-1106

Muhammad Hasnain Madni Officer- Database [email protected] +92-21-3246-1106

Minhal Shahid Management Trainee [email protected] +92-21-3246-1106

Equities Sales Team

Azhar Javaid VP- International Sales [email protected] +92-21-3246-8312

Usman Taufiq Ahmed AVP- International Sales [email protected] +92-21-3246-8285

M. Yousuf Ahmed SVP- Equity Sales [email protected] +92-21-3242-7050

Syed Farhan Karim VP- Equity Sales [email protected] +92-21-3244-6255

Farhan Mansoori VP- Equity Sales [email protected] +92-21-3242-9644

Afshan Aamir VP- Equity Sales [email protected] +92-21-3244-6256

Atif Raza VP- Equity Sales [email protected] +92-21-3246-2596

Furqan Aslam AVP- Equity Sales [email protected] +92-21-3240-1932

Adeel Ahmed VP-Head of Online [email protected] +92-21-3246-0045

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Documents

We initiate coverage of The Searle Company Ltd. (SEARL ...arifhabibltd.com/.../uploads/2017/03/Initiation-Report-SEARL.pdf · The Searle Company Limited (SEARL) Page 3 March 30, 2017