erste bank - cee sector reports_ erste sector healthcare

Erste Group Research – Sector Report All prices are those current at the end of the previous trading session unless otherwise indicated and are sourced from local exchanges via Reuters, Bloomberg and other vendors.

Erste Group Research Erste Sector Healthcare | HEALTH CARE | 20 March 2013

Erste Sector Healthcare

2013 CEE pharma sector outlook Solid fundamental stories to be augmented by interesting news flow. Top CEE pharma stocks offer good investment opportunity in 2013.

Vladimira Urbankova [email protected]

Antibiotice, Biofarm contribution

Raluca Ungureanu [email protected]

Contents

Executive Summary 2

Valuation/Recommendation 4

Market Overview 8

2012 results review 23

2013 guidance / Erste forecast 26

Antibiotice 27

Biofarm 34

Bioton 41

Egis 49

Krka 59

Richter Gedeon 68

Contacts 79

Disclosures & Disclaimer 80

Apart from their healthy business performance, supported by the dynamically developing Russian market and persistently weak forint, Hungarian pharma companies are poised to deliver interesting news flow this year. The R&D foray of Richter should bring more tangible results, with the cariprazine-based product anticipated to get the OK from the US FDA, while the biosimilars cooperation deal with Celltrion (with the first product launch in mid-2013) should brighten Egis’ prospects. We think that the current shares of both Hungarian pharmas still fail to adequately reflect these developments and hence our Buy recommendations for Richter (with a revised target price of HUF 45,265 per share) and Egis (with a revised target price of HUF 25,700 per share) are fully justified. We believe that Krka’s 2013 sales outlook is very sound, with its performance driven by fast progress in Russia (where its big investment is nearing completion), as well as its patent expiration-oriented growth in Western European markets. Although Krka’s news pipeline does not seem as exciting as that of its Hungarian peers and its profitability recently took a hit from unfavorable regulatory measures in the CEE region, we believe that following the recent share price correction the upside potential of the stock (supported by the ongoing share buyback) has yet to evaporate; with our revised target price of EUR 65.0 per share we stick to our Buy call. In the absence of positive one-offs, Bioton is poised to see a rather dramatic y/y drop on both the operating and bottom lines in 2013. Nonetheless, the recent profitability progress, driven by an improving sales mix as well as cost control, is encouraging. This, along with finding a new partner (following the Actavis contract termination) and better transparency on the contribution of Biolek and Biosenso to the company’s results, continues to represent a precondition for a return of investors’ confidence. With our new DCF-derived target price arriving at PLN 0.06 per share, we leave our Hold recommendation unchanged. Reflecting expanding exports as well as the lower clawback tax toll, we increase our target price for Antibiotice to RON 0.480 and upgrade the stock from Reduce to Hold. We stick to our opinion that Biofarm is better endowed to resist home market pressures, given its significantly lower exposure to the Rx segment, as well as stronger financial position. Stable and generous dividend policy as well as steady buying interest of SIFs represents another supportive argument for Biofarm’s story. While we revise our Biofarm target price from RON 0.218 to RON 0.252 per share and downgrade the stock to Hold, we would advise investors to accumulate the stock on any possible weakness in future. IF YOU DON’T SEE THE LINES- go to Table > show raster lines We want to have the lines fixed yin the future, if we can find a way to do it.

ISIEmergingMarketsPDF ro-kpmg6 from 62.217.241.204 on 2013-09-10 09:15:28 EDT. DownloadPDF.

Downloaded by ro-kpmg6 from 62.217.241.204 at 2013-09-10 09:15:28 EDT. ISI Emerging Markets. Unauthorized Distribution Prohibited.

Erste Group Research – Erste Sector Healthcare – 20 March 2013


Executive Summary

Recommendations and target prices at a glance

Company Currency Recommendation Recommendation Target price (LC) Target price (LC) Current Price (LC) Upside potential (%)

before now before now

Antibiotice RON Reduce Hold 0.3550 0.4800 0.4550 5.5%

Biofarm RON Accumulate Hold 0.2180 0.2520 0.2355 7.0%

Bioton PLN Hold Hold 0.07 0.06 0.06 0.0%

Egis HUF Buy Buy 22,850 25,700 18,895 36.0%

Krka EUR Buy Buy 69.0 65.0 48.6 33.9%

Richter Gedeon HUF Buy Buy 50,460 45,265 33,345 35.7%

Source: Erste Group Research. Based on closing prices as of March 18, 2013

The CEE pharma stock performance was relatively volatile and far from shiny last year, with the economic crisis taking its toll, slashing stock liquidity and putting a lid on share prices. Thus, the CEE pharmas started 2013 at attractive valuations, propelling (in some cases) at least a partial recovery YTD. Despite this, we continue to believe that there is more to come and that, in particular, both Hungarian stocks’ upside potential remains ample, with the improvement of international investors’ sentiment towards the Hungarian equity market adding to the sound fundamental prospects, augmented by interesting news flow from their product pipelines.

The 4Q12 reporting season confirmed that, contrary to some initial worries, 2012 was another relatively solid year for CEE pharma companies from the business perspective. The still buoyant Russia/CIS (the crucial export territory) compensated for their suffering in their home CEE regional markets, depressed by cost savings-oriented healthcare reforms. Importantly, the top regional pharma companies did not take a break in building up innovative product portfolios, the key prerequisite for their long-term success. With the first benefits to become more visible soon, we believe that the top CEE pharma stocks - Krka, Richter and Egis - represent top investment picks, not only for traditional risk-averse, defensive sector-oriented investors, but also for those who want to find investment stories with attractive news flow-driven upside. We reviewed our models and set new 12-month target prices for CEE pharma stocks. The 2012 results clearly demonstrated that the benefits of the weak forint weak, coupled with the robust Russia/CIS showing, more than compensated for the negative impact of the Hungarian government’s cost savings measures on Hungarian export-geared pharma companies. Moreover, the R&D-based relief to the OEP payments burden, a beneficial measure deemed originally to be just of a temporary nature, has been prolonged indefinitely. The cariprazine-based product, the first original drug from Richter’s pipeline in cooperation with Forest Laboratories, is set to take more decisive steps on its way to the market, providing a trigger to Richter’s valuation/stock price. Egis’ partnership on biosimilars marketing/distribution with Celltrion is expected to yield more tangible results soon, with the first product to be introduced to the market by mid-2013. In summary, incorporating the somewhat less harmful risk-free rate, along with the positive impact of the weaker than originally anticipated forint, our new target prices arrive at HUF 45,265 per share for Richter and HUF 25,700 per share for Egis, with upside potential of 35.7% and 36.0%, respectively. In summary, we reiterate our Buy recommendations for both firms.





Fueled by the hefty y/y pickup in Russia/CIS, complemented by healthy Western European market sales, Krka met its guidance, delivering 2012 consolidated sales growth of 6.3% y/y (to EUR 1,143.3mn). Although the region-wide pricing pressures accompanying healthcare reforms depressed the operating profitability margin, with the regional currencies’ weakness grip on the financial result easing in the course of the year and the effective tax rate decreasing, the company’s net profit slid by just 1.8% y/y (to EUR 159.9mn). While Krka keeps its regional competitive edge and its profitability margins, supported by its innovative generics pipeline, as well as efficient cost control, continue to be above those of its peers, the distance last year got somewhat narrower. On the other hand, the 2012 drop means that a new room for progress opened for this traditional outperformer among the CEE pharmas. Our revised target price of EUR 65.0 per share suggests 33.9% upside potential from the recently depressed share price levels. Consequently, we stick to our Buy call on the stock. Boosted by the Actavis cooperation contract related milestone, Bioton swung as expected into the black in 2012. Although the benefits from the numerous cooperations in Bioton’s core insulin business (with Bayer in China and GSK in Russia), as well as the Biolek and Biosenso acquisitions, have yet to show their transforming effect on the company’s business performance, it was encouraging to see that the underlying profitability has started to improve. Should the company be able to find a new partner(s) following the Actavis deal termination, as well as improve its transparency, Bioton has the potential to become the next real turnaround story. Keeping the earlier introduced risk related discount of 10% in our DCF valuation, our revised 12-month target price arrives at PLN 0.06 per share (vs. the earlier PLN 0.07). Consequently, we leave our Hold recommendation unchanged for the time being. While the 2012 results of the Romanian pharmaceutical companies were relatively solid at first glance, witnessing strong double-digit y/y bottom line growth tempo, a second look already points to the assistance of one-off factors (particularly in the case of Biofarm). Moreover, the 2013 sales outlook is far less encouraging and, despite the promising news on government plans to channel more money into healthcare and adjust the calculation of clawback tax downwards (excluding the VAT from the base), payment discipline is likely to remain poor and the clawback tax remains relatively high, burdening the pharma sector. Reflecting the accelerating exports pace along with the lower than originally expected clawback tax toll, we revise our 12-month target price for Antibiotice up to RON 0.480 per share (from RON 0.355 per share) and upgrade our recommendation from Reduce to Hold. We continue to believe that Biofarm’s investment story continues to overshadow that of Antibiotice. Although mounting marketing expenses are set to somewhat dampen profitability margins, helped by its competitive edge in the Romanian OTC sector (which is affected to a lesser extent by home market woes than the Rx segment) and healthy balance sheet, the company should be able to sustain the generous dividend program on which it embarked last year. Nonetheless, after the recent stock price rally, most of the advantages are already priced in. Our revised 12-month target price arrives at RON 0.252 per share, pointing to the currently evaporating upside potential for the stock. Consequently, we downgrade our recommendation to Hold, but we recommend investors to watch the stock, with any possible weakness in future seen as a good entry opportunity.





Valuation/Recommendation

A brief look at the current valuations demonstrates clearly that the top CEE pharma players’ stock prices remain at very appealing levels that fail to reflect their strong fundamentals and upcoming triggers. While for Richter and Egis, their Hungarian home continues to represent a potentially deterring factor from the international investors’ perspective, it is fair to say that, given their high export gearing, they remain beneficiaries of the Hungarian currency’s persistent weakness. Although the pharmaceutical market in Hungary is being hurt by unfavorable regulation and depressed prices (and profitability margins), the pharma industry could celebrate at least one partial victory in getting back (this time for an indefinite period) the R&D-based relief from their payment obligation to the state. The fast expanding exports (backed by their strong presence in Russia/CIS) further reduce the dependence of Hungarian pharma companies on their troubled home market and bode well for both Egis and Richter’s business results. On top of that both, Richter and Egis’ news flow pipelines promise to overshadow any possible home related woes in 2013. Despite the recent appreciation, Egis maintains its status as the cheapest CEE pharma stock; its valuation gap remains wide, with the stock currently traded at a 35.6% discount on 2013e PER and a 35.1% discount on 2013e PCE ratios of the CEE-based peer group. We continue to think that this is only partly justifiable by Egis’ somewhat subdued profitability parameters, which are in the medium term still hurt by the company’s relatively high exposure to the regulator-overburdened Hungarian market, as well as the somewhat less advantageous sales mix compared to its peers. After posting a -7.9% YTD performance, Richter maintains its position as the most expensive among the CEE-based pharmas. However, its multiples are still very appealing from a historical perspective, as well as in comparison with its Western-based peers. Furthermore, we continue to believe that its well-defined niche portfolio strategy and original R&D program related triggers warrant Richter’s premium. Should it return to the MSCI index later on (it was excluded due to liquidity reasons in November 2012), Richter’s premium would increase further. Our new target prices (HUF 25,700 per share for Egis and HUF 45,265 per share for Richter) reassure us that both Hungarian pharmas offer interesting upside from the current price levels. We thus stick to our Buy recommendations for both companies.

2013e 2014e 2013e 2014e 2013e 2014e 2013e 2014e 2013e 2014e

Egis to CEE Peers, Prem/Disc -35.6% -32.0% -35.1% -29.1% -21.6% -24.0% -56.4% -57.4% -53.4% -54.2%

Egis to Western Peers, Prem/Disc -37.4% -30.3% -53.0% -33.7% -75.2% -74.9% -69.6% -69.1% -68.5% -67.5%

Egis to Richter, Prem/Disc -40.2% -38.4% -39.9% -38.0% -33.5% -35.0% -57.7% -58.3% -56.7% -56.8%

Source: Erste Group Research, Factset, based on closing prices as of March 18, 2013

P/E P/CE P/BV EV/sales EV/EBITDA

Contrary to its Hungarian peers, Krka’s visible news pipeline for 2013 remains somewhat less exciting. Although the 2012 results, with gross and operating profitability margins sinking below its traditionally defended levels of 60% and 20%, respectively, somewhat shattered investor confidence, they sent Krka’s stock price to very appealing levels. Furthermore, with 2012 now representing a rather historically low comparative base, new room for improvement has opened up for this traditionally reliable outperformer among CEE pharmas. With respect to the undeniable role that one-offs played in the worse than anticipated operating profit in 2012, the first steps can be seen already in 2013. Although region-wide pricing pressures will likely keep a lid on the full recovery of its profitability margins

Given their high export gearing, Richter and Egis remain beneficiaries of the Hungarian currency’s persistent weakness Progress on cariprazine’s path to market is not yet adequately reflected in Richter’s share price Egis’ valuation gap and new catalysts in news pipeline (particularly in biosimilars cooperation deal) remain inviting Krka’s sound fundamentals not yet factored into share price





in the near term, we continue to believe that Krka’s long-term, sound fundamentals-based investment story remains largely intact. Krka has all the prerequisites to maintain solid sales growth tempo in 2013, taking advantage of its strong position in the dynamically expanding Russia/CIS markets as well as benefiting from its superior R&D pipeline (boding well for performance in Western European markets). Going forward, the stock performance should be bolstered by the company’s ongoing gathering of treasury shares. As of February 7, 2013, Krka lifted the number of treasury shares to 2,353,706, corresponding to 6.644% of the total capital (while the approved upper limit is at 10%). Following the recent share price fall, Krka continues to be traded not only at a discount to its Western peers, but also compared to Richter (e.g. P/CE, EV/Sales, EV/EBITDA). Our revised target price of EUR 65.0 per share suggests solid upside potential and hence we reiterate our Buy call on the stock.

2013e 2014e 2013e 2014e 2013e 2014e 2013e 2014e 2013e 2014e

Krka to CEE Peers, Prem/Disc -7.7% -10.5% -7.9% -7.7% 34.8% 30.4% -3.2% -2.2% -7.7% -7.2%

Krka to Western Peers, Prem/Disc -10.3% -8.3% -33.3% -13.6% -57.3% -57.0% -32.5% -29.2% -37.7% -34.2%

Krka to Richter, Prem/Disc -14.3% -19.0% -14.7% -19.2% 14.5% 11.4% -6.2% -4.4% -14.3% -12.5%



As before, Bioton’s multiples witnessed the profound impact of one-offs on the company’s results. Subtracting the bolstering impact of milestones, Bioton’s valuation parameters (except for P/BV) are still the most demanding in the CEE pharma universe. In the course of 2012, not only did the restructuring/cooperation deal related news flow intensify, but the company also recorded the first sizable payment from the finally concluded Actavis deal. Nonetheless, in January 2013, the company saw the deal terminated, as Actavis’ strategy has changed, following its acquisition by Watson Pharmaceuticals. On top of that, investors started to lose patience, with the cooperation-based business facing a slow start (the Bayer cooperation contract in China), or even more serious difficulties (Indar in Ukraine not yet on-stream, contrary to expectations), and the Biolek and Biosenso acquisitions bringing dilutive effects. While in 2012 Bioton’s stock performance topped the CEE pharma universe (also thanks to its low price, with every groszy change translating into a double-digit move), the 2013 YTD performance has been the worst in the CEE pharma universe. Still, there was something encouraging in the last two quarters, as Bioton managed to finally move out of the red on the operating level. Management is committed to a more sustainable switch to black numbers. Nonetheless, for the time being, profitability margins are expected to remain well below those of its peers. Incorporating the better than originally anticipated underlying profitability parameters, somewhat compromised by the dilutive effects of the Biolek acquisition deal, our 12-month target price for Bioton arrives at PLN 0.06 per share. While we appreciate the recent progress, we think that uncertainties related to the company’s future prospects remain rather high, prompting us to stick to the earlier introduced risk related discount of 10%. We leave our Hold recommendation unchanged.

2013e 2014e 2013e 2014e 2013e 2014e 2013e 2014e 2013e 2014e

Bioton to CEE Peers, Prem/Disc 426.5% 50.2% 53.3% 7.7% -57.7% -56.5% 32.3% 19.8% 101.0% 40.5%

Bioton to Western Peers, Prem/Disc 411.6% 53.8% 11.1% 0.8% -86.6% -85.7% -7.8% -13.3% 35.6% -0.4%



Excluding one-offs, Bioton’s multiples remain most demanding; however, should company be able to accelerate and steady its recent profitability progress, reaping more benefits from its numerous cooperation deals, potential for stock’s appreciation/valuation is ample





The Romanian pharma companies’ valuation multiples, especially those of Biofarm, continue to be relatively very demanding in the current context of the CEE pharma universe. As per tradition, Biofarm is traded at a premium to its local peer Antibiotice. In addition, following its recent share price rally bolstered by the ongoing share accumulation by SIFs, Biofarm is not only more expensive than Antibiotice, but also in some parameters trading at a premium to Krka and Richter. We continue to believe that the gap between the Romanian pharma peers is fully justified. Given its more favorable sales mix (with a high proportion of OTC drugs vs. Antibiotice’s high exposure to the Rx segment) combined with a more solid financial position (practically zero external debt, while its peer is forced to take short-term loans to cover its working capital needs) Biofarm represents the preferred choice for investors considering an investment in the Romanian pharma sector, as well as those looking for a decent (and sustainable) dividend yield in the shaky market environment. Nonetheless, as before, Biofarm’s meager stock liquidity continues to be a major brake for foreign institutional investors, in our opinion. Biofarm status as a possible strategic takeover target continues to represent the main possible impetus for a change in the attitude of international investors in the future. Finally, it is worth mentioning that, despite its relatively high exposure to the rather problematic Romanian market, Biofarm’s operating and net profitability parameters are even better than those of Richter at the moment. With the negative impact of the fierce competition on the Romanian OTC market to be more than counterbalanced by good cost control and export efforts, we increase our target price from RON 0.218 to RON 0.252 per share. However, with respect to the recent share price appreciation, we downgrade our recommendation to Hold. Antibiotice’s multiples seem more attractive than those of its local peer. Nevertheless, we believe that, with its outlook clouded by high exposure to the Romanian Rx pharmaceuticals market (hampered by receivables collection problems as well as clawback tax toll), we think that Antibiotice’s share price does not offer much upside potential in the coming periods. Reflecting the accelerating export sales tempo as well as the less sizable negative impact of the domestic market burden (clawback tax reduced due to exclusion of VAT tax from the calculation base), we raise our target price to RON 0.480 per share and lift our recommendation for Antibiotice from Reduce to Hold.

2013e 2014e 2013e 2014e 2013e 2014e 2013e 2014e 2013e 2014e

Biofarm to CEE Peers, Prem/Disc 56.6% 27.6% 68.2% 53.3% 61.1% 53.5% 31.3% 16.5% 41.8% 27.4%

Biofarm to Western Peers, Prem/Disc 52.2% 30.7% 21.9% 43.4% -48.9% -49.4% -8.5% -15.7% -4.3% -9.6%

Biofarm to Antibiotice, Prem/Disc 84.4% 55.1% 146.9% 95.2% 95.8% 85.1% 92.0% 55.1% 55.5% 36%



Biofarm remains our preferred choice in the Romanian pharma sector





CEE pharmaceuticals valuation at a glance

2011 2012e/p 2013e 2014e 2011 2012e/p 2013e 2014e 2011 2012e/p 2013e 2014e

Antibiotice 8.3 9.7 9.2 8.5 4.4 6.2 4.8 5.0 0.6 0.8 0.8 0.7

Biofarm 13.4 13.5 17.0 13.1 9.9 11.6 11.8 9.8 1.4 1.6 1.5 1.4

Bioton nm 18.7 57.3 15.5 -7.9 9.7 10.7 6.9 0.3 0.7 0.4 0.4

Egis 7.8 7.6 7.0 7.0 4.7 4.9 4.5 4.5 0.7 0.8 0.7 0.7

Krka 11.7 11.1 10.0 9.2 7.7 7.1 6.4 5.9 1.6 1.4 1.3 1.2

Richter Gedeon 11.5 13.2 11.7 11.4 7.7 8.6 7.5 7.3 1.3 1.3 1.1 1.0

Median CEE 11.5 12.1 10.9 10.3 6.2 7.8 7.0 6.4 1.0 1.1 1.0 0.9

Teva Pharmaceutical Industries Ltd. 8.1 7.6 7.9 7.3 8.1 6.9 6.4 6.0 1.6 1.6 1.6 1.4

Mylan Inc. 15.1 12.1 10.8 9.6 18.7 13.8 11.1 6.8 3.4 3.4 3.9 3.3

Actavis Inc. 19.0 15.4 11.3 10.1 15.0 10.6 8.3 6.3 3.2 3.2 3.0 2.7

Stada Arzneimittel AG 12.1 11.8 10.3 9.1 14.3 7.9 6.6 5.9 2.0 2.0 1.9 1.7

Ranbaxy Laboratories Ltd. 20.2 18.8 19.0 15.0 63.3 11.7 12.4 11.9 6.3 6.3 4.6 3.6

Recordati S.p.A. 12.4 12.5 11.2 10.4 10.4 10.2 9.6 8.6 2.5 2.5 2.2 2.0

Dr. Reddy's Laboratories Ltd. 20.9 19.6 16.6 14.8 16.7 16.0 14.2 13.4 5.2 5.2 4.5 3.6

Median Peer Group 15.1 12.5 11.2 10.1 15.0 10.6 9.6 6.8 3.2 3.2 3.0 2.7

CEE to Peer, Prem/Disc -24% -3% -3% 2% -59% -26% -28% -6% -68% -66% -68% -67%

Dividend yield

2011 2012e/p 2013e 2014e 2011 2012e/p 2013e 2014e 2011 2012e/p 2013e 2014e

Antibiotice 0.9 1.1 1.0 0.9 5.0 6.4 5.5 5.1 5.2% 0.0% 4.3% 4.7%

Biofarm 1.4 1.7 1.9 1.6 6.4 7.9 8.5 7.0 5.3% 5.5% 4.4% 5.3%

Bioton 2.6 2.8 1.9 1.6 -66.6 10.9 12.1 7.7 0.0% 0.0% 0.0% 0.0%

Egis 0.6 0.7 0.6 0.6 3.0 3.2 2.8 2.5 0.9% 1.3% 1.4% 1.4%

Krka 1.8 1.6 1.4 1.3 6.4 6.3 5.6 5.1 2.7% 2.9% 3.2% 3.5%

Richter Gedeon 1.7 1.9 1.5 1.4 6.0 8.2 6.5 5.8 2.2% 1.8% 2.2% 2.5%

Median CEE 1.5 1.6 1.5 1.3 5.5 7.2 6.0 5.5 2.5% 1.6% 2.7% 3.0%

Teva Pharmaceutical Industries Ltd. 2.8 2.3 2.4 2.2 8.6 6.9 7.5 6.9 2.2% 2.5% 3.1% 3.2%

Mylan Inc. 2.3 2.4 2.4 2.1 8.4 8.7 9.0 7.8 0.0% 0.0% 0.0% 0.0%

Actavis Inc. 1.9 2.9 2.1 1.9 7.9 12.9 8.9 7.7 0.0% 0.0% 0.0% 0.0%

Stada Arzneimittel AG 1.2 1.4 1.5 1.3 6.3 7.2 7.3 6.4 1.2% 1.7% 2.6% 2.9%

Ranbaxy Laboratories Ltd. 1.9 1.8 1.7 1.5 11.4 11.1 11.6 9.7 0.0% 0.4% 0.7% 0.9%

Recordati S.p.A. 1.6 1.9 1.8 1.7 6.5 8.2 7.4 7.0 4.2% 4.2% 4.6% 4.9%

Dr. Reddy's Laboratories Ltd. 2.9 2.8 2.4 2.1 11.9 12.9 11.1 9.6 0.8% 0.8% 0.9% 1.1%

Median Peer Group 1.9 2.3 2.1 1.9 8.4 8.7 8.9 7.7 0.8% 0.8% 0.9% 1.1%

CEE to Peer, Prem/Disc -18% -30% -30% -28% -35% -18% -33% -29% 216% 102% 214% 181%

Net margin

Company 2011 2012e/p 2013e 2014e 2011 2012e/p 2013e 2014e 2011 2012e/p 2013e 2014e

Antibiotice 17.2% 17.9% 18.2% 18.4% 7.1% 8.8% 8.4% 8.6% 7.4% 8.8% 8.7% 9.0%

Biofarm 22.5% 21.6% 22.5% 22.5% 16.6% 18.1% 13.5% 15.0% 10.4% 11.9% 9.1% 11.0%

Bioton -4.0% 25.8% 16.0% 21.0% -14.5% 6.2% 1.7% 6.8% -6.8% 3.2% 0.7% 2.6%

Egis 19.9% 23.0% 22.7% 22.9% 10.5% 14.0% 14.2% 14.3% 9.1% 10.7% 10.8% 10.1%

Krka 27.8% 24.7% 25.4% 25.9% 14.9% 14.0% 14.1% 14.3% 14.6% 13.5% 13.3% 13.2%

Richter Gedeon 27.7% 23.7% 23.2% 23.7% 16.1% 15.5% 14.3% 14.4% 11.3% 10.6% 9.7% 9.5%

Median CEE 21.2% 23.3% 22.6% 22.7% 12.7% 14.0% 13.8% 14.3% 9.8% 10.6% 9.4% 9.8%

Teva Pharmaceutical Industries Ltd. 32.6% 33.6% 31.9% 32.1% 24.2% 9.7% 21.6% 22.8% 19.8% 20.3% 17.9% 16.8%

Mylan Inc. 27.2% 27.7% 27.0% 27.3% 14.6% 16.0% 15.6% 15.9% 22.6% 32.2% 30.9% 27.5%

Watson Pharmaceuticals Inc. 23.7% 22.8% 23.5% 24.1% 5.7% 13.0% 13.3% 14.3% 16.6% 19.5% 24.1% 23.3%

Stada Arzneimittel AG 19.0% 20.0% 20.2% 20.7% 1.3% 5.8% 8.3% 9.0% 16.8% 15.7% 16.1% 16.3%

Ranbaxy Laboratories Ltd. 16.3% 15.8% 14.5% 15.0% -29.1% 7.5% 9.2% 9.7% 31.1% 24.7% 19.1% 18.1%

Recordati S.p.A. 24.7% 23.6% 24.3% 24.1% 15.2% 14.3% 14.4% 14.3% 19.9% 18.0% 18.0% 17.6%

Dr. Reddy's Laboratories Ltd. 24.4% 21.9% 22.0% 21.9% 14.7% 14.1% 14.4% 14.6% 24.9% 22.8% 21.7% 20.5%

Median Peer Group 24.4% 22.8% 23.5% 24.1% 14.6% 13.0% 14.4% 14.3% 19.9% 20.3% 19.1% 18.1%

CEE to Peer, Prem/Disc -13.0% 2.3% -3.9% -5.9% -12.7% 7.3% -4.2% -0.4% -50.8% -47.6% -50.9% -45.7%

Source: Erste Group Research, Factset, based on closing prices as of March 18, 2013, all data based on EUR terms

P/E P/CE P/BV

EBITDA margin ROE

EV/Sales EV/EBITDA





Market Overview Although the Eurozone was still trying to find the way out of its biggest financial crisis thus far, with worries about the health of the economy in Eurozone countries still mounting and economic indicators confirming the earlier recessionary fears, CEE equity markets ended mostly in positive territory in 2012. The renewed optimism in 4Q12, however, benefited mostly cyclicals, while the performance of defensives - including pharma stocks - was less impressive.

CEE pharma stocks’ performance in 2012

% Change

1Q12

% Change

2Q12

% Change

3Q12

% Change

4Q12

% Change

2012

% Change

YTD 2013

% Change

1Q12

% Change

2Q12

% Change

3Q12

% Change

4Q12

% Change

2012

% Change

YTD 2013

Antibiotice SA 5.5% -17.4% 11.8% -0.9% -3.5% 20.9% 4.1% -18.6% 9.6% 1.1% -6.1% 21.8%

Biofarm SA 3.6% -15.5% 9.5% 12.6% 8.1% 12.9% 2.2% -16.6% 7.4% 15.0% 5.2% 13.8%

BET (RO) 28.3% -14.1% 3.0% 8.6% 23.3% 8.5% 26.5% -15.3% 1.0% 10.9% 20.0% 10.4%

Bioton S.A. 66.7% -30.0% 0.0% 42.9% 66.7% -40.0% 78.9% -31.4% 2.8% 44.3% 82.1% -41.0%

WIG 20 Bench (PL) 6.6% -0.5% 4.2% 8.9% 20.4% -5.0% 14.4% -2.4% 7.1% 10.0% 31.6% -6.6%

Egis Plc -17.2% 0.0% 20.1% -0.1% -0.6% 7.4% -11.7% 3.2% 20.4% -2.2% 7.4% 2.3%

Richter Gedeon 10.7% -1.8% 4.3% -6.7% 5.9% -7.9% 18.2% 1.4% 4.6% -8.6% 14.4% -12.3%

BUX Bench (HU) 9.8% -10.1% 7.3% -2.2% 3.6% -0.1% 17.2% -7.2% 7.5% -4.3% 11.9% -4.9%

Krka -5.2% -16.2% 18.6% 0.4% -5.5% -2.9% -5.2% -16.2% 18.6% 0.4% -5.5% -2.9%

SBI Bench (SI) -0.9% -14.4% 14.0% 5.3% 1.8% -4.0% -0.9% -14.4% 14.0% 5.3% 1.8% -4.0%

Source: Erste Group Research, based on closing prices as of March 18, 2013

EUR termsLC terms

A closer look at the CEE pharma stocks’ 2012 performance data clearly demonstrates the high volatility on a quarterly basis (reflecting swinging market sentiment and uncertainties) as well as decreasing liquidity (mirroring drying up resources of investment funds allocated to the core CEE region along with their more savings and less trading-oriented mode of activity). Only a few CEE pharma sector stocks (Richter and - surprisingly - Bioton) fared better than the respective local stock indices. After the rather uninspiring 1Q12 performance, the second quarter meltdown sent the stock prices to new lows. For most of the CEE pharma stocks, the third quarter was the best one (with gains even in double-digit territory), but 4Q12 ended once again as only a mediocre period.

The prevailingly negative sentiment towards the challenging Hungarian equity market kept a lid on Richter and Egis’ share prices. Reflecting in part the significantly bigger home regulatory burden, Egis saw its share price performance lag somewhat behind that of its local peer Richter. Although Egis’ valuation gap was very appealing, and in 3Q12 the stock rebounded from its depressed levels, for 2012, Egis’ share price still recorded a slight 0.6% y/y drop in HUF terms (but 7.4% y/y rise in EUR terms). Despite the huge selling pressure, linked to its exclusion from the MSCI index, Richter fared better, closing in positive territory in 2012 in both HUF as well as EUR terms (up 5.9% y/y and 14.4% y/y, respectively). Although the diminishing appeal of the Hungarian equity market (with many international investors staying on the sidelines) took its toll and Richter’s stock liquidity contraction (of 10.3% y/y) was behind the MSCI index dropout, with a trading volume of EUR 791.2mn, the company maintained its top ranking in the CEE pharma universe in 2012. Helped by the finalization of some of the earlier promised corporate transactions and its status as a penny stock (with positive changes in the second decimal place in PLN terms translating into a double-digit rise),

2012: CEE pharma stocks’ performance far from shiny; Richter maintained its leading position in liquidity ranking (but not its place in MSCI index)





Bioton was the best performer in the CEE pharma sector universe, surging 82.1% in EUR terms in 2012 (vs. a WIG20 rise of 31.6%). In addition, Bioton, apart from Egis the only stock in the CEE pharma universe to do so, saw its liquidity improve y/y, with stock turnover expanding 5.3% y/y to EUR 104.6mn. As indicated by interim performance data, the two Romanian pharma stocks maintained their position as laggards, particularly in terms of liquidity. Although its stock liquidity contracted 64.5% y/y to just EUR 2.6mn, Romania’s Biofarm was still ahead of its local peer Antibiotice in 2012. This also applied to its share price development, with the Biofarm stock price appreciating 5.2% in EUR terms in 2012. With its share price falling 6.1% in EUR terms, Antibiotice was this time not only the worst performer among regional pharmas in 2012, but its already meager liquidity decreased quite a bit further (46.1% y/y to EUR 2.2mn), sending the stock to the bottom of the regional pharma stock ranking. The gathering of treasury shares (following the listing in Warsaw in April, the company renewed its share buyback program) did not prevent Krka’s liquidity from shrinking in 2012. Not only did its share price slip 5.5% y/y, making it the second worst performer in the CEE pharma universe, but Krka’s trading volume also plunged 11.5% y/y to EUR 153.2mn, sending it to the third position in the regional CEE pharma stock liquidity ranking, behind Egis, which it was able to overtake in 2011. Nonetheless, Krka kept its crucial importance for its home bourse. With its home trading volume of EUR 141.1mn, Krka accounted for nearly 50% of LJSE equity turnover in 2012. CEE pharma stocks liquidity in 2012

791.2

167.5 153.2104.6

2.6 2.2

-10.3%

13.9%

-11.5%

5.3%

-64.5%

-46.1%

-70%

-60%

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

0

100

200

300

400

500

600

700

800

900

Richter Egis Krka Bioton Biofarm Antibiotice

stock turnover (EUR mn) stock turnover y/y (%)

Addressing the problems associated with the Eurozone crisis is a long-term process. Although the worst seems to be over, the concerns about the public debt/banking sector situation in the most affected countries of the EU will not disappear overnight and investors’ confidence will return only gradually. Nonetheless, 2013 is anticipated to witness a turn for the better, with the CEE countries’ GDP tempo swinging (albeit only marginally and not for all of them) back into positive territory. Still, savings dominate the government programs and cost containment measures are set to continue to affect healthcare. As before, we think that the CEE-based generics producers’ pains should be minimized by the relative inelasticity of demand for their products, their cost competitiveness and well balanced territorial sales structure (with high exposure to the still solidly expanding Russia).

In 2013, CEE pharmas stock performance should benefit from strong news flow, while retaining safe haven appeal for risk-averse investors





Not only are their business prospects solid, but both Richter and Egis have more (and hopefully positive) news for investors in their pipeline for 2013. Richter’s investment story is set to get new triggers from the news flow along the road of the cariprazine-based CNS drug to the US market. Following the US FDA filing by Forest Laboratories, Richter is entitled to a milestone payment in the mid-teens in USD terms to be recorded in 1Q13. In the case of final approval by the US regulatory body (anticipated by the end of 2013), another - and this time even more sizable - payment is set to bolster Richter’s results. Investors will also closely watch the progress of cariprazine clinical trials in other indications as well as the preparations for its European markets’ entry. Last but not least, the Esmya sales pickup and news related to the ongoing clinical trials aimed at expanding the indication range will deserve investors’ attention in the course of 2013. Egis’ major anticipated news for 2013 includes its partner Celltrion’s progress in the EU registration of biosimilar products (to be marketed and distributed by Egis in selected CEE markets, including Russia), in particular the first product launch envisaged to take place in mid-2013. More information on further developments in the rosuvastatin supply contract with Watson Pharmaceuticals (recently renamed Actavis) would represent a bonus for Egis’ investors. Contrary to the previous periods, the home market of both Hungarian peers should not spoil investors’ appetite. Although pricing pressures are expected to continue to drag the pharmaceutical market down, they are envisaged to ease over time and, thanks to the R&D-based relief recently made a permanent measure, the negative impact will be at least partly mitigated. In addition, the Hungarian macroeconomic situation is expected to stabilize and the perceived risks attached to investments in Hungarian assets are set to decline over time. Although this will yield a less favorable forex situation from the exporters’ perspective, at the same time it should result in decreasing government bond yields, later on possibly to be accompanied by an upgrade of Hungary’s rating from the current junk status, both boding well for Hungarian pharma stocks’ valuations. Consequently, we believe that, although the impact of the home market cost containment measures is burdening Egis more than its home rival Richter, and that Egis’ profitability parameters remain (despite recent progress) somewhat behind the region’s best, Egis’ wide valuation gap to Richter and its regional peers is set to close (at least partially) in the coming periods. Unlike its Hungarian rivals, Krka does not have such a strong and relatively visible pipeline of good news for 2013. Following the contraction in 2012, Krka’s profitability parameters sunk below their traditionally high levels, but they nevertheless still surpass those of its Hungarian peers. Furthermore, the drop created new room for progress in forthcoming periods, while in the past, with its margins topping generics industry, Krka did not offer much upside potential in this respect. A territorially well-balanced sales structure, along with its modern generics portfolio, characterized by a high pace of innovation, is further cementing Krka’s defensive and strong fundamentals-backed investment case. Krka’s Warsaw listing is starting to show its first benefits, although the Ljubljana Stock Exchange remains a far more preferred place for international investors, capturing 92.1% of the total trading of Krka shares in 2012. Krka’s own share gathering on its home bourse is set to support the stock’s liquidity (as well as share price) further, and with the situation on the home investment front getting less tense, we expect that the selling pressures should ease in 2013. In addition, contrary to its Hungarian peers, investors in Krka shares traded on the Ljubljana Stock Exchange face no additional forex development related risks attached to the share price developments. With the 2012 share price drop, Krka entered the new year at very attractive levels and Krka’s relative undervaluation remains a strong argument in the stock’s favor.

Richter and Egis have more (and hopefully positive) news for investors in their pipeline for 2013 Egis’ wide valuation gap to Richter and its regional peers is set to close (at least partially) in the coming period Krka’s own share gathering on its home bourse is set to support the stock’s liquidity (as well as share price)





With Krka’s Warsaw trading volumes staying at a rather low level, Bioton remains the only pharmaceutical manufacturer listed on the Warsaw Stock Exchange offering reasonable liquidity. Nevertheless, with Bioton’s investment story still a bit shaky, long term-oriented investors continue to be on the sidelines, deterred by the lack of insight into the company’s transformation process. The encouraging developments as of lately, with the operating line in black territory in two subsequent quarters, failed to translate into a more stable appreciation trend for Bioton’s share price. Nonetheless, should the company be able to further improve its profitability parameters, delivering more of the restructuring gains as well as proceeds from cooperations, and shed more light on the whole turnaround progress, the stock should attract not only speculative investors in future. As before, from the international perspective, the meager stock liquidity represents the main obstacle for investing into both Romanian pharmas. Out of the two peers, Biofarm remains our preferred pick. Although at the current price levels Biofarm’s competitive advantages are largely priced in, we recommend investors watch the stock and (if liquidity issue is not a deterrent) accumulate it on a possible weakness, as we believe that, despite the challenging environment, Biofarm is set to post solid business results, allowing it to keep an attractive dividend policy. Its status as a possible takeover candidate augments the investment story in the long run.

CEE pharma shares offer interesting long-term upside potential

Company Currency Current Price (LC) 5-year-high (LC) Current price vs 5 y high (%) Target price (LC) Upside potential (%)

Antibiotice RON 0.4550 1.2730 -64.3% 0.480 5.5%

Biofarm RON 0.2355 0.3840 -38.7% 0.252 7.0%

Bioton PLN 0.06 0.86 -93.0% 0.06 0.0%

Egis HUF 18,895 23,890 -20.9% 25,700 36.0%

Krka EUR 48.6 104.8 -53.7% 65.0 33.9%

Richter Gedeon HUF 33,345 49,400 -32.5% 45,265 35.7%

Based on closing prices as of March 18, 2013; Source: Erste Group Research

The 2012 results of the CEE-based pharmaceutical companies, with the regional pharma markets delivering very sluggish sales growth in the best case, confirmed that, in times of economic slowdown and austerity measures, their home markets are far from safe havens. The unfavorable macroeconomic conditions, with the purchasing power of both patients and institutional state-linked health insurance buyers shrinking, put a lid on drug consumption in the CEE region for the time being. Although demand for pharmaceutical products and services is rather inelastic, reflecting cost containment measures and related price erosion, many CEE pharma markets witnessed a y/y drop in pharmaceutical sales in 2012 (for example, according to IMS, in value terms in wholesale prices, the Hungarian pharma market contracted 3.7% y/y in 2012). While generics remain the preferred choice, they cannot escape mounting pricing pressures, particularly in the Rx segment, with reimbursement levels critical for the sales success of a particular product. Regulations are becoming ever-more dampening for the market, with new limits imposed on the reimbursement in both absolute and relative terms. Lists of reimbursed products are getting shorter and practitioners are no longer allowed to prescribe the earlier drug range or see a cap on the overall prescription budget. Some product prescriptions are shifted to specialist competence or, in contrast, some of them are moved into the OTC area, where the patient has to fully cover expenses for medicines. The budget constraints have prompted many unorthodox

Bioton’s investment story still a bit shaky, long term-oriented investors continue to be on the sidelines, deterred by the lack of insight into the company’s transformation process The meager stock liquidity represents the main obstacle for investing into both Romanian pharmas. Out of the two peers, Biofarm remains our preferred pick CEE pharma markets: 2012 sales disappointing, 2013 outlook somewhat brighter, as major negative-impact of healthcare reforms already digested by industry.





measures, particularly in Hungary (but also in Romania) - most importantly, the introduction of industry taxes based on the amount of reimbursed drug sales and sales reps headcount. The healthcare reforms in the CEE region, targeting savings in pharmaceutical spending, have another undesirable impact on the pharma market, as the frequently changing regulations bring instability and high volatility for market participants, which face difficulties to adjust to ever-changing and very complex rules. The wholesale and retail companies tend to work with higher financial leverage and, given the worsening access to external financing (including higher interest costs), while state payment delays are chronic, they get squeezed and sometimes even forced out of business. The CEE producers have no other choice than to try to minimize the negative impact of the persisting pressures. Product portfolio management remains one of the antidotes. On one hand, the companies phase out products that are no longer profitable under new rules (for example, Richter already stopped delivering more than 10 products to the Hungarian pharma market in 2012 and more products are likely to follow in 2013). On the other side there is the acceleration of innovation, as new products tend to command higher prices (and margins). Krka’s patent expiration-oriented generics pipeline thus supports its position, not only in the West, but also in CEE markets. The optimization of the territorial sales structure (e.g. expanding presence in still quickly developing markets, such as Russia/CIS) is also a very efficient answer, as is operational cost streamlining (cutting headcount in sales and marketing in Hungary, e.g. at Egis and Richter). After the 2012 data confirmed the rather pessimistic sales guidance, 2013 should see a turn for better, as also suggested by the newly published guidance from the Hungarian pharmas. In addition, following robust growth in 2012, Russia/CIS is envisaged to remain a bright spot on the map, with the sales dynamism there foreseen to stay in double-digit terms on average. However, we believe that the CEE pharma markets’ long-term catch-up potential in drug consumption is untouched, as all of the major components of growth (ageing populations, increasing public healthcare awareness and progress in bringing innovative medicines to the market, including those addressing poorly treated and/or as yet not adequately diagnosed diseases) remain in place.

CEE pharmas performance in CEE markets (2012)

Hungary % Poland % Czech Rep. % Romania %

Sales y/y (%) of total sales Sales y/y (%) of total sales Sales y/y (%) of total sales Sales y/y (%) of total sales

EUR mn EUR mn EUR mn EUR mn

Richter Gedeon 107.0 -16.0% 9.5% 78.2 12.2% 6.9% n.a. n.a. n.a. 131.4 1.4% 11.6%

Richter Gedeon* 102.6 -16.5% 10.4% 78.2 12.2% 7.9% 29.1 14.4% 2.9% 31.3 0.6% 3.2%

Egis 102.4 -18.3% 22.1% 56.4 -5.5% 12.2% 19.0 5.1% 4.1% 18.1 5.2% 3.9%

Krka 48.7 -23.5% 4.3% 111.6 2.4% 9.8% 67.0 4.2% 5.9% 47.0 -3.3% 4.1%

Source: Erste Group Research, company data, * pharmaceuticals sales only, Egis data recalculated for calendar year

The Hungarian government’s plan originally assumed drug reimbursement savings reaching HUF 83bn in 2012 and an additional HUF 37bn in 2013 (i.e. HUF 120bn in total, compared to the 2011 comparative base of HUF 343.5bn). The data for 2012 shows that, while spending reached HUF 315.1bn (or nearly 100% of the full-year adjusted budget of HUF 315.2bn and 13.5% above the originally assumed HUF 277.7bn), payments from pharmaceutical manufacturers and wholesalers to the National Health Insurance Fund (OEP) of HUF 75.0bn surpassed the proportional amount of the budgeted sum of HUF 52bn by a wide margin. The new cost saving

Hungary: Grip of austerity measures to ease slightly in 2013. Nevertheless, following 2012 slump, market is seen to contract further





measures implemented in 2012 included renegotiation of contracts for subsidy volumes, revision of the subsidy on cholesterol-reducing drugs, cutting the reimbursement on combination drugs, a preferred reference pricing range of 10% above the reference price both for active substance reimbursement groups and therapeutic reimbursement groups (should the price not be kept within the respective range, a 15% reduction of the reimbursement amount will follow), while manufacturers are submitting their proposals in blind bidding auctions on a semiannual basis. According to the amendment to the healthcare law accepted by the Hungarian Parliament in June 2012, the so-called Spanish Model in the reimbursement system was introduced in Hungary, affecting original products that have no available generic equivalent, have been on the reimbursement list for at least six years and cost more than HUF 1,000 per package. Manufacturers of these products have to pay a sales tax equaling 10% of the monthly reimbursement sum to the OEP, on top of the earlier introduced 20% sales tax on reimbursed product sales. The measure has been anticipated to bring to the OEP some HUF 850mn in 2012 (assuming payments for the last two months of the year) and rise to HUF 5.8bn to HUF 7.4bn in 2013-14. Some 1,600 medicines are currently affected by this regulation. However, the number will change over time, as some products will mature to get on the list, while others might leave it. It is estimated that this measure results in an annual payment liability for Richter of some HUF 100mn. In addition, from April 2012, as a pilot project, the INN prescription system was introduced for cholesterol-lowering drugs statins as the first therapeutic group. Nonetheless, the measure was not implemented in practice, as the possibility of prescribing statins by brand name was again allowed by the subsequent regulation. Also, a new international reference pricing system (with a 20% ceiling above the average of the three cheapest prices of a given manufacturer applied in any of the EU countries to retain reimbursement status) is still waiting to be put into practice.

OEP budget developments

HUF bn 2011 actual 2012 budget 2012 adj.budget 2012 actual 2012 actual vs. budget 2012 actual vs. adj. budget

total revenues 1,404.1 1,700.1 1,700.4 1,744.3 2.6% 2.6%

out of which pharma manufacturers'

and wholesalers' payments 59.6 52.0 52.0 75.0 44.3% 44.3%

total expenses 1,487.3 1,735.4 1,796.0 1,791.3 3.2% -0.3%

out of which total pharmaceuticals

spending 376.9 277.7 315.2 315.1 13.5% 0.0%

out of which drug subsidies 360.6 219.0 296.0 296.0 35.2% 0.0%

Source: OEP

The 2012 results confirmed that the price erosion linked to the government measures weighed on Hungarian pharma market players’ top lines, completely erasing the positive effect of the new product launches. Both Richter and Egis saw their Hungarian sales decrease in 2012. Due in particular to ‘blind bidding auctions’, Egis was forced to slash domestic prices of its products in several consecutive rounds (by 6.9% on average from October 2011, followed by another rather massive 6.8% cut in the next auction round in April 2012 and 5.2% from October 2012). Consequently, 2011/12 sales fully matched the revised (and more pessimistic) guidance of the company, assuming an 8-10% y/y sales contraction for 2011/12. For 2012/13, referring to the gradually easing pricing pressures (as well as the low comparative base effect), CFO Poroszlai confirmed his earlier guidance in February 2013, envisaging Egis’ domestic sales declining 5% to 10% y/y.

Richter and Egis expect falling domestic sales in 2013, but drop should be less steep than in 2012 and renewed (and this time not temporarily limited) R&D relief should significantly soften impact of savings measures on operating level in coming years





Richter’s domestic sales in 2012 decreased 13.8% y/y, a slightly less sizable drop than suggested by the traditionally cautious Richter CEO Bogsch (guidance of a 15% y/y drop, revised from the originally assumed 15-20% y/y fall). For 2013, CEO Bogsch, similarly to Egis’ CFO, foresees the pressures becoming less material, and the initial guidance provided in February 2013 expects Richter’s domestic sales to decline by a maximum 5% y/y (or even end eventually flat y/y; all guidance in HUF terms). Consequently, reflecting the recent guidance, for 2013, we envisage the domestic sales of Richter and Egis slipping some 3.7% and 7% y/y, respectively, with a gradual pick-up (low single-digit-term growth of around 2-3% p.a.) to follow in the medium term. While many uncertainties remain, we want to emphasize that there are two positive regulatory steps in place for 2013. First, the blind bidding system saw some tightening, working in favor of domestic manufacturers. From January 31, 2013, manufacturers who are granted reimbursement for one of their products, but later fail to supply it continuously to the market, will be deprived of reimbursement at the next bidding round for this product. The minimum market share required for application for reimbursement status was raised to at least 5% (during seven months prior the application), from the earlier 3% level. Secondly, the law provides for a 20%-60%-90% deduction from the tax for those pharmaceutical companies whose R&D expenditures reached or exceeded 15%-20%-25% of the reimbursement based on the manufacturer price level. Importantly, this measure, originally assumed to be valid just for one year (i.e. 2012), was approved before the end of 2012 by legislators as a permanent step, improving Richter and Egis’ outlook for the coming years. Both companies qualify for the maximum allowable R&D-based relief to their OEP payment obligation. In 2012, in Richter’s case, the law amendment reduced the net OEP payments to just HUF 0.9bn (hence well below the originally estimated HUF 2bn). As a consequence of a steeper than originally expected sales drop, as well as the level of reimbursement, Egis’ actual expense recorded in the P&L statement (calculated as a difference between the payment obligation and reclaimed money) in 2011/12 amounted to just HUF 396mn, below the downward-adjusted estimate of CFO Poroszlai, according to whom the OEP payment related burden was expected at HUF 600-700mn. Following the recent changes implemented by Egis, from the accounting perspective, Richter and Egis now treat their payment obligation to the OEP in the same way, recording sales rep fees under sales and marketing expenses and sales tax under other operating expenses. (In the past, in Egis’ case, all of the OEP related toll was booked under other operating expenditures).

Egis’ payment to OEP, 1Q06/07-1Q12/13

-3,000

-2,500

-2,000

-1,500

-1,000

-500

0

500

1,000

1,500

Payments (HUF mn) Reclaimed money (HUF mn) Balance (HUF mn)

While many uncertainties remain, we want to emphasize that there are two positive regulatory steps in place for 2013 First, the blind bidding system saw some tightening, working in favor of domestic manufacturers Secondly, R&D-based relief to OEP payments was approved as permanent measure





According to Cegedim, in 2012, the Romanian pharmaceutical market at wholesale prices advanced in value terms by 8.3% y/y to RON 11.7bn; in volume terms, the tempo stood at 4.4% y/y. Sales to hospitals (up 11.7% y/y to RON 1.6bn) was one of the most dynamic market segments, with the robust tempo largely attributable to the regulatory changes, moving certain products in the national health programs from pharmacies to hospitals. OTC product sales also outpaced the overall market, advancing 12% y/y to RON 1.7bn in 2012. Cegedim forecasts the Romanian pharmaceutical market to rise just 1.4% y/y in RON terms in 2013, which, in the case of a depreciation of the Romanian currency, might translate into a drop in euro terms. There is at least one positive news item going forward. The Romanian healthcare budget should see an increase of 30% y/y, with the extra funds to be channeled into repayment of the accumulated debts. According to the Romanian Health Ministry, the debts accumulated since 2009 reached by the end of 2012 some EUR 1bn (RON 4.5bn), of which EUR 0.7bn is envisaged to be repaid by the state in 2013 and the remaining portion (EUR 0.3bn) only in 2014. While all this sounds positive at first glance, pharma market participants still have many reasons for dissatisfaction in doing business in Romania. First of all, although hopefully improving in the future, payments to the healthcare system from the state budget until now have been facing chronic delays, with receivables days staying at an astonishingly high 300+, while the return to normal will likely take some time. Although overdue receivables are not anticipated to rise, the situation will still require cautious monitoring. Furthermore, despite the solid market growth tempo reported by Cegedim, a closer look at the 2012 sales of the major CEE players in Romania confirms a somewhat grimmer picture. While Richter and Egis’ total consolidated sales in Romania advanced 1.4% and 5.2% y/y, respectively, Krka’s sales slipped 3.3% y/y (all in EUR terms). The outlook for 2013 is seen as rather sluggish for Richter, the only company providing detailed guidance here, anticipating a 0-5% y/y increase in its pharmaceutical sales in RON terms. In addition, the clawback system (5-11% tax on sales of reimbursed drugs, depending on turnover) is in place. Referring to the unclear regulatory situation, CEE-based pharma companies treated this obligation differently in the past; the latest accounts show that its deteriorating effect is getting more serious, with some of the CEE pharma companies hit in 2012 by the one-off effect of accounting for payment obligation arrears from the past. With domestic OEP payments enjoying R&D-based relief, Egis’ Romanian clawback well surpassed the Hungarian company’s home obligation, totaling HUF 527mn in 2011/12. Richter has started to record clawback payments only from 2Q12; for the full year, the amount climbed to RON 14.3mn (or around HUF 929mn). Due to the lift from the past periods’ obligation, in 2012, Krka also paid a rather high amount of Romanian clawback and the total amount of some EUR 15mn (out of which EUR 6mn was attributable to past periods) also exceed the Hungarian OEP payment obligation (of around EUR 8mn). As the second largest single regional market after Russia, Poland keeps its utmost priority for CEE-based pharma companies. Nonetheless, their 2012 results, with sales increasing just 2.4% y/y at Krka, and falling 5.5% y/y at Egis, clearly demonstrated the strong savings course of the Polish authorities, as well as all the troubles accompanying bringing the new Drug Reimbursement Act into practice. Only Richter, helped by a low comparative base and a strong revival in 4Q12, managed to post solid 12.2% y/y sales growth in Poland in 2012 (all numbers in euro terms). The new legislation took effect on January 1, 2012, but it started to affect the behavior of market participants already in the preceding period, with patients worried about increasing co-payments opting to buy their medicines

In 2013, the Romanian health care budget increase promises to address (at least partially) receivables collection problems, but overall sales tempo seen to slow down significantly Polish pharmaceutical market - troubled hotspot in 2012, but as bottom was already reached, 2013 should see y/y

improvements

Polish pharmaceutical market - troubled hotspot in 2012, but as bottom was already reached, 2013 should see y/y improvements





in advance, pushing up Polish retail pharmacy sales to record levels in December 2011 (+24.2% m/m and +23.6% y/y to PLN 3.09bn). Sales of reimbursed medicines climbed 35% y/y at the same time. Consequently, it was not surprising that (based on PharmaExpert data), in January 2012, the Polish pharmacy market plunged 16.7% y/y (and 37.6% m/m). Despite the gradual pickup, cumulatively in January-December 2012, Polish pharmacy sales contracted 5.7% y/y to PLN 26.5bn, dragged down by a 22.7% y/y slump in Rx product sales. At the same time, sales of fully paid Rx medicines grew 12.6% y/y and sales of OTC products increased 5.6% y/y. According to the data published by the National Health Fund (NFZ), in the first eleven months of 2012, expenditures on drug reimbursement amounted to nearly PLN 8.15bn, corresponding to 78.0% of the total 2012 budget for reimbursement. The average patient co-payment for reimbursement medicines is expected to increase to 34.9% for 2012 as a whole (from 34% for 2011), while patient expenditures are foreseen to drop PLN 409mn, primarily due to lower purchases, according to IMS Health. Nevertheless, the outlook is somewhat rosier for 2013. According to BMI estimates, in 2013, the Polish pharmaceutical market will rise 2.8% y/y in value terms to PLN 32.26bn. Also, the CEE-based pharmas anticipate a better year ahead, as indicated by their newly published guidance. Egis expects its Polish sales to expand y/y at a faster pace than the overall guidance for CEE markets (envisaging a 3-6% y/y rise in EUR terms for 2012/13). While Richter projects sales in Poland for 2013 slipping 5% y/y in PLN terms, it is largely attributable to the Avonex license discontinuation.

Polish pharmacy market sales developments

2,490

3,090

1,9302,120

2,320

2,220 2,150 2,2502,010 2,070

2,180

2,4702,330

2,480

11.2%

23.6%

-16.7%

-4.5%-5.8%

1.0%-0.9%

6.1%

-3.8% -3.7%

-8.0%

-0.5%

-6.2%

-19.60%

0

0

0

0

0

0

0

0

0

0

0

0

0

500

1000

1500

2000

2500

3000

3500

Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12

Market value (PLN mn) Market growth (% y/y) According to the State Institute for Drug Control (SUKL), in 4Q12, distributors and manufacturers supplied 70.35mn packages of drugs to pharmacies, non-pharmacy sales outlets and healthcare facilities in the Czech Republic, up by 12.7% q/q, but down 3.6% y/y. Moreover, for the whole year 2012 this translated into a 5.7% y/y drop to 280.19mn packages. At ex-factory prices the value of delivered medicines reached CZK 14.9bn in 4Q12 (up by 10.7% q/q and 2.9% y/y), bringing the full-year 2012 figure to CZK 58.7bn, implying a practically flat market. While the SUKL data does not directly reflect actual sales in the period (but deliveries to the distribution channels), it provides clear evidence of the dampening impact of the cost savings measures of the government (in particular, the revision of reimbursed drug prices), along with the less favorable macroeconomic situation (affecting the purchasing power of patients, decisive for the OTC sales growth), on the Czech pharmaceutical market. As of July 1, 2012, OTC medicines (some 400 drugs that can be dispensed on prescription) were excluded from the reimbursement list, with estimated savings for





health insurance companies amounting to CZK 1bn per year. There are still more savings-oriented initiatives on the table, such as increasing the health insurance premium payments for state-insured persons by CZK 49 to CZK 772 per person per month or raising fees for visiting doctors from CZK 30 to CZK 50 as of 2014. The planned abolition of an upper ceiling on obligatory health insurance premium payments should have a positive effect on the income side. The Health Ministry also proposed for health insurers to stop payments in full for all dental fillings, with an exemption for children, seniors over 65 years and people suffering from certain conditions. This measure is anticipated to bring savings of around CZK 1.4bn per year. The ministry is also considering to temporarily lower the reimbursement of medicines (for a period of one year by 5%), yielding savings of several hundreds of millions of CZK, offsetting the financial implications of the recently approved rise of VAT (from 14% to 15%) from January 2013. The biggest Czech state public health insurance company VZP plans to cut its 2013 expenditures on medical treatment 4% y/y (or CZK 6.3bn) in order to bring more balance to its accounts (after 2012 is estimated to end with a deficit of around CZK 3-4bn). Savings will affect the whole sector of medical services, assuming an ongoing reduction of acute beds in hospital and a transfer of planned medical procedures into a one-day surgery regimen. With the CEE home markets burdened by restrictive reform measures, Russia/CIS shined brightly in the 2012 sales reports of CEE pharma producers, providing support not only to their top line tempo, but also profitability margins. While the quarterly developments in 2012 were marked by relatively high volatility and big discrepancies between the results, the 2012 tempo was very sound. After sluggish 2011 sales increase of just 2% y/y, in 2012, Krka posted a high double-digit-terms rise (by 25% y/y) in Russia (and, as it was complemented by an excellent Ukraine and CIS performance, also for the whole Russia/CIS region). Also, the Hungarian peers saw very solid sales growth in Russia (6.8% y/y for Egis and 6.5% y/y for Richter), although it was somewhat tempered after the 10.9% and 26.2% y/y jump respectively, in 2011), accompanied by the robust pace in Ukraine and other CIS markets. A brief look at the 2012 sales breakdown by territory shows that the share of Russia/CIS in total sales of the top CEE-based pharma producers was well above that of the home country. The situation is not only to persist, but, with the growth tempo of Russia/CIS foreseen to outpace that of other markets, it will become even more prominent.

CEE pharmas’ performance in Russia/CIS (2012)

Russia % Ukraine % other CIS % Russia / CIS total %

Sales y/y (%) of total sales Sales y/y (%) of total sales Sales y/y (%) of total sales Sales y/y (%) of total sales

EUR mn EUR mn EUR mn EUR mn

Richter Gedeon 336.9 6.5% 29.8% 68.2 29.9% 6.0% 92.9 23.2% 8.2% 498.0 12.1% 44.1%

Richter Gedeon* 336.9 6.5% 34.0% 67.1 32.9% 6.8% 68.4 16.1% 6.9% 472.4 10.9% 47.7%

Egis 119.1 6.8% 25.7% 18.6 26.7% 4.0% 30.8 19.5% 6.6% 168.5 10.8% 36.4%

Krka 244.2 25.0% 21.4% 58.6 17.0% 5.1% 51.4 29.1% 4.5% 354.2 24.2% 31.0%

Source: Erste Group Research, company data, * pharmaceuticals sales only, Egis data recalculated for calendar year

According to preliminary DSM Group data, in 2012, the Russian pharmaceutical market advanced 11.8% y/y in ruble terms to RBL 921.8bn, while the market volume (number of packages sold) slid 0.4% y/y to 5,534mn packages. The commercial pharmaceutical market was the most dynamic segment, with sales surging 14.7% y/y to RBL 536.6bn; the parapharmaceutical market’s growth tempo was only marginally behind, reaching a sound 14.2% y/y rise (to RBL 148.6bn). Detailed information for

Russia/CIS: Healthy sales prospects are set to bolster top line growth of all major CEE pharma players in 2013, complementing Central European markets’ recovery

Helped by accelerating prices, Russian pharma market was up 11.8% y/y in value terms in 2012





January-December 2012 shows that the average price of medicines on the commercial market in December 2012 amounted to RBL 100.5 per package, up 13.4% y/y. In December 2012, the share of domestic drugs in the total commercial pharmacy market remained nearly unchanged y/y at 24% in value terms, while (with a 59% share) dominating in volume terms. Based on the data for December 2012, the difference between imported and domestic drug prices remained strikingly high; the domestic medicines’ average price per package stood at RBL 43.8 (up 23.3% y/y), vs. the imported drugs’ average of RBL 173.7 (up 6.4% y/y). As evidenced by the sales figures reported by CEE pharma companies, as well as overall market statistics provided by the DSM Group, while the measures of the Russian authorities aimed at better price control (particularly of products included on the essential drug list) achieved at least partial cost saving success, they did not much harm pharmaceutical manufacturers. According to the DSM Group, the prices of medicines on the essential product list since the beginning of the year until the end of December 2012 increased 1.53%. This compares with the 7.8% rise of non-regulated products at the same time. Russian pharmaceutical market developments in January-December 2012

0

20

40

60

80

100

120

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2011 sales (RBL mn) 2012 sales (RBL mn)

2011 average price per package (RBL) 2012 average price per package (RBL)

Importantly, the Russian pharmaceutical market is envisaged to stay on a healthy growth trajectory in the coming periods, based on the forecasts presented by various expert organizations at the beginning of the year. For example, the DSM Group’s forecast for 2013 envisages that, in the commercial pharmaceutical segment, the tempo of the Russian market will be around 14% y/y, while the hospital segment is foreseen to expand some 10% y/y and DLO sales by 5% y/y (all data in ruble terms). Due in part to differences in the comparative base, the performance of the top CEE-based pharma companies in Russia is likely to remain uneven on a quarterly basis (and the tempo might slide temporarily below the 10% mark). Nevertheless, a double-digit sales tempo in Russia remains a realistic goal for the CEE-based pharma producers for 2013, as well as in the medium term. The latest guidance from the Hungarian companies confirms this view as well. In February 2013, Egis’ CFO Poroszlai reiterated the 2012/13 targets for Russia and Russia/CIS market sales growth at 8-12% in euro terms. Richter CEO Bogsch also remained optimistic regarding the medium- to long-term outlook for the Russian market, anticipating an average rise of 10% y/y. For 2013, given the relatively high comparative base, he envisages a Russian sales rise of up to 5-10% y/y in ruble terms. At the same time, Richter’s

2013 Russian pharma market outlook remains bright, with double-digit sales tempo as realistic target for CEE pharma manufacturers





2013 sales in Ukraine are projected to increase as much as 10% y/y in USD terms and in other CIS markets by 5-10% y/y (also in USD terms). Last but not least, we continue to believe that the stable forex developments should also play in favor of a successful business performance for CEE-based exporters to the Russian pharma market, as they have all switched to the ruble as their invoicing currency.

Richter/Egis Russia/CIS guidance developments

Richter

y/y sales growth 1Q2012 1H2012 1-3Q2012 1-4Q2012p Feb-12 May-12 Aug-12 Nov-12

Russia/CIS total (EUR terms) 15.7% 12.3% 14.7% 10.9% n.a. n.a. n.a. n.a.

Russia (RBL terms) 16.2% 6.2% 7.7% 3.8% 0 to 5% 0 to 5% 0 to 5% 5.0%

Ukraine (USD terms) 47.4% 26.2% 28.1% 22.4% 5.0% 5.0% >5% 20.0%

other CIS markets (USD terms) -24.1% 14.8% 12.6% 7.2% 5.0% 5.0% 5.0% 5.0%

Source: Richter, based on pharmaceutical consolidated sales

Egis

y/y sales growth 1Q2011/12 1H2011/12 1-3Q2011/12 1-4Q2011/12 Nov-11 Feb-12 May-12 Aug-12

Russia/CIS total (EUR terms) 3.2% 5.6% 8.0% 7.4% 10 to 12% 10 to12% 5 to 10% 6 to 8%

Russia (EUR terms) 5.3% 4.3% 4.9% 5.2% 10 to 12% 10 to12% 5 to 10% 5 to 7%

Source: Egis, based on consolidated results

guidance

actual sales performance

actual sales performance

guidance

In accordance with the Concept of Long-term Socioeconomic Development of the Russian Federation until 2025, total healthcare expenditures should expand from 3.56% of GDP in 2011 to 5.5% of GDP by 2015 and stabilize at this level afterwards. The pharmaceutical market might see a profound change in the coming period as well, as the Russian government is currently planning for the introduction of an obligatory health insurance system based on the Western European model, with Rx medicines then to be reimbursed by the state (unlike the current practice, with state programs for the refunding of drugs restricted to a certain eligible part of the population and limited therapeutic diagnoses). In 2013-14, the first pilot projects will be underway, testing various options in some 4-6 Russian regions before the optimal variant is chosen for the whole country. According to the first alternative, the DLO drug subsidy system will expand to cover children 3-18 years old, the working population as well as pensioners who are not in the DLO system now, with the reimbursement rate 50% across the board. The second model assumes 100% reimbursement of drugs sold at a reference price; however, should the product price be higher, the difference would be paid by patients. The third option considered anticipates more differentiation, based on patients’ social status as well as seriousness of illness. For life threatening conditions, the reimbursement rate would be 100% for all groups of patients, while for chronic but not life endangering conditions, patients’ co-payments would reach 50-70%. Although Russia’s WTO entry had some negative consequences for Russian pharma companies (duties levied by the Federal Service on Intellectual Property, Patents & Trademarks of Russia were increased to be on par with foreign companies and custom duties for foreign medicines will be gradually reduced from 15% to 5% to 6.5% to 5%), this is not anticipated to undermine the interest of foreign companies in expanding their production in Russia and achieving local manufacturer status. The role of the domestic pharmaceutical industry is envisaged by the Russian authorities to increase significantly over time. The government strategy for

Final shape of upcoming regulatory changes in Russia is not yet clear, but CEE pharma manufacturers are well prepared for future challenges





the Russian pharmaceutical market until 2020 assumes that the share of domestically manufactured drugs will rise from the current 23-24% to 50% (in value terms) by 2020, translating into a significant decrease of Russia’s dependence on pharmaceutical imports, while local manufacturers’ portfolios will be modernized and enriched by state-of-the-art products. Starting from January 1, 2014, only those drugs manufactured (and not just packaged) in Russia will be considered local and entitled to the preference for locally manufactured drugs in government tenders (where a 15% discount is required, should the drug winning the tender be manufactured outside Russia). Furthermore, according to some ministry proposals, foreign products will not be eligible for participation in government tenders, if at least two locally manufactured medicines are registered on the market. By 2018, 90% of medicines from the list of strategically important products should already be manufactured in Russia, based on the decree of the Russian president issued in May 2012. While the competition is heating up and many Western-based companies (Teva, GSK, Sanofi, Novo Nordisk and Pfizer, among others) have recently started to build up their greenfield investments or enter into joint ventures, the CEE companies still enjoy the first mover advantage in this respect, with Krka and Richter in particular having already established significant local operations. Moreover, both Krka and Richter are currently expanding their Russian facilities. Apart from tableting, the new Krka’s factory will comprise a logistics center, warehouse and energy facility. The investment project (worth EUR 135mn) is scheduled to be completed by end of 2013. After completion, the new factory will increase Krka’s Russian local base production output from the current 0.8bn to some 1.8bn tablets and capsules, supplying more than 50% of Krka’s estimated Russian sales. While Krka does not plan API manufacturing in Russia, the products from the new factory might also be channeled to other neighboring markets in the future. Investments in strengthening its Russian presence also dominate the foreign CAPEX plans of Richter at the moment. In 2012, Richter spent in Russia some HUF 8bn, or 80% of its foreign CAPEX there, in a project aiming to double its production capacities by 2015 (and provide 40-50% of the company’s Russian market sales by then, vs. the current 20% share). Changes of prices on the Russian commercial pharmacy market, December 2011-December 2012

0.2%

0.5%0.6%

1.1%

1.8%-1.8%

3.0%0.7%

-0.5%0.4%

-0.8%

2.5%

0.2%

0.3%-0.2%

0.4%

1.5%-1.3%

2.6%

1.2%

-0.1%0.5% -0.7%

0.8%

1.0%

4.9%

2.7%

-0.1%

-3.1%

-7.9%

3.6%

3.0%

1.4%1.8% -1.7%

3.0%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12

Top 100 trade names (RBL) Market (RBL) Market (USD)





As all of the top CEE pharma companies are heavily export-oriented, deriving some 76% (Egis) up to around 90% (Krka, Richter) of their total revenues from exports, foreign exchange developments keep playing an important role for their business performance. The increased volatility of the regional currencies further magnified the importance of the forex situation on their results. For the top line, the average exchange rate represents a good proxy for the impact of forex developments in the respective period; the changes are smoothed out over time and hence also more predictable. However, the financial result’s final outcome is subject to potentially very rapid swings, as it is the last day of the period that matters here, when restating relevant balance sheet positions (most importantly receivables and payables, but also financial liabilities, including intra-company loans). The currencies in focus remain the Polish zloty and Russian ruble, followed by other regional currencies such as the Czech crown and Romanian RON, and obviously the euro, the invoicing currency for exports to the EU. After all the CEE-based pharmas switched to the ruble as their invoicing currency in Russia, the importance of the US dollar for their result fell significantly, with the US currency remaining in use mainly in some smaller CIS markets. Out of the major CEE pharmas, only Richter has more sizable US market-derived revenues (given its partnerships with Teva and Forest Laboratories there). On top of that, the PregLem acquisition financing exposed Richter to Swiss franc fluctuations, a new factor affecting its results since 2011. In line with our expectations, reflecting the strength of the US dollar, all major CEE currencies (HUF, PLN and CZK) depreciated vs. the US dollar in 2012, although the pace of weakening vs. the euro was less steep and some of them (like the Russian ruble and Ukrainian hryvnia) even marginally firmed vs. the euro in 2012. The forex developments in 2012, while benefiting the Hungarian pharmas, weighed on Krka, with its predominantly euro-incurred costs and relatively high export revenue exposure to the CEE region. Although the CEE currencies entered 2013 on a weaker basis, we continue to think that, following the depreciation in 2012, the trend is envisaged to reverse, with the firming of major currencies (CZK, PLN, HUF and RON) to take place no later than in 2H13. While the firming of the forint in the medium term will be unfavorable for both Richter and Egis, who should see their top lines and profitability lose their forex cushion, the gradually reversing picture (with regional currencies on an appreciation path) is set to bolster Krka’s results. Nonetheless, we have to emphasize that, given the forint’s persisting weakness, 2013 seems to still be very promising from the currency perspective for both Hungarian pharma peers.

CEE currencies vs. USD, EUR in 2012

2011 average 2012 average 2011 y/y 2011 average 2012 average 2011 y/y

USD USD USD EUR EUR EUR

Hungarian forint 200.9 225.4 -10.8% 279.2 289.4 -3.5%

Czech crown 17.7 19.6 -9.7% 24.6 25.1 -2.2%

Polish zloty 3.0 3.3 -9.0% 4.1 4.2 -1.6%

Romanian leu 3.0 3.5 -12.1% 4.2 4.5 -4.9%

Russian rouble 29.4 31.1 -5.5% 40.9 39.9 2.3%

Ukrainian hryvnia 8.0 8.0 -0.3% 11.1 11.0 0.6%

Source: Erste Group Research, national banks' statistics

In 2012, CEE currencies’ fortunes were volatile, marked by weakening y/y vs. strong US dollar (but in most cases also vs. crisis-plagued euro). Nonetheless, appreciation remains medium- to long-term scenario, with first steps in this direction expected no later than

2H13





Since the publication of our last CEE pharma sector report in September 2012, interest rates in major world economies have stayed at their historically low levels (the US Federal Reserve keeps the key interest rate at the unprecedented range of zero to 0.25%). In the Eurozone, interest rates are anticipated to remain low in the coming quarters (with the European Central Bank’s interest rate possibly cut from the current 0.75% to 0.5% in mid-2013). While in the CEE region the picture is mixed at the moment, in most of the markets (Hungary, the Czech Republic, Poland), downward corrections of rates dominate the agenda. Nonetheless, the external indebtedness of CEE pharma companies continues to be minimal (with some of them, like Egis, sitting on a heavy cash pile). And as the investment plans of the regional pharma companies do not rely on extensive tapping of financial markets, the current credit market conditions have not been of significant importance for their financial results. Thus, the main factors we have to reconsider in our models are the applied equity risk premiums and risk-free rates, as well as changing currency forecasts. Our methodology for setting equity risk premiums (linked to the respective country’s S&P long-term foreign currency rating) that we introduced in our pharma sector report in May 2009 remains unchanged. In summary: 4.5% is used as a base equity risk premium (mirroring the long-term outperformance of stocks vs. bonds), 25bp is added for each rating notch below AAA and 40bp is added for each rating notch below investment grade (i.e. below BBB-). For perpetuity, extra charges are trimmed to 20bp and 35bp, respectively (while still based on the current rating). Since our last report, some CEE countries saw their ratings cut by major rating agencies, including S&P. Most importantly, Slovenia saw another downgrade to A- in February 2013 (while in March 2012 its rating stood at A+ and in September 2011 its status was even at AA-). Hungary’s rating from S&P was cut once again since our last sector report in September 2012, from BB+ to BB. As before, the application of the methodology keeps punishing the two Hungarian pharma companies, with the resulting equity risk premium well above other regional peers’, particularly that of Krka. Nevertheless, while the Hungarian macroeconomic picture remains somewhat fragile, Hungarian government bond yields embarked on a descending path. Consequently, in our Richter and Egis DCF models, while maintaining our conservative stance, reflecting the recent developments, we decrease the risk-free rate from 7.5% (applied in September 2012) to 7.0%. At the same time, we lower the risk rate for Slovenia from 6.6% to 6.0%. For Romania, we decided to leave the risk free rate unchanged at 6.8% and for Poland we opted for a downward fine-tuning from 5.3% to 4.5%.

Government bond yields down, equity market risk premiums up, forcing us to adjust our DCF-

based valuation models





2012 results review Antibiotice: In 2012, Antibiotice‘s sales growth was at a solid 7.9% y/y to RON 297.05mn. Operating profit surged 32.1% y/y to RON 34.76mn, translating into an EBIT margin of 11.7%. Reflecting the y/y improving financial result and decreasing effective tax rate, net profit rose by a hefty 33.2% y/y to RON 27.39mn. Antibiotice’s sales lagged slightly below our more optimistic expectations, while on the bottom line the company fared better than we had cautiously projected. Nevertheless, as the company for the first time reported its figures under IFRS standards, while our projections were based on RAS standards, direct comparison is impossible. Furthermore, the picture provided by the company is as yet incomplete, as Antibiotice has yet to publish the full set of its 2012 data. Biofarm: In 2012, Biofarm sales advanced 12.3% y/y to RON 105.0mn. Although, similarly to its peer Antibiotice, Biofarm had to cope with the negative impact of the weakening RON on raw material expenses and face fierce competition in the company’s core OTC market, its EBIT expanded 6.6% y/y to RON 16.1mn and net profit jumped 47.9% y/y to RON 21.0mn in 2012, ending above our conservative estimates. Although the steep y/y progress was partly attributable to gains on the revaluation of its stocks portfolio, the adjusted net profit was still 5.8% higher y/y. Nonetheless, we want to point out that, similarly to Antibiotice, the company’s switch from RAS to IFRS data prevents a full direct comparison of the achieved results with our estimates (which were based on RAS data). Bioton: Bioton published its 4Q12 results on February 15, 2013. In 4Q12, fueled by expanding insulin sales both at home as well as on export markets, sales advanced 21.0% y/y to PLN 87.8mn. Reflecting a bold move on the gross profit line (up 25.6% y/y) as well as more strict cost control, the operating result ended in black territory, at PLN 3.3mn. Nevertheless, weighed down by the y/y deteriorating financial result (dragged down by forex losses), as well as the increasing tax burden, the company recorded a net loss of PLN 14.1mn. Still, as the comparative base period was hampered by losses associated with asset disposals (SciGen Israel), the net loss narrowed significantly y/y in 4Q12. All of this translated into 2012 performance as follows. Buoyed by a milestone related to the Actavis deal (EUR 22.25mn or PLN 94.7mn), sales climbed 40.3% y/y to PLN 405.3mn and the company’s operating and bottom lines were pushed into black territory, to operating profit of PLN 68.3mn and net profit of PLN 38.8mn (vs. the year-earlier operating loss of PLN 48.4mn and the net loss after minorities of PLN 77.6mn). Nonetheless, excluding the milestone related boost, the underlying performance remained rather weak, with an operating loss of PLN 26.1mn (all data consolidated according to IFRS standards). Egis: Egis published its 1Q12/13 report on February 12, 2013, after market close. The mounting pricing pressures associated in particular with ‘blind bidding’ auctions sent Egis’ domestic sales down 19.8% y/y in the October-December 2012 period. Nonetheless, reflecting the relatively low comparative base, the export picture was much more optimistic, with exports surging 21.8% y/y to EUR 85.8mn. In summary, despite the y/y diminishing support from the currency side, Egis’ 1Q12/13 sales advanced 3.5% y/y, to HUF 31,445mn. As the improving sales mix was compromised by less favorable currency developments and price erosion at home as well as on some CEE markets, the gross profitability margin slightly worsened y/y (to 58.6%) in 1Q12/13. Reflecting in particular the decreasing gross profitability margin, along with operating costs outpacing the top line tempo,





operating profit growth was tempered to just 1.6% y/y. Operating profit reached HUF 5,611mn in 1Q12/13. With the weakening of the forint at the end of 1Q12/13 resulting in a positive net forex impact of HUF 925mn, the 1Q12/13 financial result not only ended safely in black territory, but improved y/y to HUF 1,457mn. While in the year-earlier period, part of the profitability gains was wiped out by the accounting for losses at the associated company Hungaropharma (of HUF 1,026mn), in their absence, there was room for a bold move on the bottom line in 1Q12/13. Bolstered further by the y/y unchanged (and, at 6.6%, relatively low) effective tax rate, 1Q12/13 net profit climbed 23.5% y/y. Krka: Publishing its 2012 results on March 14, 2013, Krka wrapped up the reporting season in the CEE pharma universe. In 2012, Krka’s consolidated sales advanced by 6.3% y/y to EUR 1,143.3mn as the y/y pickup in Russia/CIS, complemented by the solid performance in Western European markets offset sluggish CEE sales. Reflecting region-wide mounting pricing pressures along with the y/y less favorable currency developments, Krka’s gross margin deteriorated y/y to 59.1% in 2012. Furthermore, although the company managed to trim its administrative costs by 3.9% y/y, both its R&D expenses as well as sales & marketing costs outpaced the sales tempo, dragging Krka’s operating profit down by 9.1% y/y (to EUR 192.3mn) in 2012. On the other hand, following significant q/q improvement in 4Q12, in 2012, the financial result ended far less deeply in red territory than in the year earlier period (loss of EUR 1.8mn vs. a loss of EUR 11.6mn in 2011). In addition, as the effective tax rate decreased y/y, the drop in 2012 net profit was minimized to 1.8% y/y, translating into a net profit after minorities of EUR 159.9mn. Richter Gedeon: Richter announced its 4Q12 results on February 7, 2013. Reflecting the low comparative base (burdened by one-off losses linked to the Protek and Hungaropharma write-offs), Richter’s 4Q12 net profit jumped 52.6% y/y. The rise was more sizable than was expected by market participants. Reflecting the mounting pricing pressures, Richter’s domestic sales performance in 4Q12 was sluggish, with sales plunging 12.0% y/y to HUF 6,689mn, sending the 2012 domestic sales figure to HUF 30,932mn, down 13.3% y/y. The export picture was slightly more optimistic. Due to the high comparative base in Russia, as well as in Ukraine and other CIS markets, the sales pace in Russia/CIS was dampened to 2.5% y/y in 4Q12. Nevertheless, reflecting the previous quarters’ robust performance, this translated into an excellent 12.1% y/y rise in total Russia/CIS sales (to EUR 498.0mn) in 2012. With unrealized financial income (lifted by a reassessment of trade receivables and payables and other currency related items) swinging y/y into the black and compensating for the deteriorating realized financial items balance, the financial result improved significantly y/y to profit of HUF 349mn (vs. an HUF 3.4bn loss in 4Q11). In addition, the year-earlier period was marked by losses stemming from Protek investment write-offs and impairment losses at Hungaropharma. Thus, bolstered further by accounting for a deferred tax, the bottom line jumped 52.6% y/y in 4Q12.





2012 CEE Pharma performance at a glance

Antibiotice

IFRS 2012p 2011 y/y

Total sales (RON mn) 297.05 275.23 7.9%

Operating profit (RON mn) 34.76 26.31 32.1%

Net income (RON mn) 27.39 20.56 33.2%

Operating margin 11.7% 9.6%

Net margin 9.2% 7.5%

Biofarm

IFRS 2012 2011 y/y

Total sales (RON mn) 104.94 93.42 12.3%

Operating profit (RON mn) 16.11 15.11 6.6%

Net income (RON mn) 21.04 14.22 47.9%



Bioton

IFRS consolidated 4Q2012p 4Q2011 y/y 2012p 2011 y/y

Total sales (PLN 000) 87,795 72,575 21.0% 405,330 288,984 40.3%

Operating profit (PLN 000) 3,267 -14,244 n.m. 68,344 -48,384 n.m.

Net income (PLN 000) -14,093 -54,326 -74.1% 38,808 -77,554 n.m.

Operating margin 3.7% -19.6% 16.9% -16.7%

Net margin -16.1% -74.9% 9.6% -26.8%

Egis

IFRS consolidated 1Q12/13 1Q11/12 y/y

Net sales (HUF mn) 31,445 30,392 3.5%

Operating profit (HUF mn) 5,611 5,522 1.6%

Net income (HUF mn) 6,587 5,333 23.5%



Krka


Total sales (EUR 000) 329,367 307,477 7.1% 1,143,301 1,075,627 6.3%

Operating profit (EUR 000) 48,901 42,585 14.8% 192,308 211,561 -9.1%

Net income (EUR 000) 48,377 47,351 2.2% 159,915 162,801 -1.8%

Operating margin 14.8% 13.8% 16.8% 19.7%

Net margin 14.7% 15.4% 14.0% 15.1%

Richter


Total sales (HUF mn) 83,547 89,591 -6.7% 326,702 307,868 6.1%

Operating profit (HUF mn) 10,966 12,023 -8.8% 50,284 60,927 -17.5%

Net income (HUF mn) 13,686 8,966 52.6% 50,777 49,281 3.0%


Net margin 16.4% 10.0% 15.5% 16.0%

Source: Company data, Erste Group Research





2013 CEE Pharma guidance at a glance

Company Sales Sales growth (y/y) EBIT EBIT growth (y/y %) Net profit Net profit growth (y/y %)

Antibiotice n.a. n.a. n.a. n.a. n.a. n.a.

Biofarm RON 115.09mn 9.7% in RON terms RON 19.54mn 21.3% in RON terms RON 19.03mn -9.5% in RON terms

Bioton n.a. n.a. n.a. n.a. n.a. n.a.

Egis HUF 138.1bn to HUF 140.8bn 4 to 6% in HUF terms n.a. n.a. n.a. n.a.

Krka EUR 1,202mn 5.0% n.a. n.a. EUR 160mn 0.0%

Richter Gedeon EUR 1,164mn 3% in EUR terms EBIT margin of 14 to 15% n.a. n.a. n.a.

Source: Company data, target sales figures of Richter and Egis recalculated based on guidance for y/y growth

2013 CEE Pharma Erste Group Research forecasts at a glance

Company Sales y/y % EBIT y/y % Net profit y/y % Comment

Antibiotice RON 324.2mn 7.4% RON 40.2mn 14.8% RON 27.7mn 3.2% Based on the company's progress in obtaining

authorizations for expanding exports, as well as lower than

previously expected clawback taxes (after exclusion of VAT

from tax base) we anticipate solid y/y improvements in

2013.

Biofarm RON 111.5mn 6.2% RON 18.8mn 9.3% RON 15.0mn -22.0% In absence of positive one-offs (stemming from equity

portfolio revaluations in 2012), we envisage the company's

net profit to decrease y/y in 2013.

Bioton PLN 390.4mn -3.7% PLN 24.1mn -64.7% PLN 8.8mn -77.4% In the y/y absence of sizable milestone revenues, the 2013

earnings are envisaged to head south

Egis HUF 139,344mn 4.9% HUF 20,820mn 1.9% HUF 19,795mn 6.8% The relative weakness of the forint continues to play a

major role in the final outcome, with an HUF 1 weakening

lifting the operating line by some HUF 100mn.

Krka EUR 1,217.6mn 6.5% EUR 212.2mn 10.4% EUR 171.3mn 7.1% Krka is the strongest beneficiary of the potential

appreciation of CEE currencies in the course of 2013. In

the y/y absence of negative one-offs, EBIT margin is expect

to improve y/y

Richter HUF 354,243mn 8.4% HUF 53,935mn 7.3% HUF 51,102mn 0.6% The possible milestone payment from Forest Laboratories,

linked to the US regulatory approval before the year-

end,represents an upside to our forecast

Source: Erste Group Research

2013 CEE Pharma reporting calendar

Date Company Release / event

11.4.2013 Krka 2012 annual report

19.4.2013 Biofarm 2012 annual report

29.4.2013 Antibiotice 2012 annual report

30.4.2013 Bioton 2012 annual report

14.5.2013 Egis 2Q2012/13 results

14.5.2013 Biofarm 1Q2013 results

15.5.2013 Antibiotice 1Q2013 results

15.5.2013 Bioton 1Q2013 results

16.5.2013 Krka 1Q2013 results

1. or 2. week of May Richter Gedeon 2Q2013 results

4.7.2013 Krka AGM

25.7.2013 Krka 1H2013 results

1.8.2013 Egis 3Q2012/13 results

1. or 2. week of August Richter Gedeon 1H2013 results

14.8.2013 Antibiotice 1H2013 results

14.8.2013 Biofarm 1H2013 results

2.9.2013 Bioton 1H2013 results

12.11.2013 Egis 4Q2012/13 results

14.11.2013 Biofarm 1-3Q2013 results

14.11.2013 Bioton 3Q2013 results

14.11.2013 Krka 1-3Q2013 results

15.11.2013 Antibiotice 1-3Q2013 results

1. or 2. week of November Richter Gedeon 3Q2013 results

Source: Erste Group Research, company data



Erste Group Research – Erste Sector Healthcare – 20 March 2013 Erste Group Research – Company Report Antibiotice | Pharmaceuticals | Romania 20 March 2013


Antibiotice

All prices are those current at the end of the previ ous tr adi ng session unl ess other wise indicated and ar e sourced fr om local exchanges vi a Reuters, Bl oomberg and other vendors .

TEST Erste Gr oup R esearch – C ompany R eport

Antibiotice | Phar maceuticals | Romania

20 March 2013

RON mn 2011 2012e 2013e 2014e

Net sales 281.9 302.0 324.2 346.5

EBITDA 48.8 54.6 60.3 65.1

EBIT 32.1 35.1 40.2 43.0

Net result after min. 20.1 26.9 27.7 30.5

EPS (RON) 0.04 0.05 0.05 0.05

CEPS (RON) 0.07 0.07 0.09 0.09

BVPS (RON) 0.50 0.55 0.58 0.61

Div./share (RON) 0.02 0.00 0.02 0.02

EV/EBITDA (x) 5.1 6.3 5.5 5.1

P/E (x) 8.5 9.6 9.3 8.5

P/CE (x) 4.5 6.2 4.8 5.0

Dividend Yield 5.1% 0.0% 4.3% 4.7%

0.25

0.30

0.35

0.40

0.45

0.5052 weeks

Antibiotice BET (Rebased)

Performance 12M 6M 3M 1M

in RON 41.2% 20.6% 24.3% 3.4%

Share price (RON) close as of 18/03/2013 0.4550 Reuters ATBE.BX Free float 37.0%

Number of shares (mn) 568.0 Bloomberg ATB RO Shareholders Ministry of Health (53.0%)

Market capitalization (RON mn / EUR mn) 258 / 59 Div. Ex-date SIF Oltenia (10%)

Enterprise value (RON mn / EUR mn) 345 / 78 Target price 0.4800 Homepage: www.antibiotice.ro

Overstretched payment terms hinder outlook We upgrade the stock from Reduce to Hold and raise our target price to RON 0.48/share (RON 0.355 previously), based on the company’s progress in obtained authorization for expanding exports, as well as lower expected clawback tax expenses after the exclusion of VAT from the tax base. The company successfully passed the inspection run by the FDA, which paves the way for increasing exports on the US market and also counts as a strong marketing tool in the negotiation of contracts on other foreign markets. Higher exports will offset the deceleration of sales on the core Rx market caused by overstretched payment terms, the clawback tax and the weak recovery of population purchasing power. Envisaged lower pressure on marketing budget, given shift in competition towards the more attractive OTC segment – unregulated and suggests the possibility of negotiating shorter payment terms, while also providing room for slight margin improvement, on average by 1pp, over the detailed forecast period. Working capital management will remain the main challenge for this company, as we do not envisage a sizeable improvement in payment conditions on its core Rx market. Short-term financing needs on an ascending path remain our main cause for concern. In the meantime, the very long payment terms, of over 300 days, might translate into weak receivables collection quality and write-offs, as in recent years.

from Reduce to Hold

Analyst:

Raluca Ungureanu +4021 311 27 54 [email protected]





FY12 results review Antibiotice, like all listed Romanian companies, has to publish results under IFRS starting with FY12. Thus, the preliminary figures for last year came in under different accounting rules and formats, which makes it very difficult to compare 2012 performance with previous years. As a result of this, and given our expectations that the audited figures will differ from the preliminary data, we decided for work with estimates under local accounting standards. In summary, the company reported RON 297mn revenues for last year, roughly 8% higher y/y, while net profit jumped 33%. EBIT, computed by us based on the available data, increased 32% y/y to RON 34.7mn. However, one must bear in mind that, unlike RAS figures, the operating profit we have computed under IFRS includes the FX impact. Antibiotice

IFRS (RON mn) 2012 2011 y/y

Revenues 297.05 275.23 7.9%

Other revenues 27.28 31.16 -12.5%

Inventory change 0.52 0.87 -40.3%

Own production 2.62 0.57 360.7%

Raw materials -102.13 -87.00 17.4%

Wages -68.93 -68.43 0.7%

Depreciation -18.12 -15.46 17.2%

Other expenses -103.52 -110.62 -6.4%

EBITDA 52.88 41.78 26.6%

EBIT 34.76 26.31 32.1%

Financing costs -2.28 -2.50 -8.9%

Rev. from AFS securities 0.00 2.94 n.m.

EBT 32.48 26.75 21.4%

Tax expense -5.09 -6.19 -17.8%

Net profit 27.39 20.56 33.2%

Source: Antibiotice Iasi

Change in estimates / Outlook Although the company should, from now on, report financial figures under IFRS, we prefer to stick to our RAS estimates until audited quarterly data for previous years are available, so that we have reliable guidance for the forecast scenario.

RAS

(RON, mn) Now Before Change Now Before Change

Sales 324.2 336.4 -4% 346.5 345.3 0%

EBITDA 60.3 55.8 8% 65.1 57.9 12%

EBIT 40.2 35.7 13% 43.0 37.8 14%

Net profit 27.7 24.2 15% 30.5 27.1 13%

EBITDA margin 18.6% 16.6% 18.8% 16.8%

EBIT margin 12.4% 10.6% 12.4% 10.9%

Net margin 8.6% 7.2% 8.8% 7.8%


2013e 2014e

Significant differences between RAS and IFRS figures and reporting format makes comparison with previous years

difficult





While we made no major adjustments in terms of sales for 2013 and onwards, we were more optimistic with regard to operating profitability compared to the previous reports for two main reasons: i) the recently signed contracts for finished product distribution in the US (worth USD 5mn) and on the Algerian market (USD 4mn per year) and ii) the change in the clawback tax mechanism in favor of companies (VAT is excluded from the tax base). We remind the reader that the clawback tax is applied on the difference between the quarterly reimbursed drugs value and a reference value set by the National Insurance House (according to pharma companies, this charge amounted to about 30% of prescription drug sales). Developments regarding domestic drug sales are quite worrying, with the clawback tax and very high receivables collection period of over 300 days blamed for the market’s significant deceleration last year to only 8.3% in RON terms, from double-digit levels in previous years, and expected to further curb sales, to only 1.4% this year. However, we are confident that Antibiotice will manage to rise above the market, given its strategic position in the healthcare system and strong presence on the hospital channel. Moreover, a deceleration of sales on the domestic market will be offset by higher exports. Last year, the company managed to solve the problems with the contract for selling finished products on the US market, which should result in annual sales worth USD 3mn. Moreover, two additional contracts signed last year with two US drug distributors will generate about USD 5mn sales in 2013 and the successful inspection run in December and January by the US Food and Drug Administration (FDA) paves the way for further brisk growth of exports. Thus, after last year’s 25% jump in exports (+9.5% in USD terms), largely supported by the weaker LC, for FY13 we expect a 8.7% advance in RON terms (+12% in USD), while for the period 2014-17 a CAGR of 5% is a reachable target, in our view. Exports last year accounted for about 23% of sales. When estimating sales abroad we keep in mind that obtaining authorization to sell medicine is a long-drawn-out process. We expect the company’s domestic sales to advance faster than the market, given its strong partnerships with hospitals and also its strategic position in Romania’s healthcare sector. Overall, we forecast the company’s sales increasing by 9.5% this year and a CAGR of 6% over the period 2014-17. As already mentioned, we are more optimistic regarding the company’s room to manage operating costs. Practically, the main challenges for this company are the clawback tax, given its focus on Rx drugs and marketing expenses. The clawback tax we have assumed to decrease this year by some 5%, following the exclusion of VAT from the tax base. Marketing expenses we have assumed to advance less aggressively compared to the previous report. While up to last year, pharma producers focused on expanding market share, the clawback tax charged on Rx drugs sales and increasing working capital financing pressure made pharma operators shift their attention towards the OTC segment. Despite its small size (15% of market), this business line is not regulated and offers the ‘opportunity’ of negotiating faster payment terms. We therefore believe that marketing campaigns addressing the Rx segment will not be as hefty as they were in the past.

New export contracts and lower clawback to have positive impact on operating profitability

Reliable export policy to compensate for weaknesses of domestic Rx market

Strategic position on pharma sector to ensure growth above market on core Rx segment

Clawback tax and long payment terms affecting Rx segment shifted competition towards

OTC segment





Over the last year, Antibiotice’s marketing expenses, as a percentage of own production sold adjusted for commercial discounts, decreased towards the level from 2010, based on our calculations, after reaching their peak in 2008. Our expectations are for lower pressure on this side, meaning there is no ‘need’ to increase this ratio.

Marketing and raw material expenses development

Source: Erste Group Research, Antibiotice

Note: Own production sold has been adjusted for commercial discounts

27.9%

25.3%

24.3%

20.1%

27.3%

25.0%

23.1%

27.6%

22.8%

24.1%

27.1%

25.1%

15%

17%

19%

21%

23%

25%

27%

29%

2007 2008 2009 2010 2011 2012e

Marketing expenses / Ajusted own production sold

Raw material expenses / Adjusted own production sold

Raw material expenses as a percentage of own production sold adjusted for commercial discounts changed from one year to another due to FX volatility, as the company imports part of the raw materials employed in production. For the detailed forecast period, our estimates point to a ratio of 25% +/- 1pp of raw material expenses to adjusted own production sold. Following the changed assumptions of our forecast scenario, we have raised the EBIT estimates for the detailed forecast period, with an EBIT margin of between 12-14%, which is, however, below the levels seen up to 2007. The stretched payment terms, with receivables collected in more than 300 days (i.e. 324 days at the end of September 2012), will continue to keep the company’s ST financing under pressure.

Lower presure on marketing budget due to lower attractiveness of Rx segment

EBIT margin to stabilize at 12-14%, above levels seen up to 2007





Working Capital Development

Source: Erste Group Research, Antibiotice

62.8%

54.9% 52.5%

60.1%

84.2%78.2% 78.8%

73.1%

27.6%

36.9%

42.6%

54.4%

40.4%

36.4% 37.1%

41.8%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

2005 2006 2007 2008 2009 2010 2011 2012e

ST Debt / Working Capital

Working Capital / Sales

Short-term bank debt increased over the last couple of years, both in terms of value and weight in working capital, a ratio that we consider relevant in monitoring the pressure a company faces in funding its working capital needs. Improvement may be seen if the government keeps its promise and pays EUR 800mn this year in overdue bills and reduce payments in the sector to 60 days (from the current more than 300 days). However, in order to be conservative, we did not assume any sizeable improvement in payment conditions in the pharma sector. Funding working capital needs will therefore remain a major challenge, putting pressure on company profitability in the medium term.

Recommendation and target price Following the upward adjustment of operating profit, the target price increased to RON 0.48 from RON 0.355. In light of the positive developments on the exports side and also considering the above expectations for FY12 performance, we upgrade the stock from Reduce to Hold.

Pressure on working capital financing to remain major challenge





WACC calculation2013e 2014e 2015e 2016e 2017e 2018e (TV)

Risk free rate 6.8% 6.8% 6.8% 6.8% 6.8% 5.0%

Equity risk premium 7.2% 7.2% 7.2% 7.2% 7.2% 6.7%

Beta 1.1 1.1 1.1 1.1 1.1 1.0

Cost of equity 14.7% 14.7% 14.7% 14.7% 14.7% 11.7%

Cost of debt 10.3% 10.3% 10.3% 10.3% 10.3% 8.5%

Effective tax rate 18.0% 18.0% 18.0% 18.0% 18.0% 17.0%

After-tax cost of debt 8.4% 8.4% 8.4% 8.4% 8.4% 7.1%

Equity weight 65% 65% 65% 65% 65% 80%

WACC 12.5% 12.5% 12.5% 12.5% 12.5% 10.7%

DCF valuation

(RON mn) 2013e 2014e 2015e 2016e 2017e 2018e (TV)

Sales growth 7.4% 6.9% 5.9% 6.0% 6.6% 4.5%

EBIT 40.2 43.0 46.3 53.3 56.5 56.8

EBIT margin 12.1% 12.2% 12.5% 13.4% 13.5% 13.0%

Tax rate 18.0% 18.0% 18.0% 18.0% 18.0% 17.0%

Taxes on EBIT -7.2 -7.7 -8.3 -9.6 -10.2 -9.7

NOPLAT 33.0 35.3 38.0 43.7 46.4 47.2

+ Depreciation 20.1 22.1 22.1 22.1 22.1 24.0

Capital expenditures / Depreciation 102.0% 101.8% 115.4% 119.9% 131.2% 100.0%

+/- Change in working capital -12.6 -12.0 -10.4 -16.0 -11.7 -10.4

Chg. working capital / chg. Sales -47.2% -55.4% -61.1% -57.9% -57.7% -55.0%

- Capital expenditures -20.5 -22.5 -25.5 -26.5 -29.0 -24.0

Free cash flow to the firm 20.0 22.9 24.2 23.3 27.7 36.8

Terminal value growth 2.0%

Terminal value 430.1

Discounted free cash flow - Dec 31 2012 17.8 18.1 17.0 14.6 15.4 234.1

Enterprise value - Dec 31 2012 317.0

Minorities 0.0

Non-operating assets 0.0

Net debt 86.3

Other adjustments 0.0

Equity value - Dec 31 2012 230.7

Number of shares outstanding (mn) 568.0

Cost of equity 14.7%

12M target price per share (RON) 0.480

Current share price (RON) 0.455

Up/Downside 5.9%

Enterprise value breakdown Sensitivity (per share)

0 12.0% 12.5% 13% 13.5% 14.0%

9.7% 0.491 0.518 0.545 0.572 0.600

10.2% 0.460 0.486 0.512 0.537 0.563

10.7% 0.434 0.458 0.480 0.506 0.530

11.2% 0.410 0.433 0.455 0.478 0.501

11.7% 0.388 0.410 0.432 0.453 0.475

0 1.0% 1.5% 2.0% 2.5% 3.0%

9.7% 0.482 0.512 0.545 0.583 0.627

10.2% 0.455 0.482 0.512 0.545 0.583

10.7% 0.432 0.455 0.480 0.512 0.545

11.2% 0.410 0.432 0.455 0.482 0.512

11.7% 0.391 0.410 0.432 0.455 0.482

Terminal value EBIT margin

Terminal value growth

PV of

terminal

value

74%

PV of

detailed

period

26%






Income Statement 2009 2010 2011 2012e 2013e 2014e(RAS, RON mn, 31/12) 31/12/2009 31/12/2010 31/12/2011 31/12/2012 31/12/2013 31/12/2014

Net sales 219.75 243.63 281.86 301.99 324.21 346.51

Invent. changes + capitalized costs -2.22 2.58 1.45 3.14 7.51 6.81

Total revenues 217.53 246.21 283.31 305.13 331.72 353.32

Other operating revenues 1.21 2.32 1.17 20.00 0.80 1.04

Material costs -61.24 -76.02 -95.22 -113.00 -109.14 -116.65

Personnel costs -63.42 -65.44 -68.43 -68.93 -68.95 -67.97

Other operating expenses -54.30 -63.33 -72.08 -88.63 -94.09 -104.64

EBITDA 39.78 43.74 48.75 54.57 60.35 65.10

Depreciation/amortization -13.61 -13.18 -16.67 -19.49 -20.10 -22.10

EBIT 26.17 30.56 32.08 35.07 40.25 43.00

Financial result -10.53 -12.09 -5.67 -3.09 -6.41 -5.80

Extraordinary result 0.00 0.00 0.00 0.00 0.00 0.00

EBT 15.65 18.47 26.41 31.98 33.84 37.20

Income taxes -3.73 -5.93 -6.34 -5.09 -6.09 -6.70

Result from discontinued operations 0.00 0.00 0.00 0.00 0.00 0.00

Minorities and cost of hybrid capital 0.00 0.00 0.00 0.00 0.00 0.00

Net result after minorities 11.92 12.54 20.07 26.89 27.75 30.51

Balance Sheet 2009 2010 2011 2012e 2013e 2014e(RAS, RON mn, 31/12)

Intangible assets 1.81 1.99 1.65 4.89 5.18 5.73

Tangible assets 156.83 166.41 173.69 188.34 188.49 193.39

Financial assets 0.08 0.08 0.02 0.08 0.08 0.08

Total fixed assets 158.72 168.48 175.36 193.31 193.75 199.20

Inventories 34.15 40.41 41.93 47.96 46.19 47.47

Receivables and other current assets 179.77 179.81 224.84 223.39 239.83 254.42

Other assets 0.48 0.33 0.30 0.35 0.37 0.34

Cash and cash equivalents 3.58 3.72 5.34 6.01 7.52 14.16

Total current assets 217.98 224.27 272.41 277.71 293.91 316.39

TOTAL ASSETS 376.70 392.75 447.77 471.02 487.66 515.59

Shareholders'equity 242.02 262.61 286.83 313.73 330.37 348.68

Minorities 0.00 0.00 0.00 0.00 0.00 0.00

Hybrid capital and other reserves 0.00 0.00 0.00 0.00 0.00 0.00

Pension and other LT personnel accruals 0.00 0.00 0.00 0.00 0.00 0.00

LT provisions 14.01 13.90 14.59 10.00 16.00 15.00

Interest-bearing LT debts 0.00 0.00 0.00 0.00 0.00 0.00

Other LT liabilities 0.03 0.00 0.00 0.10 0.10 0.10

Total long-term liabilities 0.03 0.00 0.00 0.10 0.10 0.10

Interest-bearing ST debts 74.75 69.30 82.42 92.29 83.00 90.00

Other ST liabilities 45.89 46.93 63.93 54.90 58.18 61.81

Total short-term liabilities 120.63 116.23 146.35 147.19 141.18 151.81

TOTAL LIAB. , EQUITY 376.70 392.75 447.77 471.02 487.66 515.59

Cash Flow Statement 2009 2010 2011 2012e 2013e 2014e(RAS,RON mn, 31/12)

Cash flow from operating activities -26.82 24.95 17.64 34.17 41.73 46.43

Cash flow from investing activities -10.66 -2.03 -17.04 -19.50 -20.49 -22.48

Cash flow from financing activities -1.07 -22.77 1.01 -13.99 -19.73 -17.31

CHANGE IN CASH , CASH EQU. -38.54 0.14 1.61 0.67 1.51 6.63

Margins & Ratios 2009 2010 2011 2012e 2013e 2014eSales growth 1.8% 10.9% 15.7% 7.1% 7.4% 6.9%

EBITDA margin 18.3% 17.8% 17.2% 17.9% 18.2% 18.4%

EBIT margin 12.0% 12.4% 11.3% 11.5% 12.1% 12.2%

Net profit margin 5.5% 5.1% 7.1% 8.8% 8.4% 8.6%

ROE 4.9% 5.0% 7.3% 9.0% 8.6% 9.0%

ROCE 4.7% 4.4% 6.1% 7.3% 7.9% 8.2%

Equity ratio 64.2% 66.9% 64.1% 66.6% 67.7% 67.6%

Net debt 71.2 65.6 77.1 86.3 75.5 75.8

Working capital 96.9 107.7 125.8 130.2 152.4 164.2

Capital employed 327.2 342.1 378.5 410.1 422.0 439.6

Inventory turnover 1.6 1.8 2.1 2.3 2.1 2.2

Source: Company data, Erste Group estimates



Erste Group Research – Erste Sector Healthcare – 20 March 2013 Erste Group Research – Company Report Biofarm | Pharmaceuticals | Romania 20 March 2013


Biofarm

from Accumulate to Hold



Biofar m | Phar maceuticals | R omania

20 March 2013

RON mn 2011 2012e 2013e 2014e

Net sales 93.4 105.0 111.5 131.0

EBITDA 21.0 22.9 25.0 29.4

EBIT 16.1 17.2 18.8 22.7


EPS (RON) 0.01 0.02 0.01 0.02

CEPS (RON) 0.02 0.02 0.02 0.02

BVPS (RON) 0.14 0.15 0.15 0.17

Div./share (RON) 0.01 0.01 0.01 0.01

EV/EBITDA (x) 6.5 7.8 8.6 7.0

P/E (x) 13.7 13.4 17.2 13.1

P/CE (x) 10.1 11.4 11.8 9.8

Dividend Yield 5.2% 5.5% 4.4% 5.3%

0.160.170.180.190.200.210.220.230.240.25

52 weeks

Biofarm BET (Rebased)


in RON 17.8% 26.9% 12.7% -1.1%

Share price (RON) close as of 18/03/2013 0.2355 Reuters BIOF.BX Free float 57.0%

Number of shares (mn) 1,094.9 Bloomberg BIO RO Shareholders SIF Oltenia (26.9%)

Market capitalization (RON mn / EUR mn) 258 / 58 Div. Ex-date 08/05/13 SIF Banat Crisana (20.6%)

Enterprise value (RON mn / EUR mn) 179 / 41 Target price 0.2520 Homepage: www.biofarm.ro

Mounting competition calls for caution We raise our target price from RON 0.218 to RON 0.252/share, but downgrade the stock to Hold from Accumulate, given this year’s share price rally of more than a 15% advance YTD. We stick to our positive view on the OTC drugs and nutritive supplements producer, given its proven ability to profitably grow even under tough market conditions. As expected, considering the strong performance in 1H12 and 1-3Q12, respectively, the FY12 results came in stronger y/y, with sales 12% higher and a 6.6% increase in EBIT. Net profit jumped 48% y/y, boosted by the revaluation of the equity portfolio and dividend inflows in FY12. Consequently, the dividend proposed for last year is higher, of RON 0.013 compared with RON 0.01 for FY11. The new status of the company as a stable dividend player is also supportive to the stock’s LT valuation. We have cut the operating margin estimate over the detailed forecast period, on average by 2pp, and assumed that the EBIT margin will stabilize at about 17.5%. The company enjoys a competitive advantage thanks to affordable prices at the bottom of the market range, which provides room in future for passing through to consumers the higher marketing expenses claimed by mounting competition in the core OTC market. The large payment delays in the sector (over 300 days) and clawback tax affecting the Rx drugs segment, shifted competition into the OTC segment, where shorter payment terms can be negotiated. Relaxing payment terms on the pharmaceutical market, as assumed by the government in this year’s budget, should make the Rx market segment more attractive and lower competition on the OTC segment.

Analyst:

Raluca Ungureanu +4021 311 27 54 [email protected]





No major differences between IFRS and RAS The company reported the preliminary financial results under IFRS for the first time, making it difficult to make a comparison with results from previous years, which were only reported under local accounting rules. We note that, starting with FY12, Romanian listed companies have to prepare their reports according to IFRS. In the case of Biofarm, fortunately, there are no major differences between the figures reported under the two accounting standards for FY11. In these circumstances, it is safe to assume that the 2012 figures under RAS are very close to those reported under IFRS. Given the lack of an IFRS track record, we decided for the time being to continue working with figures under RAS.

FY12 results review Overall, the company reported strong performance for last year, with sales surpassing the RON 100mn threshold and advancing, for the third year in a row, at double-digit pace. The operating profit advanced 6.6% y/y, with a 0.9pp decrease in the operating margin, to 15.3%, given higher y/y marketing and clawback tax expenses. The operating margin remin however elevated and comes as confirmation of this company’s ability to grow in a profitable manner even under tough market conditions. Practically, the much stretched payment terms on the Rx drugs segment resulted in mounting competition on Biofarm’s core OTC market, where producers can negotiate shorter payment terms. The company thus had to fight in a market segment which accounts for only 15% of total drugs sales and with multinationals enjoying lavish marketing and advertising budgets. The recipe for success seems to be Biofarm’s affordable prices at the lower end of the market range, as well as the strength of its traditional brands. Net profit for the year jumped roughly 48% y/y to RON 21mn, with a strong boost from the year-end revaluation of the company’s stock portfolio (RON 3.2mn) and the dividends received from its listed holdings (RON 1.3mn). We recall that, in 2007, Biofarm purchased shares worth EUR 10mn at that time, in Transelectrica, the five SIFs, Banca Transilvania, BRD GSG, Armax Gaz, Dafora and Transilvania Constructii. The adjusted net profit (for the above-mentioned positive contributions) is around RON 16mn, some 6% higher y/y.

IFRS Reported y/y

(RON, mn) FY12 FY11

Net sales 104.9 93.4 12.3%

EBITDA 21.8 20.1 8.6%

EBIT 16.1 15.1 6.6%

Net profit 21.0 14.2 47.9%

Net profit adj. 16.0 15.1 5.8%

EBITDA margin 20.7% 21.5%

EBIT margin 15.3% 16.2%

Net profit margin 20.0% 15.2%

Net profit adj. margin 15.2% 16.2%

Source: Erste Group Research, Biofarm

Strong performance in 2012, with 12% y/y increase in sales and 15% advance of

operating profit

Net profit jumped 48% y/y, strongly supported by year-end revaluation of stock portfolio and dividends cashed from revenue-generating stocks





Change in estimates / outlook In spite of the company’s strong set of results in 2012, we decided to slightly decrease our forecast in terms of both sales and operating profitability, as we anticipate even higher competition on the core market, accompanied by elevated marketing efforts. According to the market research company Cegedim, sales of drugs decelerated last year to 8.3% y/y, from double-digit levels in previous years, due to easing Rx drugs sales (to 7.1% y/y) caused by the clawback tax mechanism, which discouraged sales of prescription drugs, especially cheaper ones. OTC drugs sales advanced 11.5% y/y. The market research company expects the market to further decelerate in 2013, to only 1.4%, for the same reason. We therefore see pharma operators directing their energies towards the OTC segment, which would unavoidably put pressure on Biofarm’s results, both in terms of sales and operating profits. We thus expect sales on the domestic market to advance at a CAGR of 7% over the detailed forecast period, in line with the market. In terms of exports, we stick to our previous estimate of a brisk growth of exports up to 2014, by which time a level of EUR 4mn should be reached, from just EUR 0.8mn in 2011, thanks to higher sales in Russia, Ukraine and other former Soviet countries. Foreign markets are seen by Biofarm and its peer Antibiotice as a way of mitigating the cash shortage affecting business on the domestic market, given that payments abroad are made faster (i.e in around 90 days compared with over 300 days on the local market). RAS

(RON, mn) Now Before Change Now Before Change

Net sales 111.5 110.2 1.2% 131.0 126.3 3.7%

EBITDA 25.0 28.9 -13.3% 29.4 32.5 -9.5%

EBIT 18.8 22.7 -17.0% 22.7 25.8 -12.0%

Net profit 15.0 18.2 -17.6% 19.6 23.6 -16.8%

EBITDA margin 22.5% 26.2% 22.5% 25.8%

EBIT margin 16.9% 20.6% 17.3% 20.4%

Net margin 13.5% 16.5% 15.0% 18.7%


2013e 2014e

We expect the operating margin to be under pressure from incremental marketing expenses resulting from the fierce competition in the core market. In 2012, marketing expenses had a weight of about 22% in own production sold adjusted for commercial discounts, a level that we do not expect to decrease in the coming years. Relaxation on this side might occur if arrears in the sector are reduced, as assumed by the government, making the Rx business profile more attractive and consequently lowering competition on the OTC segment. We note that the Ministry of Health enjoyed a sizeable increase in the budget this year, to 4.5% of GDP (from 4% previously), with EUR 800mn to be used in order to reduce payment terms to 60 days, according to an EU directive provisions (from the current over 300 days). Even if this objective is difficult to achieve, some improvements are expected in the form of a reduction of the receivables collection period in the pharma sector. In any case, Biofarm remains a strong cash generator, operating without ST bank loans for financing its working capital needs, despite the fund shortage in the sector.

Mounting competition on core OTC market will continue to put pressure on marketing budget

Exports might reach 10% of sales by 2014, thanks to higher sales in Russia, Ukraine and other former

Soviet countries

Marketing expenses, critical challenge for Biofarm, to remain at elevated levels

Cash generation capabilities remain strong plus





Due to the low weight of prescription drugs in Biofarm’s portfolio, the impact of the clawback tax is not as detrimental as in the case of its peer Antibiotice, although following changes in the taxation mechanism early last year, its level increased from RON 0.3mn/year to RON 0.8mn. The tax level should decrease this year, as a result of the exclusion of VAT from the tax base.

Marketing and raw material expenses development (2008 - 2012)

Source: Erste Group Research, Biofarm

Note: Own production sold has been adjusted for commercial discounts

16.1%

17.0%

20.1%

22.0% 22.2%

26.3%26.2%

26.4%

28.0%

26.5%

0%

5%

10%

15%

20%

25%

30%

2008 2009 2010 2011 2012e

Marketing expenses / Adj. own production sold

Raw material expenses / Adj. own production sold

Biofarm is exposed to FX risk due to the large weight of imported raw materials employed in production and packaging, and is at an advantage when the LC strengthens. So far, the company has shown evidence of good cost control in conjunction with its ability to pass through higher costs into product prices, with the ratio of raw materials/own production sold showing no major fluctuations from one year to another. The above-mentioned assumptions led to an EBIT margin for FY13 of 16.9%. Starting with 2014, we envisage a slight annual improvement of operating profitability towards 17.5%. Management’s sound track record in terms of cost control, along with the company’s competitive edge in its key therapeutic areas and nutritive supplements are the main reasons for the expected gradual improvement in operating margin in the coming years. However, on average, we have lowered the EBIT margin estimate by approx. 2pp over the detailed forecast period.

EBIT margin expected at 16.9% this year, and seen stabilizing at 17.5%

Affordable product prices allows Biofarm to protect its margins against pressure on key expense categories





Dividend of RON 0.013/share Starting last year, Biofarm joined the dividend players group, with distributions expected to continue for as long as the main shareholders are closed-end funds (SIFs). The BoD proposed the distribution of a gross DPS of RON 0.013 for last year, up from RON 0.01/share for FY11. In spite of the large cash distributions and stretched payment terms, our view is that the company will manage to fund its working capital needs without the ‘support’ of bank debt. Recommendation and target price In spite of the slight decreases in terms of operating profit estimates, a stronger than anticipated cash position supported the company’s fair value and led to a target price of RON 0.252, higher than the previous one (RON 0.218). However, following the recent share price rally, we had to downgrade the stock to Hold from Accumulate. Any improvement in market conditions, especially with regards to payment terms, would trigger an upward revision of our forecasts.

Biofarm to confirm its new status as stable revenue-generating stock






Risk free rate 6.8% 6.8% 6.8% 6.8% 6.8% 5.5%


Beta 1.1 1.1 1.1 1.1 1.1 1.0

Cost of equity 14.7% 14.7% 14.7% 14.7% 14.7% 12.2%

Cost of debt 9.3% 9.3% 9.3% 9.3% 9.3% 8.0%



Equity weight 90% 90% 90% 90% 90% 90%

WACC 13.9% 13.9% 13.9% 13.9% 13.9% 11.6%

DCF valuation

(RON mn) 2013e 2014e 2015e 2016e 2017e 2018e (TV)

Sales growth 6.2% 17.5% 7.9% 6.8% 6.8% 5.5%

EBIT 18.8 22.7 24.8 28.2 28.2 29.7

EBIT margin 16.9% 17.3% 17.6% 17.5% 17.5% 17.5%

Tax rate 20.0% 20.0% 20.0% 20.0% 20.0% 19.0%

Taxes on EBIT -3.8 -4.5 -5.0 -5.6 -5.6 -5.7

NOPLAT 15.1 18.2 19.9 22.6 22.6 24.1

+ Depreciation 6.2 6.7 7.3 7.8 7.8 8.5










Minorities 0.0


Net debt -78.6



Number of shares outstanding (mn) 1,094.9


12M target price per share (RON) 0.252

Current share price (RON) 0.236

Up/Downside 7.0%


0 16.5% 17.0% 18% 18.0% 18.5%

10.6% 0.257 0.262 0.266 0.271 0.275

11.1% 0.250 0.254 0.259 0.263 0.267

11.6% 0.244 0.248 0.252 0.256 0.260

12.1% 0.238 0.242 0.246 0.250 0.254

12.6% 0.233 0.237 0.240 0.244 0.248

0 1.0% 1.5% 2.0% 2.5% 3.0%

10.6% 0.252 0.259 0.266 0.274 0.284

11.1% 0.246 0.252 0.259 0.266 0.274

11.6% 0.240 0.246 0.252 0.259 0.266

12.1% 0.235 0.240 0.246 0.252 0.259

12.6% 0.231 0.235 0.240 0.246 0.252



WA

CC

WA

CC

PV of

detailed

period

27%

PV of

terminal

value

73%






Income Statement 2009 2010 2011 2012e 2013e 2014e(RAS, RON mn, 31/12) 31/12/2009 31/12/2010 31/12/2011 31/12/2012 31/12/2013 31/12/2014

Net sales 67.11 82.29 93.44 104.97 111.50 130.97

Invent. changes + capitalized costs 1.49 0.96 -0.10 1.02 0.00 0.00

Total revenues 68.60 83.25 93.34 105.99 111.50 130.97


Material costs -20.57 -24.93 -29.41 -31.84 -36.73 -44.53

Personnel costs -13.08 -14.26 -14.38 -16.43 -16.92 -17.43


EBITDA 18.25 21.63 21.04 22.90 25.04 29.44


EBIT 13.71 16.93 16.10 17.24 18.84 22.70

Financial result 8.88 0.10 2.04 5.39 -0.97 0.66


EBT 22.59 17.04 18.14 22.63 17.87 23.36

Income taxes -2.95 -3.43 -2.68 -3.39 -2.86 -3.74




Balance Sheet 2009 2010 2011 2012e 2013e 2014e(RAS, RON mn, 31/12)


Tangible assets 58.51 53.61 56.69 58.97 85.18 88.80


Total fixed assets 72.79 67.51 68.66 73.50 102.61 106.44

Inventories 11.28 13.55 15.23 15.62 20.77 24.40


Other assets 0.17 0.22 0.27 0.28 0.00 0.00



TOTAL ASSETS 154.08 168.23 184.83 198.46 192.87 215.54

Shareholders'equity 136.05 145.76 154.25 164.54 168.29 187.92

Minorities 0.00 0.00 0.00 0.00 0.00 0.00



LT provisions 4.89 3.36 3.88 1.50 2.05 2.05







TOTAL LIAB. , EQUITY 154.08 168.23 184.83 198.46 192.87 215.54

Cash Flow Statement 2009 2010 2011 2012e 2013e 2014e(RAS,RON mn, 31/12)

Cash flow from operating activities 4.49 31.20 16.57 16.25 9.92 21.48


Cash flow from financing activities -0.72 3.26 -4.42 -6.22 -36.56 -4.18

CHANGE IN CASH , CASH EQU. 0.96 29.77 7.06 4.35 -36.27 10.46


EBITDA margin 26.6% 26.0% 22.5% 21.6% 22.5% 22.5%

EBIT margin 20.0% 20.3% 17.3% 16.3% 16.9% 17.3%


ROE 14.8% 9.7% 10.3% 12.1% 9.0% 11.0%

ROCE 17.0% 12.8% 15.7% 19.5% 14.0% 13.7%

Equity ratio 88.3% 86.6% 83.5% 82.9% 87.3% 87.2%

Net debt -37.4 -67.2 -74.2 -78.6 -42.3 -52.8

Working capital 68.8 82.2 89.6 92.3 68.3 84.0

Capital employed 104.4 82.8 84.3 87.5 128.6 137.7





Erste Group Research – Erste Sector Healthcare – 20 March 2013 Erste Group Research – Company Report Bioton | Pharmaceuticals | Poland 20 March 2013


Bioton

Hold



Bioton | Phar maceuticals | Pol and

20 March 2013

PLN mn 2012p 2013e 2014e 2015e

Net sales 405.3 390.4 443.6 482.3

EBITDA 104.6 62.3 93.0 109.5

EBIT 68.3 24.1 52.3 66.3


EPS (PLN) 0.01 0.00 0.00 0.01

CEPS (PLN) 0.01 0.01 0.01 0.01

BVPS (PLN) 0.15 0.15 0.15 0.16

Div./share (PLN) 0.00 0.00 0.00 0.00

EV/EBITDA (x) 10.7 12.1 7.7 6.1

P/E (x) 18.3 57.3 15.5 11.1

P/CE (x) 9.5 10.7 6.9 5.7

Dividend Yield 0.0% 0.0% 0.0% 0.0%

0.05

0.06

0.07

0.08

0.09

0.10

0.11

0.1252 weeks

Bioton WIG 20 (Rebased)


in PLN -33.3% -14.3% -33.3% 0.0%

Share price (PLN) close as of 18/03/2013 0.0600 Reuters BOTN.WA Free float 71.3%

Number of shares (mn) 8,386.8 Bloomberg BIO PW Shareholders Prokom Investm. (12.1%)

Market capitalization (PLN mn / EUR mn) 503 / 121 Div. Ex-date Troqueera Enterprises Ltd (11.78%)

Enterprise value (PLN mn / EUR mn) 754 / 182 Target price 0.0600 Homepage: www.bioton.pl

First steps on way to turnaround

Finding a new partner following the Actavis contract termination, as well as improving transparency on the impact of the Biolek and Biosenso acquisitions, remain the keys to unlocking Bioton’s share price (as well as valuation) potential. Nevertheless, on an encouraging note, the company recently started to deliver more good news to investors, with growth on the top line (driven by the insulin business) accelerating and - thanks to strict cost control and a better sales mix - finally moving into black territory on the operating level. Factoring in the faster progress towards profitability, but also somewhat more dilutive effects from the Biolek and Biosenso deals, our revised 12M DCF-derived target price arrives at PLN 0.06 per share. All told, we confirm our Hold recommendation.

The major changes incorporated into our model include: 1) the sizable rebound of domestic insulin sales; 2) the delays in bringing a Ukrainian insulin sales agreement on-stream; 3) the consequences of termination of the Actavis cooperation contract; 4) the speedier progress in enhancing operating profitability 5); and the dilutive effects of the recent capital hikes linked to the Biolek and Biosenso acquisitions.

In summary, incorporating the more robust sales tempo in the Polish insulin market, we lift our sales target for 2013 to PLN 390.4mn (up 5.3% vs. our earlier forecast). Furthermore, helped by the improving sales mix, we expect the profitability progress to be more remarkable, with both the operating and bottom lines safely in the black. We raise our operating profit target to PLN 24.1mn (up 19.5% vs. our earlier estimate). As the forex impact on the financial result is still difficult to assess more accurately, we stick to our conservative stance and revise our net profit forecast to PLN 8.8mn (down 36.2% vs. our earlier target).

Analyst:

Vladimira Urbankova, MBA +435010017343 [email protected]





Changes in forecast/outlook Similarly to previous years, the company’s top line developments have been volatile in the course of 2012, with the y/y comparison distorted by the impact of one-off items. The milestone payment (EUR 22.25mn or PLN 94.7mn) related to the signing of the Actavis cooperation deal gave a boost to Bioton’s sales in 1Q12. The subsequent quarter already fully demonstrated the problems Bioton has been facing both at home as well as on the export side, with some of the earlier signed contracts’ materialization behind schedule. Nonetheless, the fourth quarter of 2012 saw remarkable progress, in particular on the domestic front, with the company’s share of Gensulin in the classical insulin market rising to the highest-ever level of 31.5%. Bolstered also by a q/q pickup in insulin sales in China, Bioton’s sales advanced 21% y/y to PLN 87.8mn, sending the 2012 top line to PLN 405.3mn, 3.3% above our forecast. We continue to assume that, going forward, the insulin segment will dominate Bioton’s sales structure, with the domestic tempo taking advantage of the expanding product range and more complex offer and the cooperation contracts overcoming initial problems and finally providing a more significant lift to its exports. First of all, based on the contract with Germany's Bayer (signed in June 2009 and valid until 2015), Bioton supplies its partner with insulin for the Chinese market. In 2010, for the exclusive right to market and distribute insulin produced by Bioton under the trade name SciLin in China, Bayer committed to pay Bioton an upfront payment of EUR 31mn and - after some delays - the first insulin deliveries started in September 2010. However these are still uneven, in particular on a quarterly basis. In 2012, Bioton’s insulin sales in China amounted to just PLN 6.0mn, out of which nearly one half was delivered in 4Q. According to the revised company guidance, in 2013, sales are anticipated to amount to some PLN 20mn (less than earlier expected PLN 30mn) and to double y/y in 2014. Secondly, in December 2010, Bioton inked an agreement with GlaxoSmithKline (GSK) and the first shipments within the frame of the GSK contract commenced as planned in September 2011. For the full-year 2012, they reached just PLN 2.8mn (below the initially indicated PLN 5mn). Consequently, the 2013 guidance was also cut here to PLN 4-4.5mn (from the earlier estimated PLN 8-9mn). Last but not least, Bioton still aims for a comeback to the Ukrainian market. While at the time of signing its contract with Indar ZAO, Bioton announced that deliveries are envisaged at around PLN 21mn on an annual basis for the next three years, due to the slipping deadlines linked to the registration of products, contrary to adjusted expectations (sales of PLN 1-3mn), there were no deliveries within the frame of the contract in 2012. The company started to cooperate with a local distributor, bringing in finished product insulin sales of around PLN 1.9mn in 2012. According to the latest estimates, the initial shipments within the Indar contract frame should bring sales of some USD 1mn in 2013.

Reflecting the high level of inventories at wholesalers, as well as the regulatory turmoil at the beginning of the year on one side, but a gradual recovery towards the end of the year on the other hand, in 2012, Bioton’s domestic sales of insulin amounted to around PLN 81.7mn (out of which just PLN 25.6mn were recorded in 1H12). With the basic human insulin made by Bioton keeping its full reimbursement status as well as price

Reflecting first sizable contribution from Biolek and Polish sales tempo acceleration after 2012 regulatory turmoil, we raise our 2013 top line target to PLN 390.4mn The insulin segment set to dominate Bioton’s sales structure, driven by improving exports to China, Russia and Ukraine along with solid domestic market

performance





competitiveness, Bioton’s domestic sales are poised to see solid growth in coming years. In addition, the company is set to benefit from the sales expansion of complementary products for diabetes care (an insulin pen and glucometer distribution deal with ARKRAY), as well as new product launches. All told, factoring in the faster than earlier envisaged home market sales rebound, to be slightly compromised by delays in shipments within the Indar contract, along with the somewhat less robust sales in China and Russia, we fine-tune our assumptions for Bioton’s total 2013 insulin sales to PLN 144.1mn, out of which some PLN 88.7mn is to be brought in by domestic sales. The Italian companies’ sales contribution to the 2012 top line stood at PLN 59.8mn, marginally above our target of PLN 57.4mn. Hence, we leave our forecasts unchanged here and, for 2013, we continue to project low single-digit-term growth, bringing the sales contribution from the Italian business to around PLN 61mn in total. In 2012, Bioton for the first time fully consolidated Biolek, the veterinary products manufacturer acquired in late 2011. While the 2012 sales guidance was revised from PLN 50mn to PLN 15-20mn, due to postponements in product registrations and launches on the export markets, including the crucial Chinese one, Biolek sales in 2012 did not materialize. According to the latest information from the company, the first Biolek product sales in China are now envisaged to start in 1Q13 and are projected to amount to some PLN 50-55mn in 2013. To be on the safe side, however, we opt to stick to our original forecast here (of around PLN 50mn for 2013). Last but not least, due to the termination of the Actavis cooperation contract, we are forced to remove from our model the remaining portion of milestone payments subject to the achievement of certain milestones on bringing insulin to the respective markets in 2013-15. Nonetheless, based on the agreement with Actavis, Bioton will be able to retain the sizable first milestone of EUR 22.25mn linked to the signing of the deal. (Originally, in total, Bioton was entitled to obtain EUR 55.5mn for its insulin distribution rights in the EU, US and Japan). While the termination of the deal was a result of the changed strategic outlook following the Actavis acquisition by Watson Laboratories, and Bioton’s management already started negotiations with possible partner(s), hoping to ink a similar deal no later than early 2014, we remain on the conservative side and do not incorporate any possible proceeds from such a transaction into our model, leaving them as an interesting upside. In summary, reflecting the above-mentioned changes, we revise our 2013 sales forecast from PLN 370.7mn to PLN 390.4mn. We continue to assume that the renewed dynamism in insulin sales will lend momentum to Bioton’s top line in the coming periods. Despite the less sizable help from one-offs (reflecting the removal of the Actavis deal related payment of EUR 4mn), we increase our 2014 target from PLN 403.4mn to PLN 443.6mn. While thanks to the Actavis milestone, the reported gross margin was at a relatively solid 52.9%, excluding one-offs, gross profitability remained rather subdued in 2012, with a gross margin of just 38.6%. Reflecting the 4Q12 improvement (with the gross margin at 45.7%), the 2012 gross margin slightly surpassed our expectations (51.0%). For 2013, with the benefits stemming from the Biolek consolidation (with an estimated gross margin of 40-50%) set to kick in and the company’s sales mix continuing its recent favorable trend, we think that our 2013 gross margin target of 45.1% is achievable. Nonetheless, in the absence of a one-off linked to the Actavis

We fine-tune our assumptions for Bioton’s total 2013 insulin sales to PLN 144.1mn, out of which some PLN 88.7mn is to be brought in by domestic sales The first more sizable Biolek product sales in China are now envisaged to start in 2013 Due to the termination of the Actavis cooperation contract, we are forced to remove from our model the remaining portion of milestone payments The renewed dynamism in insulin sales will lend momentum to Bioton’s top line in the coming periods Gross profit: Pace of improvements accelerated recently, benefits from Biolek consolidation to be visible from

2013 onwards





deal in 2014, we opt to trim the gross margin to 49.4% (from the earlier estimated 49.5%). In 2012, operating expenses were lower than we expected, due in particular to the cost savings in the G&A area, including the R&D activities. Following deceleration in the second half of the year, in 2012, administrative and general costs were 15.4% lower than we projected. The company aims to continue more strict control going forward. Consequently, we are prompted to reduce our 2013 forecast by 11.9% compared to our previous estimate of PLN 95.3mn. On the other hand, sales and marketing costs gathered momentum in 4Q12, with their full year tempo somewhat steeper than we had originally anticipated. Hence, we opt to fine-tune our assumptions for 2013 and project sales and marketing costs at around PLN 70.5mn, up 23% compared to our previous forecast. In summary, reflecting the better than estimated 2012 operating line performance, with clear progress achieved in 2H12 (when Bioton was able to post operating profit for two consecutive quarters), our new 2013 operating profit target arrives at PLN 24.1mn (19.5% higher than our earlier target of PLN 20.2mn), translating into an operating profit margin of 6.2% (vs. the previous 5.4% forecast). Although the EBIT margin is still relatively low for a pharma company, one has to bear in mind that it implies solid progress compared to the past years. Excluding the buoying effect of the Actavis cooperation deal related income, we see the 2012 operating line ending at a loss of PLN 26.1mn (while the 2H12 operating profit amounted to PLN 5.1mn). For 2014, as we continue to anticipate improving operating cost control, our operating profit target arrives at PLN 52.3mn, more than doubling y/y. Changes to 2013 and 2014 forecasts Consolidated, IFRS

(PLN, mn) Now Before Change Now Before Change

Net sales 390.4 370.7 5.3% 443.6 403.4 10.0%

Costs of goods sold 214.4 203.6 5.3% 224.5 203.8 10.2%

Gross profit 176.0 167.1 5.3% 219.1 199.6 9.8%

Sales & marketing exp. 70.5 57.3 23.0% 81.1 61.6 31.6%

General & admin. exp. 84.0 95.3 -11.9% 88.2 96.3 -8.4%

Other operating income 7.5 13.0 -42.1% 7.4 12.8 -42.1%

Other operating exp. 4.8 7.2 -32.5% 5.0 7.2 -30.7%

Operating profit 24.1 20.2 19.5% 52.3 47.3 10.6%

Financial result -16.0 -6.8 134.5% -14.8 -5.6 166.7%

Pre-tax profit 8.1 13.4 -39.1% 37.4 41.7 -10.2%Income taxes 1.5 2.5 -39.1% 7.1 7.9 -10.2%

Profit/loss on discont.operations 0.0 0.0 0.0% 0.0 0.0 0.0%

Minority interest 2.2 2.9 -25.3% 2.2 3.0 -25.3%

Net income 8.8 13.8 -36.2% 32.5 36.8 -11.5%

Gross margin 45.1% 45.1% 49.4% 49.5%

EBIT margin 6.2% 5.4% 11.8% 11.7%

Net margin 2.2% 3.7% 7.3% 9.1%


2013e 2014e

Reflecting the less favorable forex fortunes at the end of 2012 (with a closing exchange rate of the PLN firming vs. the US dollar, which resulted in forex losses), the company's financial result sunk into red territory in 2012, to a financial loss of PLN 20.3mn (vs. the 1H12 profit of PLN 0.8mn and our forecast of a 2012 financial loss of PLN 7.6mn). In addition, the company’s tax charge was pushed to PLN 13.1mn in 4Q12, lifting the total tax toll for 2012 to PLN 23.0mn. Thus, although the company recorded a gain on discontinued operations, namely on the disposal of SciGen Israel (including the license for Sci-B-Vac), totaling PLN 13.1mn, the 2012 net profit ended 23.8% behind our target of PLN 50.9mn. Also, going forward, the forex

With underlying operating profitability parameters improving faster than expected, we raise our 2013 EBIT target to PLN 24.1mn In absence of one-off help from milestones, net profit is expected to fall 77.4% y/y to PLN 8.8mn in 2013. Nonetheless, excluding one-off effects from comparative base, it implies bold move on way to achieve sustainably positive results.





situation might be quite volatile and the related financial expenses (in particular, forex and possible investment revaluation related losses) continue to pose a threat to the financial result. With the 2012 financial result significantly worse than we envisaged, we opt to adjust our 2013 forecast from a financial loss of PLN 6.8mn to a financial loss of PLN 16.0mn. Although the tax situation is difficult to assess, based on the recent guidance, we expect the company to continue in the activation of tax losses carried forward in the coming periods, reducing the effective tax rate below the statutory one. Factoring in the higher than earlier envisaged financial result burden, we revise our net profit forecast from PLN 13.8mn to PLN 8.8mn for 2013. For 2014, we stick to our cautious stance and, reflecting the worse than originally envisaged financial result, we project net profit of PLN 32.5mn, up 271% y/y (but 11.5% below our previous forecast).

4Q12 results review Bioton published its 4Q12 results on February 15, 2013.


Total sales (PLN 000) 87,795 72,575 21.0% 405,330 288,984 40.3%

Operating profit (PLN 000) 3,267 -14,244 n.m. 68,344 -48,384 n.m.

Net income (PLN 000) -14,093 -54,326 -74.1% 38,808 -77,554 n.m.

Operating margin 3.7% -19.6% 16.9% -16.7%

Net margin -16.1% -74.9% 9.6% -26.8%

Source: Bioton, 4Q11 and 2011 results were restated

In 4Q12, fueled by expanding insulin sales both at home as well as in some of the export markets (China), sales advanced 21.0% y/y to PLN 87.8mn. According to IMS data, sales of Gensulin in Poland in 4Q12 amounted to 307.8 thousand packs and the share of Gensulin in the Polish market of classic insulin reached the historical high level of 31.5%. Reflecting an improving sales mix, with an increasing stake of highly profitable insulin products, the company managed to make a bold move on the gross profit line, with the gross profit rising 25.6% y/y to PLN 40.1mn (and translating into a gross profit margin of 45.7%). Further bolstered by more strict cost control, the operating result ended in black territory at PLN 3.3mn. Nevertheless, burdened by the y/y deteriorating financial result (dragged down by forex losses), as well as the increasing tax toll, the company recorded a net loss of PLN 14.1mn. Still, as the comparative base period was hampered by losses associated with asset disposals (SciGen Israel), the net loss narrowed significantly y/y in 4Q12. All of this translated into 2012 performance as follows. Buoyed by the Actavis deal related milestone (EUR 22.25mn or PLN 94.7mn), sales climbed 40.3% y/y to PLN 405.3mn and the company’s operating and bottom lines were pushed into black territory, to operating profit of PLN 68.3mn and net profit of PLN 38.8mn (vs. the year-earlier operating loss of PLN 48.4mn and the net loss after minorities of PLN 77.6mn). Nonetheless, excluding the milestone related boost, underlying performance remained rather weak, with an operating loss of PLN 26.1mn.





Valuation / Recommendation With Bioton’s home country’s S&P rating unchanged since our last update in September 2012, based on our unified methodology for setting the equity risk premium, we stick to applying the equity risk premium for 2013-17 of 6.0% and 5.7% for perpetuity. With Polish 10-year government bond yields somewhat below the level reached in autumn 2012, we adjust the risk-free rate applied in our DCF model to 4.5% (vs. the earlier 5.1%). The acquisitions of Biolek and Bisenso, with the purchase price for the veterinary business companies further enhanced, based on the achieved milestone events (all paid for in Bioton shares), brought additional dilutive effects, with the number of shares issued by the end of February 2013 up 14.8% compared to our last update. Factoring in the forecast changes (including a changing timeframe and capital hikes linked to the acquisition deals) into our model, we arrive at a 12-month target value of PLN 0.07 per share. While we welcome the recent progress, with its promise that the company has finally embarked on a path to a sustainable operational turnaround, we still think that the company’s transparency is not ideal, with many factors difficult to predict. We thus decided to stick to our earlier introduced risk related discount to our DCF-derived target price of 10%, yielding a new target price of PLN 0.06 (vs. PLN 0.07 per share targeted earlier). Bioton's recent share price developments clearly demonstrated its sensitivity to deal related news flow. The Actavis deal termination resulted in a fresh wave of pessimism, although the impact on the company’s immediate future will not be substantially harmful. We believe that, in the worst-case scenario, the company has the capability to complete the insulin product development and registration on its own. Moreover, there is a good chance to bring a new partner (or partners) at any stage of the process, most importantly for the marketing and distribution, where Bioton clearly lacks the knowhow and resources to achieve significant success. The finding of a new partner is undoubtedly one of the top issues for management this year, and the related news flow promises to become a new trigger for Bioton’s share price. Management also remains firmly committed to keeping operating costs under control and not deviating from its recent course towards sustainable profitability. With quarterly results enjoying a low underlying comparative base, visible progress is in the cards for this year. The Biolek and Biosenso deal related dilutive waves remain the factor potentially distracting investors. Nevertheless, we think that, should the company report increasingly positive news, the investment story will become more attractive for long-term-oriented institutional investors, and not only those looking for short-term gains, fueled by the volatility of the stock at low price levels. In summary, we prefer to stick to our conservative stance. Our revised 12-month target price of PLN 0.06 per share suggests that the stock adequately reflects the pros and cons of Bioton’s investment case. Consequently, we leave our Hold recommendation unchanged for the time being.

We revise our 12-month target price to PLN 0.06 and stick to Hold. With business outlook remaining rather opaque and related uncertainties not allowing for full incorporation of possible benefits from recent deals, we see no reason to rush into stock




Erste Group Research – Sector Report


Risk free rate 4.5% 4.5% 4.5% 4.5% 4.5% 5.0%


Beta 0.84 0.84 0.84 0.84 0.84 1.0

Cost of equity 9.5% 9.5% 9.5% 9.5% 9.5% 10.7%

Cost of debt 7.0% 7.0% 7.0% 7.0% 7.0% 7.5%



Equity weight 86% 86% 86% 86% 86% 87%

WACC 9.0% 9.0% 9.0% 9.0% 9.0% 10.1%

DCF valuation

(PLN mn) 2013e 2014e 2015e 2016e 2017e 2018e (TV)

Sales growth -3.7% 13.6% 8.7% 11.4% 9.9% 4.5%

EBIT 24.1 52.3 66.3 87.8 108.3 92.6

EBIT margin 6.2% 11.8% 13.7% 16.3% 18.3% 15.0%

Tax rate 19.0% 19.0% 19.0% 19.0% 19.0% 19.0%

Taxes on EBIT -4.6 -9.9 -12.6 -16.7 -20.6 -17.6

NOPLAT 19.5 42.3 53.7 71.1 87.7 75.0

+ Depreciation 38.2 40.7 43.2 46.1 49.3 49.3



Chg. working capital / chg. Sales 21.0% -7.3% -7.8% -8.1% -9.5% -9.5%





Discount factor 0.92 0.84 0.77 0.71 0.65 0.59



Minorities 90.8


Net debt 184.5



Number of shares outstanding (mn) 8,386.8

Cost of equity 9.5%

12M target price per share (PLN) 0.07

- risk related discount 10.0%

12M target price per share (PLN) 0.06

Current share price (PLN) 0.06

Up/Downside 0%


0 14.0% 14.5% 15.0% 15.5% 16.0%

9.1% 0.06 0.07 0.07 0.07 0.08

9.6% 0.06 0.06 0.06 0.07 0.07

10.1% 0.06 0.06 0.06 0.06 0.07

10.6% 0.05 0.05 0.06 0.06 0.06

11.1% 0.05 0.05 0.05 0.05 0.06

0 1.0% 1.5% 2.0% 2.5% 3.0%

9.1% 0.06 0.06 0.07 0.08 0.08

9.6% 0.06 0.06 0.06 0.07 0.08

10.1% 0.05 0.06 0.06 0.06 0.07

10.6% 0.05 0.05 0.06 0.06 0.06

11.1% 0.05 0.05 0.05 0.06 0.06




WA

CC

WA

CC

PV of detailed period25%

PV of terminal

value75%





Income Statement 2010 2011 2012p 2013e 2014e 2015e(IAS, PLN mn, 31/12) 31/12/2010 31/12/2011 31/12/2012 31/12/2013 31/12/2014 31/12/2015

Net sales 378.10 288.98 405.33 390.36 443.64 482.34

Cost of goods sold -165.88 -186.40 -190.79 -214.37 -224.50 -232.36

Gross profit 212.21 102.59 214.54 175.99 219.14 249.98

SG&A -153.17 -157.10 -151.71 -154.53 -169.31 -186.54



EBITDA 128.71 -11.47 104.57 62.32 92.98 109.55


EBIT 90.06 -48.38 68.34 24.13 52.27 66.31

Financial result 9.77 0.26 -20.34 -15.98 -14.82 -13.12


EBT 99.84 -48.13 48.01 8.15 37.44 53.19

Income taxes -6.05 6.14 -22.99 -1.55 -7.11 -10.11

Result from discontinued operations 16.94 -39.27 12.79 0.00 0.00 0.00


Net result after minorities 117.18 -76.18 38.81 8.78 32.54 45.28

Balance Sheet 2010 2011 2012p 2013e 2014e 2015e(IAS, PLN mn, 31/12)

Intangible assets 703.09 1,131.34 1,112.72 1,107.75 1,103.74 1,099.70

Tangible assets 392.24 424.38 446.18 456.96 463.10 469.83


Total fixed assets 1,146.51 1,633.96 1,631.75 1,642.71 1,650.39 1,659.09

Inventories 97.99 95.29 83.31 85.47 92.73 95.30


Other assets 0.00 0.00 0.00 0.00 0.00 0.00



TOTAL ASSETS 1,584.75 2,027.40 1,926.57 1,967.22 2,025.01 2,086.38

Shareholders'equity 1,093.70 1,199.26 1,248.22 1,250.15 1,295.39 1,355.96

Minorities 76.18 189.32 90.83 90.83 90.83 90.83



LT provisions 0.00 0.00 0.00 0.00 0.00 0.00







TOTAL LIAB. , EQUITY 1,584.75 2,027.40 1,926.57 1,967.22 2,025.01 2,086.38

Cash Flow Statement 2010 2011 2012p 2013e 2014e 2015e(IAS,PLN mn, 31/12)

Cash flow from operating activities 27.17 -19.63 142.98 58.10 77.46 89.83

Cash flow from investing activities 57.98 -99.74 -101.42 -34.02 -37.02 -40.02

Cash flow from financing activities -82.18 85.08 -24.22 -6.06 -11.00 -10.45

CHANGE IN CASH , CASH EQU. 2.97 -34.29 17.34 18.03 29.44 39.36

Margins & Ratios 2010 2011 2012p 2013e 2014e 2015eSales growth 32.1% -23.6% 40.3% -3.7% 13.6% 8.7%

EBITDA margin 34.0% -4.0% 25.8% 16.0% 21.0% 22.7%

EBIT margin 23.8% -16.7% 16.9% 6.2% 11.8% 13.7%

Net profit margin 24.8% -14.5% 6.2% 1.7% 6.8% 8.9%

ROE 11.2% -6.6% 3.2% 0.7% 2.6% 3.4%

ROCE 6.8% -2.6% 2.0% 1.1% 2.5% 3.1%

Equity ratio 73.8% 68.5% 69.5% 68.2% 68.5% 69.3%

Net debt 123.4 239.2 184.5 160.4 119.9 70.1

Working capital 214.4 29.0 -126.8 -132.9 -88.5 -29.3

Capital employed 1,370.8 1,776.1 1,673.2 1,654.8 1,667.3 1,686.1





Erste Group Research – Erste Sector Healthcare – 20 March 2013 Erste Group Research – Company Report Egis | Pharmaceuticals | Hungary 20 March 2013


Egis

Buy



Egis | Phar maceuticals | Hungar y

20 March 2013

HUF mn 2012 2013e 2014e 2015e

Net sales 132,825.0 139,344.1 146,967.4 154,990.2

EBITDA 30,536.0 31,625.5 33,606.0 35,800.4

EBIT 20,436.0 20,819.8 22,091.8 23,518.7

Net result after min. 18,531.0 19,795.5 21,004.6 22,439.0

EPS (HUF) 2,380.13 2,542.53 2,697.83 2,882.07

CEPS (HUF) 3,672.75 3,933.53 4,179.88 4,462.76

BVPS (HUF) 23,053.72 25,356.26 27,804.09 30,426.16

Div./share (HUF) 240.00 250.00 260.00 275.00

EV/EBITDA (x) 3.1 3.0 2.5 2.1

P/E (x) 7.4 7.4 7.0 6.6

P/CE (x) 4.8 4.8 4.5 4.2

Dividend Yield 1.4% 1.3% 1.4% 1.5%

12,00013,00014,00015,00016,00017,00018,00019,00020,000

52 weeks

Egis BUX (Rebased)


in HUF 25.3% 8.0% 10.5% -2.1%

Share price (HUF) close as of 18/03/2013 18,895 Reuters EGIS.BU Free float 49.1%

Number of shares (mn) 7.8 Bloomberg EGIS HB Shareholders Servier (50.9%)

Market capitalization (HUF mn / EUR mn) 147,111 / 481 Div. Ex-date 19/04/12

Enterprise value (HUF mn / EUR mn) 94,068 / 308 Target price 25,700 Homepage: www.egis.hu

Healthy growth prospects in Russia, weak forint bodes well for another solid year

Factoring in changes to our Egis projections, including the new timeframe and higher equity risk premium, but lower risk-free rate, our DCF-derived 12-month target price arrives at HUF 25,700 per share, up 12.5% compared to our previous target. With the R&D-based relief along with the benefits from weak forint lessening the impact of the home market woes, and healthy business prospects driven by the sound Russia/CIS performance and further bolstered by Celltrion deal benefits kicking in from 2H13, Egis’ investment story should lure more investors into play. Despite the solid YTD performance, Egis’ valuation multiples remain very appealing. We confirm our Buy call on the stock.

We have incorporated into our model: 1) more dynamic export sales, reflecting the upward revision of the company’s guidance for sales of finished products to Western markets, along with the positive effect of the weaker than earlier envisaged forint in 2012/13; 2) support from the more favorable currency situation, as well as the positive effect of an improving sales mix and cost containment measures on gross profitability; 3) the less damaging impact of the home regulatory burden, given the indefinite prolongation of R&D relief to OEP payments.

In summary, we fine-tune our sales target for 2012/13 to HUF 139,344mn, corresponding to a 4.9% y/y rise. Although the ongoing price erosion in the CEE region, and most importantly in Hungary, will put a lid on the y/y progress, with respect to the hit from the home regulatory toll being far less harmful than originally estimated, we raise our operating and bottom line projections to HUF 20,820mn and HUF 19,795mn, up 20.3% and 21.2%, respectively, compared to our previous estimates.

Analyst:






Changes in forecast/outlook The price erosion completely erased the positive contribution from new product launches in October-December 2012, the first quarter of Egis’ fiscal year 2012/13. In order to maintain reimbursement and defend its competitive position, Egis was once again forced to lower prices in Hungary during the October 2012 ‘blind bidding’ auctions round. On an encouraging note, the cut was this time slightly less pronounced, at an average of 5.2%. (This compares with a 6.8% decrease from April 1, 2012, and a 6.9% reduction in October 2011.) However, as this was combined with the effect of the relatively high comparative base, Egis’ domestic sales contracted 19.8% y/y to HUF 7,148mn in 1Q12/13. Pointing to easing pricing pressures and a low comparative base, offering much less room for sizable cuts, CFO Poroszlai confirmed the earlier guidance for 2012/13, anticipating Egis’ domestic sales falling as much as 5-10% y/y. Consequently, while 1Q12/13 domestic sales lagged 4% behind our forecast, we leave our 2012/13 sales target broadly unchanged at HUF 29.2bn (corresponding to a 7% y/y drop). In the medium term, we continue to envisage Egis’ domestic sales recovering and sales advancing some 2-3% p.a. Russia/CIS: In 1Q12/13, Egis’ sales performance in Russia (sales up 11.8% y/y) was broadly in line with our expectations. The low comparative base (caused by the temporary shortfall of one product due to logistics reasons) played in favor of the steep y/y progress in Ukraine and other CIS markets, pushing the total Russia/CIS sales figure 2.2% above our forecast in 1Q12/13. As the high 1Q12/13 Russia/CIS tempo of 18.0% y/y was partly attributable to a comparative base effect, CFO Poroszlai reiterated the earlier 2012/13 guidance, assuming an 8-12% y/y rise for Russia/CIS as well as for Russia (all guidance in euro terms, although the company switched its invoicing to ruble terms from January 2011). The sales growth pace for 2012/13 assumed in the latest guidance corresponds to our original assumption. Hence, while sticking to the growth rate of around 11% y/y, but reflecting the marginally less robust 2011/12 performance, we fine-tune our 2012/13 forecasts for Russia/CIS from around EUR 181.8mn to EUR 179.7mn and for Russia alone from EUR 131.6mn to EUR 128.5mn. CEE markets: Sales in Eastern Europe surged 16.6% y/y (to EUR 30.4mn) in 1Q12/13, reassuring investors that the crucial Polish market (sales up 23.7%y/y) is getting back on track. However, the bold move out of the 2012 doldrums (caused by the unfavorable effect of the onset of regulatory changes in Poland from January 2012) was expected. As the gradually higher comparative base will dampen the y/y tempo in the course of the year, the company left the original guidance for 2012/13 (assuming a 3-6% y/y increase in euro terms) intact. Consequently, with sales in CEE markets broadly in line with our forecast and guidance reiterated, we see no reason to change our projections. Our CEE sales growth target for 2012/13 remains at 3.5% y/y, translating into sales of around EUR 126.0mn, Western markets: Bolstered by the relatively low comparative base, in 1Q12/13, bulk chemicals and other sales expanded 26.0% y/y to EUR 6.9mn. Nonetheless, such a high tempo is not viewed as sustainable for the rest of the year. The results of this order-driven segment are very volatile on a quarterly basis, with orders from Servier retaining their key importance for the final outcome. CFO Poroszlai reiterated the guidance, envisaging up to a 5% y/y increase in this sales category for full-year 2012/13. Consequently, we stick to our 2012/13 sales target of around EUR 44.0mn (corresponding to 1.5% y/y growth). Although, after taking advantage of the low

Domestic market: 1Q12/13 sales drop slightly more sizable than expected, but outlook for 2012/13 confirmed Supported by y/y weaker forint, export sales are set to back up Egis’ top line growth in 2012/13. Russia/CIS set to shine brighter, CEE poised for y/y revival in 2012/13

After factoring the above-mentioned changes into our sales projections, we revise our 2012/13 sales target to around HUF 139.3bn





comparative base, sales of finished products more than doubled y/y in 1Q12/13, the CFO opted to make only a minor upward adjustment to his original guidance, assuming sales growth of 10-15% y/y vs. the earlier indicated range of a 5% to 10% y/y rise. Consequently, we adjust our forecast accordingly, envisaging 2012/13 sales of finished pharmaceuticals to Western European markets at some EUR 20.4mn (corresponding to a 10% y/y increase). Finally, we incorporate into our projections newly revised forex assumptions and the actual 2012 data (including the annual average exchange rates of HUF 225.37/USD and HUF 289.42/EUR). For 2013, we revise our forecast from HUF 229.5/USD to HUF 235.0/USD and from HUF 278.0/EUR to HUF 297.5EUR. After factoring all of the above-mentioned changes into our sales projections, our 2012/13 sales target arrives at around HUF 139.3bn (slightly up from the earlier estimated HUF 136.1bn). For 2013/14, reflecting the still robust exports, along with the weaker than earlier anticipated forint, we set our new sales target at HUF 147.0bn, up marginally (0.7%) compared to our previous forecast. Changes to 2012/13 and 2013/14 forecasts Consolidated, IFRS

(HUF, mn) Now Before Change Now Before Change

Net sales 139,344 136,121 2.4% 146,967 145,888 0.7%

Cost of sales 60,253 59,019 2.1% 63,391 63,096 0.5%

Gross profit 79,091 77,102 2.6% 83,577 82,792 0.9%

Marketing & distr. costs 34,132 32,411 5.3% 35,981 34,997 2.8%

Administration costs 10,522 11,144 -5.6% 11,098 11,883 -6.6%

R&D costs 12,710 12,071 5.3% 13,405 12,937 3.6%

Other oper. exp. 2,093 5,432 -61.5% 2,189 5,512 -60.3%

Other oper. income 1,185 1,264 -6.2% 1,188 1,276 -6.9%

Operating profit 20,820 17,308 20.3% 22,092 18,740 17.9%

Financial result 1,591 1,296 22.8% 1,593 1,620 -1.7%Share of results of associates -169 -151 11.6% -84 -76 11.6%

Pre-tax profit 22,242 18,453 20.5% 23,601 20,284 16.4%

Income taxes 2,447 2,122 15.3% 2,596 2,333 11.3%

Net income 19,795 16,331 21.2% 21,005 17,951 17.0%

Gross margin 56.8% 56.6% 56.9% 56.8%

EBIT margin 14.9% 12.7% 15.0% 12.8%

Net margin 14.2% 12.0% 14.3% 12.3%


2012/13e 2013/14e

The y/y less favorable currency developments and pricing pressures in certain markets (particularly in Hungary) put a lid on the gross margin, sending it down y/y, from 59.1% in 1Q11/12 to 58.6% in 1Q12/13. Still, the gross margin was far better than we cautiously projected for the period (56.2%). Consequently, although price erosion will partly erase the benefits from the forint weakening and improving sales mix going forward, we are prompted to increase our gross margin target for 2012/13 from 56.6% to 56.8%. While the domestic pricing pressures, combined with the gradual appreciation of the Hungarian currency, will undoubtedly put a brake on the gross margin, reflecting the positive impact of the improving sales structure (with Russia/CIS sales outpacing the overall sales tempo) as well as cost containment measures, our gross margin target for FY13/14 arrives at 56.9%, slightly above the earlier projected 56.8%. Reflecting the expanding activities in Russia/CIS as well as preparations for the upcoming biosimilars market launch, Egis’ sales & marketing costs rose 4.6% y/y in 1Q12/13; their share expanded to 24.0% of total sales in





1Q12/13, up from the year-earlier 23.7%. Consequently, we opt to slightly raise our projections here, expecting sales and marketing costs accounting for 24.5% of sales in 2012/13 (vs. the earlier projected 23.8% of sales). As before, we assume that, in 2013/14, sales and marketing expenses will continue to rise slightly faster than the top line, due in part to the roll-over of the biosimilars to more markets, including Russia/CIS. Although the 1Q12/13 data (with a 16.0% jump in G&A area spending) looked disappointing at first glance, one has to bear in mind that the y/y steep increase was attributable to the low base (with G&A costs reduced by a provisions reversal), while in 1Q12/13 the amount of provisioning followed the regular pattern. Consequently, with the underlying G&A costs even shrinking 1% y/y, we opt to trim our forecast for general and administrative costs to around HUF 10.5bn in 2012/13. Given the elevated top line forecast, this translates into a somewhat lower (7.6%) share of sales in 2012/13. We expect G&A expenses to stay at the same level in relative terms in 2013/14. In 1Q12/13, R&D expenses advanced 10.1% y/y. Nonetheless, as spending in this area tends to be uneven and the company reiterated its guidance envisaging a practically unchanged share of R&D costs in total sales in a y/y comparison, we decided to fine-tune our forecast for 2012/13 accordingly, to around 9.1% of the total sales (corresponding to HUF 12.7bn). Going forward, we continue to assume that the share of R&D costs will be maintained relatively unchanged y/y at around 9.1% of sales in 2013/14. The change in the Hungarian legislation in December 2012 prolonged the possibility of reclaiming the OEP payments, with no time limit set this time for Hungarian pharma companies, including Egis. Thus, although the sales tax on reimbursed drug sales was increased to 20% and sales rep fees doubled from July 1, 2011, thanks to the available R&D-based relief, the company can continue to deduct a part of the respective burden from its obligation. In 2011/12, the total OEP related payments amounted to HUF 3,251mn, but the deductible amount stood at HUF 2,855mn at the same time, with just the difference showing up in the P&L statement. As the average reimbursement level was decreasing more than originally expected, the final 2011/12 OEP payment bill was significantly lower than our original estimate. Reflecting the indefinite availability of the R&D-based relief to the OEP payments, as well as the latest company guidance, we decrease our estimate here and assume that Egis will record in its P&L account a total expense of some HUF 400mn (down from the earlier estimated HUF 3,571mn, assuming relief impossibility) in its fiscal year 2012/13. With 2013/14 mirroring the availability of R&D-based relief, along with sales and the reimbursement levels heading south, we reduce our OEP payment related toll forecast from HUF 3,606mn to HUF 380mn. Incorporating the favorable effects of the weak forint (bolstering the gross margin), along with the more profound impact of the R&D-based relief to the OEP payments, our operating margin target for 2012/13 arrives at 14.9%, up from the originally projected 12.7%. We increase our EBIT target for 2012/13 by 20.3% to HUF 20,820mn. Mirroring easing pricing pressures, recovering home sales, as well as the significant reduction of the OEP regulatory burden impact on the P&L level, only partly compromised by the firming forint, we expect operating profit in 2013/14 to rise 6.1% y/y to HUF 22,092mn, translating into y/y progress of the EBIT margin, to 15.0%. Reflecting the losses at Hungaropharma weighing on Egis’ share of its associate’s result, the overall 2011/12 financial result ended in red territory. The Hungaropharma losses represent a one-off, which is not anticipated to reoccur this fiscal year. Nonetheless, as they were recorded in 1Q11/12, in

Except for marketing & distribution costs, all operating expenses are envisaged not to outpace 2012/13 sales tempo Renewed and indefinite R&D-based relief to OEP payments bodes well for EBIT in 2012/13 and coming years We increase our 2012/13 EBIT margin target to 14.9%. Given y/y firmer forint, 2013/14 will see only minor progress, with EBIT margin now projected at 15.0% Our net profit target for 2012/13 arrives at HUF 19,795mn, up 21.2% compared to our earlier forecast





their absence, the company had relatively big room for the y/y bold move on the net level in 1Q12/13. On top of that, the forex fortunes were favorable, with the end of period weakening of the forint resulting in a positive forex impact of HUF 925mn in 1Q12/13. Although the currency situation remains volatile this year, with the end of the period’s decisive exchange rate fluctuations making it especially difficult to predict the final forex impact, we opt to increase our 2012/13 financial result estimate (excluding the share of associates) from HUF 1,296mn to HUF 1,591mn. Finally, in line with the company’s latest guidance, we incorporate into our projections the lower than earlier estimated effective tax rate (cutting it from 11.5% to 11%). All told, our new net profit target arrives at HUF 19,795mn for 2012/13 (vs. the earlier forecast of HUF 16,331mn) and HUF 21,005mn for 2013/14 (vs. the previous target of HUF 17,951mn).

1Q12/13 results review Egis announced its 1Q12/13 results on February 12, 2013, after market close. Reflecting the less sizable deterioration of both gross and operating profitability parameters, the improving financial result as well as the y/y absence of negative one-offs, the bottom line tempo reached a robust 23.5% y/y, surpassing by a wide margin both the market consensus as well as our more optimistic forecast.

Consolidated sales review 1Q12/13 1Q11/12 y/y

Hungary (HUF mn) 7,148 8,917 -19.8%

Russia (EUR mn) 29.0 26.0 11.8%

CIS (EUR mn) 13.7 10.2 33.5%

Eastern Europe (EUR mn) 30.4 26.0 16.6%

Other (EUR mn) 12.7 8.2 55.3%

Total export (EUR mn) 85.8 70.4 21.8%

IFRS consolidated 1Q12/13 1Q11/12 y/y

Net sales (HUF mn) 31,445 30,392 3.5%

Operating profit (HUF mn) 5,611 5,522 1.6%

Net income (HUF mn) 6,587 5,333 23.5%



Source: Egis Domestic sales: Reflecting the mounting pricing pressures, domestic sales contracted 19.8% y/y in the October-December 2012 period. In order to maintain the reimbursement and market position of certain products, Egis was forced to cut prices in Hungary by 5.2% on average from October 1, 2012. Exports: Exports amounted to EUR 85.8mn (up 21.8% y/y) in 1Q12/13. Bolstered by steady expansion of the sales network, the company’s sales in Russia advanced 11.8% y/y to EUR 29.0mn in 1Q12/13. Helped by the low base (due to a temporary shortfall of one product for logistics reasons), Ukrainian sales jumped 59.1% y/y to EUR 5.6mn. In addition, sales in other CIS markets soared 20.1% y/y, lifting Egis’ sales in Russia/CIS up 18.0% y/y to EUR 42.7mn in 1Q12/13. Reflecting the strong y/y pickup from the very weak previous year period (hampered by the unfavorable impact of healthcare reform) in the crucial Polish market, sales to Eastern Europe rose a hefty 16.6% y/y to EUR 30.4mn in 1Q12/13. In addition, the low comparative base worked in the company’s favor in Western European





sales. Bolstered by y/y increasing orders from Servier, bulk chemicals and others sales grew 26.0% y/y to EUR 6.9mn. And finally, buoyed by contractual business, sales of finished pharmaceuticals to Western European countries more than doubled y/y to EUR 5.7mn in 1Q12/13. According to the company, the y/y worse forex situation (with the forint appreciating y/y) erased some HUF 1bn from Egis’ export sales figure in HUF terms in 1Q12/13. Profitability: The price erosion in certain markets (particularly in Hungary), along with the y/y less favorable forex situation, put a lid on the company’s gross margin, sending it down from 59.1% in 1Q11/12 to 58.6% in 1Q12/13. Although the underlying costs were trimmed 1% y/y, due to higher provisions (vs. the year-earlier period’s provisions reversal), administrative and general costs went up 16.0% y/y. Lifted by intense promotional activities in Russia/CIS, sales and marketing costs expanded 4.6% y/y. Furthermore, the company took advantage of the newly passed legislation allowing for partial R&D-based relief to the OEP payments recorded under other operating expenses. At the same time, the Romanian clawback related charge stood at HUF 146mn. All told, reflecting in particular the decreasing gross profitability margin, along with operating costs outpacing the top line tempo, operating profit growth was tempered to just 1.6% y/y. Operating profit reached HUF 5,611mn in 1Q12/13. The operating margin worsened to 17.8% in 1Q12/13 (from 18.2% in the year-earlier period). Bolstered by the favorable currency fortunes (with the weakening of the forint at the end of 1Q12/13 resulting in a positive net forex impact of HUF 925mn), the 1Q12/13 financial result not only ended safely in black territory, but improved y/y to HUF 1,457mn. While in the year-earlier period part of the profitability gains was wiped out by the accounting for losses at the associated company Hungaropharma (of HUF 1,026mn), in their absence, room for a bold move on the bottom line was open in 1Q12/13. Bolstered further by the y/y unchanged (and, at 6.6%, relatively low) effective tax rate, 1Q12/13 net profit climbed 23.5% y/y.

Valuation / Recommendation Compared to other core CEE countries, the macroeconomic situation in Hungary continues to be more challenging, with the government’s unorthodox economic policies yielding still relatively high volatility on the market. This is also mirrored in government bond yields staying well above their CEE-based counterparts. Nonetheless, Hungarian government bond yields have taken a downward trajectory, prompting us to lower the risk-free rate from 7.5% (used in our previous report on Egis in September 2012) to 7.0% for the detailed forecast period of 2013-17. With the country’s rating slashed one notch by S&P in November 2012, we are forced to raise the applied equity risk premium from 7.15% to 7:55% for the forecast period of 2013-17 and from 6.65% to 7.0% for perpetuity yields. Consequently, we derive a WACC of 13.3% for 2013-17 and 11.9% for perpetuity, vs. the 13.4% and 11.6%, respectively, used in our previous valuation. After incorporating all of the above-mentioned changes to our forecasts into our DCF model (as well as a new timeframe), our DCF-derived 12-month target price arrives at HUF 25,700 per share, up 12.5% compared to our earlier target price of HUF 22,850. Egis’ 1Q12/13 results were well ahead of expectations, with most market participants (including us) worried about the deteriorating sales outlook at home, as well as the dampening effect of the price erosion and y/y

We adjust our DCF model parameters to include increasing equity risk premium following Hungary’s rating downgrade





appreciating forint on the company’s margins. Although (as before) the company’s relatively high home market exposure (despite a 19.8% y/y sales drop, Hungary’s share stood at 22.7% of sales in 1Q12/13) continues to represent a disadvantage compared to its peers, we believe that, boosted by the still relatively weak forint and healthy growth prospects in Russia/CIS, complemented by efficient cost control, the company has all the prerequisites to post very solid results in 2012/13. Although the quarterly price cut as of October 2012 was relatively sizable, the trend points to somewhat easing pricing pressures going forward; hence (factoring in a low comparative base in the coming periods), the company’s guidance for 2012/13 was confirmed in February 2013. In addition, Egis’ regulatory toll will be not as big as originally thought, with the R&D-based relief to the OEP payments prolonged for an indefinite period. Egis’ progress in its generics portfolio rejuvenation (with new products typically offering higher prices and margins), along with reaping more benefits from cost efficiency enhancement programs, should yield more visible results on both the gross and operating profitability levels as well. Although Egis is not a dividend story, doubling the nominal dividend to HUF 240 per share (corresponding to a 10% payout ratio), approved to be paid on the 2011/12 results, was welcomed by investors. Moreover, an increase in the dividend payout to some 10% seems likely to be a new policy to be implemented in the future. Egis’ cooperation with Celltrion is well on track, with the first tangible results to tap opportunities in the newly opening area of biosimilars anticipated soon. In March 2012, Egis’ partner Celltrion submitted to the European Medicine Agency (EMA) an application for marketing authorization for its biosimilar infliximab (a biosimilar equivalent to original product Remicade [Merck&Co and J&J], with combined global sales amounting to USD 8.2bn in 2011). Recently, Egis confirmed that it expects the first product resulting from the cooperation contract with Celltrion to be launched by mid-2013 (to post some EUR 30mn in sales in the first full year of sales). The introduction is planned in one of the CEE countries/EU members), with the roll-out to follow during the next fiscal year 2013/14, depending on the obtaining of regulatory approvals (as well as reimbursement status, a necessary precondition for sales, given the relatively high price for the therapy). According to the contract, Egis has exclusive rights to market eight biosimilar products from the Celltrion portfolio in five countries of the CIS region (including Russia) and semi-exclusive rights in an additional 12 countries in the CEE region. Although (apart from the first product infliximab) the names of the other products were not publicly disclosed, biosimilars to bestselling products, such as Roche’s Herceptin, are anticipated to top the list of products under cooperation.

While many uncertainties continue to surround this issue, Egis’ plans to supply Watson with rosuvastatin zinc product to compete with AstraZeneca’s Crestor remain one of the possible triggers for both the stock price and valuation. As the US product launch is still subject to the outcome of a pending lawsuit (with the earliest possible launch at risk for Watson foreseen in April 2013, but the more likely introduction only following the patent expiration, and hence no sooner than in 2016), Egis hesitates to provide any information regarding the possible date for commercial launch or expected sales revenues of the product. We think that Egis has nothing to lose in this case, while the possible contribution to the top line will be, in

Domestic pressures are easing Increase in the dividend payout to some 10% seems likely to be a new policy Egis’ cooperation with Celltrion is well on track Egis’ plans to supply Watson with rosuvastatin zinc product to compete with AstraZeneca’s Crestor remain one of the possible triggers





our opinion, in the range of several dozens of millions of USD as product peak sales (and bringing an above-average operating profitability margin).

Last but not least, a brief look at its balance sheet confirms that Egis is in very healthy shape, with practically no external debt and a huge cash cushion (of HUF 44.7bn at the end of December 2012). While this adds more arguments to Egis’ solid defensive case at the moment, it is worth mentioning that the company recently confirmed that it aims to use its cash pile for M&A activities, with results possibly coming soon. According to Egis’ CFO, the company is currently evaluating several options in the M&A field, with the main target to enrich the portfolio with interesting products (rather OTC or Rx drugs, but not subject to heavy reimbursement/pricing pressures) and/or strengthen its position/expand in regional markets with attractive growth potential. An acquisition in Russia is also under consideration, as it would enable the company to protect itself from possibly intensifying protectionist measures by the Russian government towards the pharma industry. All told, we continue to think that Egis’ investment case is gaining attractiveness, with new potential triggers (biosimilars, M&A activities) adding to the traditionally sound fundamentally-based story of the company. Despite the solid YTD performance, the valuation multiples remain attractive and the valuation gap still wide, justifying our Buy call on the stock.

Egis is in very healthy shape, with practically no external debt and a huge cash cushion, possibly to be used for M&A activities Our 12-month target price of HUF 25,700 per share suggests that, despite solid YTD performance, upside potential for stock remains attractive. We stick to our Buy

recommendation






Risk free rate 7.0% 7.0% 7.0% 7.0% 7.0% 5.0%


Beta 0.84 0.84 0.84 0.84 0.84 1.0

Cost of equity 13.3% 13.3% 13.3% 13.3% 13.3% 12.0%

Cost of debt 7.5% 7.5% 7.5% 7.5% 7.5% 5.5%



Equity weight 99% 99% 99% 99% 99% 99%

WACC 13.3% 13.3% 13.3% 13.3% 13.3% 11.9%

DCF valuation

(HUF mn) 2013e 2014e 2015e 2016e 2017e 2018e (TV)

Sales growth 4.9% 5.5% 5.5% 5.7% 5.8% 6.0%

EBIT 20,819.8 22,091.8 23,518.7 24,981.9 26,618.2 23,885.8

EBIT margin 14.9% 15.0% 15.2% 15.3% 15.4% 13.0%

Tax rate 11.0% 11.0% 11.0% 11.0% 11.0% 19.0%

Taxes on EBIT -2,290.2 -2,430.1 -2,587.1 -2,748.0 -2,928.0 -4,538.3

NOPLAT 18,529.6 19,661.7 20,931.6 22,233.9 23,690.2 19,347.5

+ Depreciation 10,805.7 11,514.2 12,281.7 13,107.0 13,994.3 13,994.3


+/- Change in working capital -2,396.7 -2,778.4 -2,752.7 -2,901.6 -3,162.0 -3,432.1


- Capital expenditures -16,320.9 -17,929.4 -19,396.1 -20,985.1 -22,694.5 -13,994.3

Free cash flow to the firm 10,617.7 10,468.1 11,064.4 11,454.2 11,827.9 15,915.4


Terminal value 163,608.6

Discount factor 0.88 0.78 0.69 0.61 0.54 0.48

Discounted free cash flow - September 30 2012 9,375.0 8,161.1 7,616.4 6,961.9 6,347.6 86,080.4

Enterprise value - September 30 2012 124,542.3

Minorities 0.0


Net debt -43,021.0


Equity value - September 30 2012 167,563.3

Number of shares outstanding (mn) 7.8Cost of equity 13.3%

12M target price per share (HUF) 25,700

Current share price (HUF) 18,895

Up/Downside 36.0%


25700 12.0% 12.5% 13.0% 13.5% 14.0%

10.9% 25,807 26,493 27,180 27,866 28,553

11.4% 25,101 25,751 26,401 27,051 27,701

11.9% 24,465 25,083 25,700 26,317 26,935

12.4% 23,891 24,479 25,067 25,654 26,242

12.9% 23,370 23,931 24,491 25,052 25,613

25700 1.0% 1.5% 2.0% 2.5% 3.0%

10.9% 25,700 26,401 27,180 28,051 29,033

11.4% 25,067 25,700 26,401 27,180 28,051

11.9% 24,491 25,067 25,700 26,401 27,180

12.4% 23,966 24,491 25,067 25,700 26,401

12.9% 23,485 23,966 24,491 25,067 25,700




WA

CC

WA

CC


PV of terminal

value69%





Income Statement 2010 2011 2012 2013e 2014e 2015e(IAS, HUF mn, 30/09) 30/09/2010 30/09/2011 30/09/2012 30/09/2013 30/09/2014 30/09/2015

Net sales 118,915.00 128,939.00 132,825.00 139,344.13 146,967.41 154,990.24

Cost of goods sold -52,206.00 -56,833.00 -57,157.00 -60,253.12 -63,390.59 -66,683.90

Gross profit 66,709.00 72,106.00 75,668.00 79,091.01 83,576.82 88,306.34

SG&A -38,169.00 -41,408.00 -42,315.00 -44,653.82 -47,079.31 -49,620.06

Other operating revenues 1,003.00 1,245.00 1,191.00 1,185.05 1,188.01 1,199.89

Other operating expenses -12,385.00 -15,641.00 -14,108.00 -14,802.46 -15,593.71 -16,367.47

EBITDA 25,455.00 25,609.00 30,536.00 31,625.52 33,605.99 35,800.39

Depreciation/amortization -8,297.00 -9,307.00 -10,100.00 -10,805.73 -11,514.18 -12,281.69

EBIT 17,158.00 16,302.00 20,436.00 20,819.79 22,091.81 23,518.69

Financial result 2,243.00 -626.00 -148.00 1,422.30 1,508.81 1,693.62


EBT 19,401.00 15,676.00 20,288.00 22,242.08 23,600.62 25,212.31

Income taxes -2,618.00 -2,091.00 -1,757.00 -2,446.63 -2,596.07 -2,773.35



Net result after minorities 16,783.00 13,585.00 18,531.00 19,795.45 21,004.55 22,438.96

Balance Sheet 2010 2011 2012 2013e 2014e 2015e(IAS, HUF mn, 30/09)

Intangible assets 4,089.00 4,101.00 4,136.00 4,236.00 4,341.90 4,450.45

Tangible assets 63,508.00 69,347.00 73,931.00 78,579.81 83,934.39 89,664.25

Financial assets 7,431.00 5,055.00 4,181.00 4,494.58 5,168.76 6,202.51


Inventories 38,768.00 35,836.00 33,788.00 35,091.87 36,641.57 38,158.78

Receivables and other current assets 42,773.00 40,824.00 46,273.00 48,517.83 51,093.77 53,747.00

Other assets 0.00 0.00 0.00 0.00 0.00 0.00

Cash and cash equivalents 17,973.00 35,557.00 45,929.00 55,893.95 65,708.40 76,205.82

Total current assets 99,514.00 112,217.00 125,990.00 139,503.65 153,443.74 168,111.61

TOTAL ASSETS 174,542.00 190,720.00 208,238.00 226,814.04 246,888.79 268,428.81


Minorities 0.00 0.00 0.00 0.00 0.00 0.00



LT provisions 1,216.00 1,244.00 1,208.00 1,232.16 1,256.80 1,281.94

Interest-bearing LT debts 2,989.00 3,017.00 2,559.00 2,495.03 2,432.65 2,371.83


Total long-term liabilities 2,989.00 3,017.00 2,562.00 2,497.73 2,435.08 2,374.02


Other ST liabilities 20,994.29 24,661.29 24,629.29 25,311.58 26,359.10 27,513.10

Total short-term liabilities 14,308.00 22,682.00 23,441.00 24,581.35 25,913.80 27,315.85


Cash Flow Statement 2010 2011 2012 2013e 2014e 2015e(IAS,HUF mn, 30/09)

Cash flow from operating activities 12,948.00 25,027.00 24,413.00 28,204.43 29,740.30 31,967.91

Cash flow from investing activities -17,191.00 -13,469.00 -12,921.00 -16,320.85 -17,929.36 -19,396.14

Cash flow from financing activities -1,022.00 -1,206.00 -1,120.00 -1,918.64 -1,996.49 -2,074.35

CHANGE IN CASH , CASH EQU. -5,265.00 10,352.00 10,372.00 9,964.95 9,814.45 10,497.42


EBITDA margin 21.4% 19.9% 23.0% 22.7% 22.9% 23.1%

EBIT margin 14.4% 12.6% 15.4% 14.9% 15.0% 15.2%


ROE 11.9% 8.7% 10.9% 10.5% 10.1% 9.9%

ROCE 12.4% 9.3% 12.5% 12.8% 12.8% 12.9%

Equity ratio 85.4% 84.8% 86.2% 87.0% 87.7% 88.3%

Net debt -14,763.0 -32,381.0 -43,021.0 -53,042.9 -62,912.7 -73,463.6

Working capital 85,206.0 89,535.0 102,549.0 114,922.3 127,529.9 140,795.8






Erste Group Research – Erste Sector Healthcare – 20 March 2013 Erste Group Research – Company Report Krka | Pharmaceuticals | Slovenia 20 March 2013


Krka

Buy



Kr ka | Pharmaceuticals | Slovenia

20 March 2013

EUR mn 2012p 2013e 2014e 2015e

Net sales 1,143.3 1,217.6 1,306.4 1,406.7

EBITDA 282.3 309.9 338.3 371.4

EBIT 192.3 212.2 231.4 253.3


EPS (EUR) 4.51 4.83 5.27 5.77

CEPS (EUR) 7.05 7.55 8.24 9.07

BVPS (EUR) 34.98 37.86 41.68 45.90

Div./share (EUR) 1.45 1.55 1.70 1.90

EV/EBITDA (x) 6.3 5.6 5.1 4.6

P/E (x) 11.1 10.0 9.2 8.4

P/CE (x) 7.1 6.4 5.9 5.4

Dividend Yield 2.9% 3.2% 3.5% 3.9%

40

45

50

55

60

6552 weeks

Krka SBI TOP (Rebased)


in EUR -4.8% 5.6% 0.5% -7.5%

Share price (EUR) close as of 18/03/2013 48.6 Reuters KRKG.LJ Free float 68.3%

Number of shares (mn) 35.4 Bloomberg KRKG SV Shareholders SOD Fund (15.0%)

Market capitalization (EUR mn) 1,720.1 Div. Ex-date 10/07/12 KAD (9.86%)

Enterprise value (EUR mn) 1,722.1 Target price 65.0 Homepage: www.krka.si

Fundamental story still sound, but recent scratches need to be polished out

While Krka’s sales prospects remain very sound and the company is committed to strict cost control going forward, the burden related to the CEE healthcare austerity measures weighs more heavily than originally envisaged on Krka’s traditionally strong profitability margins, prompting a downward revision of our DCF-derived 12-month target price to EUR 65.0 per share (vs. the earlier target of EUR 69.0). Nevertheless, backed up by a strong Russian presence as well as a robust R&D pipeline, the long-term story is intact, in our view. Furthermore, the company plans to continue the ongoing share buyback (up to the limit of 10% of total capital), boding well for stock appreciation in coming periods. We confirm our Buy recommendation on the stock.

The changes to our model focus on incorporating 1) the price erosion in the CEE pharma markets, dragging down gross margin; 2) the less robust than envisaged EBIT margin, as a result of lower gross profitability, coupled with the more sizable sales & marketing costs, pushed up by the regional regulatory toll; 3) the positive impact of the regional currencies’ appreciation trend on the financial result; 4) lower effective tax rate.

In summary, we leave our sales target for 2013 broadly unchanged at EUR 1,217.6mn. Nonetheless, reflecting increasing pricing pressures along with the regulatory burden in the core CEE markets, we reduce our operating profit target to EUR 212.2mn for 2013. The regional currencies’ appreciation (foreseen to happen in 2H13) should work in favor of the y/y improvement of the financial result. Bolstered further by a decreasing tax rate, our net profit target for 2013 arrives at EUR 171.3mn, up 7.1% y/y (but down by 6.3% compared to our previous forecast).

Analyst:






Changes in forecast/outlook CEE markets: The 2012 results confirmed that, like its peers, Krka could not escape from the negative consequences of the austerity measures, including pricing and regulatory pressures, in the CEE markets. In addition, as the euro area-based pharma player, Krka was also suffering from the regional currencies’ relative weakness, with the negative effect on Krka’s results much more pronounced than in the case of its Hungarian peers (who also saw their local currency on a depreciation path vs. the euro). Nonetheless, we continue to believe that both the currency grip as well as price erosion is set to ease somewhat over the course of 2013. The CEE markets should return to growth, but their tempo is likely to be confined for time being to low single-digit terms. As the major trends were already reflected in our previous update (when we trimmed our 2013 forecast for Krka’s sales in the CEE region by 1%), we feel that our reduced sales forecast of EUR 295.1mn (translating to a 4.5% y/y rise) is realistic. For 2014, we assume the gradual revival to continue and set a sales target of EUR 311.3mn, corresponding to 5.5% y/y progress. Southeast Europe: The final 2012 sales report provided an evidence of a robust 4Q12 recovery of Krka’s sales in SEE markets, where the economic slowdown was dampening the company’s sales tempo in the first nine months of 2012. In 2012, Krka’s sales in SEE markets lagged behind our original forecast of EUR 152.0mn by 2.6%. We prefer to remain on the conservative side (due in particular to the persisting problematic receivables collection in the Romanian pharma market). Consequently, we stick to our recently fine-tuned projections (sales target of EUR 153.3mn) here. For 2014, we see the y/y pace accelerating slightly, to a 4.5% y/y rise (bringing the sales figure to EUR 160.2mn). Russia/CIS: Krka’s Russia/CIS sales advanced a hefty 24.2% y/y in 2012. As 4Q12 sales were even above the exceptional showing of 4Q11, the 2012 sales figure of EUR 354.2mn was well ahead of our original forecast (EUR 329.4mn). In Russia alone, Krka’s sales of EUR 244.2mn (up 25% y/y) surpassed our original estimate by a wide margin. In addition, this was complemented by an impressive sales growth in Ukraine and other CIS markets. We believe that more progress is still in the cards, with the solid ruble position and steadily high oil prices promising a sound macroeconomic picture, boding well for sales improvements in the Russian market. We leave our recently revised target for Krka’s 2013 sales in Russia/CIS unchanged at EUR 389.6mn, corresponding to a 10% sales growth tempo. For 2014, with Krka’s newly enlarged Russian factory due to be on stream, we set a sales target of EUR 428.6mn (corresponding to another 10% y/y increase). . Western Europe: After excellent sales performance in 2011 (with sales in Western Europe and Overseas markets expanding by a hefty 21.8% y/y), the company’s sales growth slowed down somewhat, with the strong previous year’s comparative base putting a brake on y/y progress, namely in the fourth quarter. In 4Q12, sales in Western markets slid 9.1% y/y, sending the 2012 tempo to 5.2% y/y and prompting us to decrease our 2013 sales target in this category to around EUR 288mn in our recent update. Nevertheless, going forward, we believe that, further supported by the sales network enlargement and new product launches, Krka’s sales in Western Europe should maintain solid tempo. For 2014, we project Krka’s Western European sales to advance 8.5% y/y, to EUR 312.1mn.

The 2012 report confirmed the earlier published sales highlights. With major changes already reflected in our previous company update, we opt for only minor fine-tuning of our projections, while leaving our 2013 sales target broadly unchanged





In summary, reflecting the final 2012 figures more accurately, we leave our sales target for 2013 broadly unchanged at EUR 1,217.6mn, translating into a 6.5% y/y rise (a notch above the company’s current guidance of sales of EUR 1,202mn). Although we still believe that Krka has all prerequisites to return to a double-digit top line growth pace in the coming years, should the economic situation in its key regional markets improve more rapidly, we stick to a more cautious stance in the near term and envisage the sales growth rate remaining somewhat below that mark (at 6.5% in 2013 and 7.3% y/y in 2014). Changes to 2013 and 2014 forecasts Consolidated, IFRS

(EUR, mn) Now Before Change Now Before Change

Net sales 1,217.6 1,218.7 -0.1% 1,306.4 1,312.0 -0.4%

Costs of goods sold 496.7 482.7 2.9% 531.1 517.9 2.5%

Gross profit 720.9 736.0 -2.0% 775.4 794.2 -2.4%

Sales & marketing exp. 332.1 318.9 4.2% 354.6 343.3 3.3%

R&D expenses 107.1 107.2 -0.1% 115.0 116.1 -1.0%

General & admin. exp. 77.9 79.5 -2.0% 83.6 85.6 -2.3%

Other oper. income 8.5 6.1 39.9% 9.1 8.5 7.2%

Operating profit 212.2 236.4 -10.2% 231.4 257.7 -10.2%

Financial result -3.5 -8.2 -57.3% -3.9 -6.6 -41.6%

Income taxes 37.6 45.6 -17.7% 40.9 50.2 -18.4%

Minorities -0.1 -0.1 4.7% -0.1 -0.1 4.7%

Net income 171.3 182.7 -6.3% 186.6 200.9 -7.1%

Gross margin 59.2% 60.4% 59.3% 60.5%

EBIT margin 17.4% 19.4% 17.7% 19.6%

Net margin 14.1% 15.0% 14.3% 15.3%


2013e 2014e

Despite the improving sales mix, weighed down by mounting pricing pressures in particular in the CEE region, the 2012 gross profit margin deteriorated to 59.1%, below the year-earlier period’s level of 61.3%, as well as our forecast of 60.3%. With the 2012 picture worse than we envisaged, and pricing pressures in the CEE region (in particular in Hungary) expected to ease only slightly this year, we prefer to take a more cautious stance going forward and opt for a downward adjustment of our estimates, cutting our gross margin forecast to 59.2% (vs. the earlier projected 60.4%) for 2013. Going forward, we anticipate that the positive effects stemming from changes in the product and territorial sales structure on Krka’s gross profitability to be to a certain extent compromised by the price erosion on CEE markets. Factoring in the more favorable forex situation with the regional currencies embarking on an appreciation path, we envisage the 2014 gross margin improving, but for the time being only marginally, to 59.3%. After the 4Q acceleration, in 2012, sales and marketing costs went up by 11.3% y/y to account for 27.8% of the total 2012 sales, surpassing our forecast by 6.7%. However, here it is worth mentioning that Krka, unlike its Hungarian peers, accounts for the industry related regulatory toll solely in its sales and marketing expenses and is not entitled to the R&D based relief to OEP payments. Furthermore, in 2012, Krka for the first time recorded the Romanian clawback tax, which including the previous period’s charge reached some EUR 15mn (with the past period’s one-off amounting to around EUR 6.0mn). Assuming further expansion of sales & marketing costs (driven by support to the new product launches) as well as the ongoing regulatory burden (lessened to some extent by falling sales in

Pricing pressures keep lid on gross profitability margin





Hungary and the y/y absence of one-offs in Romania), we opt for an upward adjustment of our sales and marketing cost estimate to 27.3% of total 2013 sales (above the earlier projected 26.2% of sales). For 2014, we assume sales and marketing cost growth to slow down, and hence its relative share to slightly decrease compared to the elevated 2013 level. In 2012, the company managed to reduce general and administrative costs by 3.9% y/y to EUR 72.6mn, 3.8% below our estimate of EUR 75.5mn. Although we think that, after the relatively sizable cost-cutting move in 2012, room for savings is getting narrower, this prompts us to trim our G&A expenses forecast to 77.9mn, or 6.4% of total 2013 sales. For 2014, we expect the company to continue with cost optimization in the area of G&A expenses, with the share of G&A costs stabilizing at around 6.4% of total sales. Krka’s R&D expenditures were in line with our forecasts in 2012, with their relative share at 8.8% of the total sales. Also going forward Krka remains committed to its heavy emphasis on investments in the R&D area as the main source of its future growth, and hence we continue to envisage the share of R&D expenses in total sales at around the past years’ average level of 8.8% both in 2013 and 2014. The levels of necessary new provisioning and the release of previous provisions have traditionally been among the biggest question marks in projecting Krka’s results. After a bumpy 2009, when the total reversal of provisioning (recorded under other operating income) stood at EUR 91.4mn, while additional provisions (weighing on sales and distribution expenses) totaled EUR 47.5mn, neither 2010-2011 period nor 2012 saw any major events. Although the company believes that the provisions of EUR 47.5mn created for the perindopril case will be reversed at some point in the future, this is not envisaged to happen in 2013. We assume no major litigation on the horizon and anticipate the level of provisioning remaining at a minimal level in 2013. At the same time, we also envisage a low level of provision releases. In summary, reflecting the slightly higher 2012 other operating income balance (of EUR 8.5mn) than we originally assumed, we opt to increase our earlier forecast, projecting other operating income of around EUR 8.5mn in 2013 and EUR 9.1mn in 2014. All told, our 2013 EBIT target arrives at EUR 212.2mn (10.2% down from the previously estimated EUR 236.4mn), translating into an EBIT margin of 17.4% (down from the 19.4% projected earlier). For 2014, we still believe that a slight improvement of the operating margin is achievable and set our EBIT target at EUR 231.4mn, corresponding to an EBIT margin of 17.7%. After the unfavorable forex hedging fortunes hit the 1Q12 financial result, the company refrained from hedging activities and, following q/q progress in 4Q12 (with a gain of EUR 5.1mn), the financial result for the full-year 2012 was far better than we expected (a EUR 1.8mn loss, vs. our forecast of a EUR 10.3mn loss). And, as the company reassured us that no foreign currency hedging activity is anticipated to weigh on the 2013 results and its net debt position further improved in 2012, we believe that our recently revised estimates are too conservative at the moment. Although the regional currencies’ appreciation path might be somewhat more volatile in the course of 2013 and consequently we still project the financial result ending in red territory, we now anticipate the financial loss to be of a smaller magnitude, at EUR 3.5mn (vs. the earlier projected EUR 8.2mn). Going forward, we fine tune our estimate for the 2014 financial result downwards, to EUR 3.9mn loss. Also, the more favorable tax treatment in Slovenia (with the statutory corporate tax rate to be reduced from 18% applicable in 2012 to 15% in 2015) should work in favor of the company’s bottom line development going forward. Although the final effective tax rate also depends on taxable profit in various countries where Krka has operations,

Reflecting more subdued gross margin profitability along with more sizable sales & marketing spending, we reduce our 2013 EBIT target to EUR 212.2mn We set our new net profit target for 2013 at EUR 171.3mn, down by 6.3% compared to our previous forecast





as well as on investment related allowances available going forward, the 2012 effective tax rate of 16.1% was well below our estimate, prompting us to make a cautious downward correction for 2013 and forthcoming years (from 21% to 18%). In summary, our net profit target for 2013 arrives at EUR 171.3mn, 6.3% down from the previous EUR 182.7mn, but still corresponding to a 7.1% y/y rise. Here we remain slightly more optimistic than the company’s recent guidance, assuming flat net profit y/y in 2013, as we believe that, in the absence of any one-offs burden and with an improving forex situation and taxation regime, the y/y progress on the bottom line is within the reach. For 2014, we think that, backed by the strong Russia/CIS performance coupled with the patent expiration-driven expansion in Western markets, Krka has all prerequisites to accelerate its top line growth and, thanks to ongoing strict cost control, also post solid improvements on the bottom line. We set our 2014 consolidated net profit target at EUR 186.6mn, corresponding to a 9.0% y/y increase.

2012 results review Krka published its 2012 report on March 14, 2013, wrapping up the reporting season in the CEE pharma universe.

Consolidated sales review

EUR 000 4Q2012p 4Q2011 y/y 2012p 2011 y/y

Slovenia 21,729 24,371 -10.8% 91,002 101,827 -10.6%

South-East Europe 45,285 38,636 17.2% 148,140 146,136 1.4%

Russia/CIS 115,150 95,626 20.4% 354,213 285,226 24.2%

Central Europe 76,548 71,108 7.7% 282,400 288,217 -2.0%

Western Europe & Overseas 70,655 77,736 -9.1% 267,546 254,221 5.2%


Total sales (EUR 000) 329,367 307,477 7.1% 1,143,301 1,075,627 6.3%

Operating profit (EUR 000) 48,901 42,585 14.8% 192,308 211,561 -9.1%

Net income (EUR 000) 48,377 47,351 2.2% 159,915 162,801 -1.8%


Net margin 14.7% 15.4% 14.0% 15.1%

Source: Krka

As Krka published its key 2012 sales performance data earlier in January, the full 2012 report did not bring any major surprises as far as the top line is concerned, but rather reassured investors that the company’s sales tempo did not take a pause in 4Q12. In 2012, the top line was reported to have advanced 6.3% y/y to EUR 1,143.3mn, out of which the fourth quarter contributed EUR 329.4mn (up 7.1% y/y). Exports accounted for around 92% of total consolidated sales in 2012. Despite (also due to the high comparative base) decelerating in 4Q, full-year 2012 sales in Western Europe and overseas markets rose by a sound 5.2% y/y, to EUR 267.5mn (in 4Q12 alone, they slid 9.1% y/y). Moreover, as the exceptionally high comparative base did not put a brake on y/y progress in 4Q, performance in Russia/CIS markets was excellent, with Krka’s 2012 sales jumping 24.2% y/y to EUR 354.2mn, or 31% of total 2012 sales. In Russia alone, Krka’s 2012 sales tempo reached a robust 25% y/y, with sales amounting to EUR 244.2mn. Krka also did very well in Ukraine, where its sales expanded 17% y/y, and in Kazakhstan, where its sales soared 27% y/y. Sales in Southeast Europe witnessed an impressive acceleration in 4Q (up 17.2% y/y and 56.1% q/q), but given the previous periods subdued performance, this translated into just a 1.4% y/y rise to EUR 148.1mn in 2012. In addition,

Fueled by the pickup in Russia/CIS sales and support from solid Western European markets performance, 2012 sales advanced 6.3% y/y to EUR 1,143.3mn, fully confirming the earlier disclosed sales highlights





CEE market sales continued in their recovery in 4Q, getting out of the previous doldrums, when they were hit by the negative impact of the ongoing healthcare reforms as well as regional currencies’ depreciation. Nevertheless, even following a 7.7% y/y rise in 4Q12, for the full-year 2012 Krka’s sales performance in Central European markets was sluggish. Weighed down by the fall in Hungary (down by 24% y/y), the company’s sales in the CEE markets slipped 2% y/y (to EUR 282.4mn), while still delivering 24.7% of the 2012 total. Krka’s sales in Poland, the largest of its CEE markets, rose a modest 2% y/y to EUR 111.6mn in 2012. Reflecting region-wide escalating pricing pressures along with less favorable currency developments (with CEE region currencies weakening vs. the EUR in 2012), Krka’s gross margin deteriorated y/y from 61.3% in 2011 to 59.1% in 2012. Furthermore, although the company managed to trim its administrative costs by 3.9% y/y, both its R&D expenses as well as sales & marketing costs outpaced the sales tempo, dragging Krka’s operating profit down by 9.1% y/y (to EUR 192.3mn) in 2012. The EBIT margin deteriorated to just 16.8% (down from 19.7% in 2011).On the other hand, following significant q/q improvement in 4Q12 (gain of EUR 5.1mn), in 2012, the financial result ended far less deeply in red territory than in the year-earlier period (loss of EUR 1.8mn vs. a loss of EUR 11.6mn in 2011). In addition, as the effective tax rate decreased y/y (from 18.6% to 16.1%), the drop in 2012 net profit was minimized to 1.8% y/y, translating into a net profit after minorities of EUR 159.9mn.

Valuation / Recommendation Although its home country of Slovenia did not escape the consequences of the deepening Eurozone crisis, Krka’s valuation model parameters are still far more favorable than those of its Hungarian rivals. First, despite the recent rise, the risk-free rate remains lower compared to the one we apply for the home countries of Krka’s regional peers. Reflecting the currently relatively low levels of Slovenian government bond yields, we stick to our risk-free rate assumptions in our DCF model for Krka at 6.0% for 2013-17. For perpetuity, we continue to apply a risk-free rate of 5%. Secondly, our methodology for setting equity risk premiums is linked to the country’s S&P long-term currency rating. Here, Slovenia, despite its recent downgrade (with an A- rating), keeps its status as one of the top performers in the CEE region. The methodology yields an equity risk premium for the explicitly forecast period at 6.0% and for perpetuity at 5.7%, still well below equity risk premiums for Krka’s Hungarian peers. Our calculated WACC arrives at 11.0% for 2013-17 and 10.6% for perpetuity. Incorporating the revised estimates and changing timeframe into our model (compared to our last company update from March 2013), we arrive at a new DCF-derived 12-month target price of EUR 65.0 per share, 5.8% down from the earlier value of EUR 69.0 per share. With its 2012 gross and operating profitability margins sinking below 60% and 20%, respectively (levels not seen since 2004), the company somewhat shattered investors’ confidence. Although the 2012 interim results indicated that Krka is facing mounting pricing pressures in the CEE region, magnified to a certain extent by its status as the only euro area-based company among the publicly traded CEE pharmas, the scope of the deterioration was above market expectations as well as our estimates. Nonetheless, the drop creates a new situation now. Contrary to the past, when Krka’s generics industry-topping margins offered no space for improvement and the company was seen as merely defending them, a new room for progress has

As price erosion and regulatory measures in the CEE region took their toll, the bottom line retreated 1.8% y/y in 2012 Despite the recent deterioration, its home country status warrants the relative advantage for Krka’s valuation compared to its peers





appeared. As the contraction in the EBIT margin was to a certain extent attributable to one-offs related to the Romanian clawback tax, the first step forward seems to be in the cards, even if everything else remains unchanged. Moreover, we believe that the situation on Hungarian markets is set to stabilize and pricing pressures to ease over time. The regional currencies’ appreciation path should play (contrary to Hungarian pharma companies) a supportive role for Krka in the medium to long run as well. Like its Hungarian peers, Krka’s balance sheet is very healthy, with a cash position of EUR 23mn (and net debt of just EUR 5.8mn) at the end of 2012, enabling it to be more active in the M&A field in future. All told, we continue to believe that Krka’s long-term investment case remains very solid. The company’s territorial sales structure is very well balanced and, as evidenced by its sales performance track record, the company is able to compensate for a temporary setback in some markets by acceleration in others, posting stable sales growth (and on average exceeding that of its Hungarian peers). Krka, as traditionally the second largest among the CEE pharma players in Russia, is well positioned to benefit from the Russian pharma market dynamism. The new investment, worth EUR 135mn, is to be completed by the end of 2013 and is set to increase production capacity from 800mn to 1.8bn tablets and further boost prospects there. On the top of that, Krka has relatively higher exposure to Western markets, where it exploits the advantages of its product pipeline full of generic bestsellers (in particular in the cardiovascular and CNS area) waiting for patent expirations. Although Krka’s engagement in the patent expiration field is inevitably accompanied by numerous pending lawsuits, thus far Krka has not lost any important case. With the new products typically commanding higher prices, the company with its relatively high share of new products in its sales structure has all the prerequisites to achieve above-average profitability margins. Although the regulatory burden is partly wiping out these benefits at the moment, we believe that the pressures should ease in relative terms in forthcoming periods and Krka, also sticking to its strict cost control, should be not only able to keep its competitors at a distance, but to make the difference in profitability parameters wider once again. While Krka’s market capitalization is comparable to that of Richter, the stock’s liquidity is well below that of its Hungarian rival, discouraging in part the most demanding foreign portfolio investors. We continue to believe that the stock is set to benefit the company’s further gathering of shares on the Ljubljana Stock Exchange, providing solid support to the stock’s liquidity and share price, amid market turbulence. (In 2012, Krka repurchased 108,813 own shares, for a total value of around EUR 12.6mn, corresponding to 8.9% of the total stock turnover of Krka shares on the Ljubljana Stock Exchange. Although, factoring in less robust profitability parameters (depressed by regional regulatory toll), we reduce our DCF-based target price to EUR 65.0 per share, following the latest share price correction this is pointing still to more than 30% upside potential. Consequently, we confirm our Buy call on Krka.

We continue to believe that Krka’s long-term investment case remains very solid Krka is well positioned to benefit from the Russian pharma market dynamism and its product pipeline full of generic bestsellers The stock is set to benefit the company’s further gathering of shares on the Ljubljana Stock Exchange Our new target price arrives at EUR 65.0 per share and we

confirm our Buy call on Krka






Risk free rate 6.0% 6.0% 6.0% 6.0% 6.0% 5.0%


Beta 0.84 0.84 0.84 0.84 0.84 1.0

Cost of equity 11.0% 11.0% 11.0% 11.0% 11.0% 10.7%

Cost of debt 7.5% 7.5% 7.5% 7.5% 7.5% 6.5%



Equity weight 98% 98% 98% 98% 98% 99%

WACC 11.0% 11.0% 11.0% 11.0% 11.0% 10.6%

DCF valuation

(EUR mn) 2013e 2014e 2015e 2016e 2017e 2018e (TV)

Sales growth 6.5% 7.3% 7.7% 8.1% 8.4% 6.0%

EBIT 212.2 231.4 253.3 279.7 310.5 314.6

EBIT margin 17.4% 17.7% 18.0% 18.4% 18.8% 18.0%

Tax rate 18.0% 18.0% 18.0% 18.0% 18.0% 18.0%

Taxes on EBIT -38.2 -41.6 -45.6 -50.4 -55.9 -56.6

NOPLAT 174.0 189.7 207.7 229.4 254.6 258.0

+ Depreciation 97.6 106.9 118.1 131.1 144.9 144.9








Discounted free cash flow - Dec 31 2012 58.8 69.1 80.3 92.1 103.3 1,641.2

Enterprise value - Dec 31 2012 2,044.8

Minorities 1.4


Net debt 5.8


Equity value - Dec 31 2012 2,037.6



12M target price per share (EUR) 65.012M target price per share (EUR) 65.0

Current share price (EUR) 48.6

Up/Downside 33.9%


65 17.0% 17.5% 18.0% 18.5% 19.0%

9.6% 68.5 70.4 72.3 74.2 76.1

10.1% 64.9 66.6 68.4 70.2 72.0

10.6% 61.7 63.3 65.0 66.7 68.3

11.1% 58.8 60.4 62.0 63.5 65.1

11.6% 56.3 57.8 59.3 60.8 62.2

65 1.5% 2.0% 2.5% 3.0% 3.5%

9.6% 65.0 68.4 72.3 76.8 82.0

10.1% 62.0 65.0 68.4 72.3 76.8

10.6% 59.3 62.0 65.0 68.4 72.3

11.1% 56.8 59.3 62.0 65.0 68.4

11.6% 54.7 56.8 59.3 62.0 65.0




WA

CC

WA

CC


PV of terminal

value80%





Income Statement 2010 2011 2012p 2013e 2014e 2015e(IAS, EUR mn, 31/12) 31/12/2010 31/12/2011 31/12/2012 31/12/2013 31/12/2014 31/12/2015

Net sales 1,010.02 1,075.63 1,143.30 1,217.61 1,306.45 1,406.67

Cost of goods sold -385.41 -416.70 -467.56 -496.70 -531.07 -569.53

Gross profit 624.61 658.92 675.74 720.91 775.37 837.14

SG&A -334.11 -361.56 -390.86 -410.05 -438.18 -469.89



EBITDA 293.19 298.75 282.28 309.85 338.26 371.43


EBIT 211.47 211.56 192.31 212.24 231.37 253.31

Financial result -0.10 -14.03 -1.81 -3.49 -3.88 -3.97


EBT 211.37 197.53 190.50 208.74 227.49 249.35

Income taxes -40.45 -37.24 -30.66 -37.57 -40.95 -44.88




Balance Sheet 2010 2011 2012p 2013e 2014e 2015e(IAS, EUR mn, 31/12)


Tangible assets 686.46 707.51 772.29 849.52 934.47 1,027.92


Total fixed assets 846.51 863.87 926.00 1,005.82 1,093.77 1,190.64

Inventories 229.34 254.23 250.75 259.44 270.43 282.88


Other assets 0.00 0.00 0.00 0.00 0.00 0.00



TOTAL ASSETS 1,488.20 1,534.03 1,626.75 1,743.02 1,872.61 2,016.89


Minorities 1.58 1.51 1.44 1.44 1.44 1.44



LT provisions 108.89 104.82 104.75 103.17 101.63 100.10








Cash Flow Statement 2010 2011 2012p 2013e 2014e 2015e(IAS,EUR mn, 31/12)

Cash flow from operating activities 181.52 246.04 260.80 240.21 246.02 253.48


Cash flow from financing activities -74.52 -127.22 -93.59 -54.17 -57.73 -63.15

CHANGE IN CASH , CASH EQU. -5.62 11.38 2.81 4.02 4.46 5.51

Margins & Ratios 2010 2011 2012p 2013e 2014e 2015eSales growth 6.0% 6.5% 6.3% 6.5% 7.3% 7.7%

EBITDA margin 29.0% 27.8% 24.7% 25.4% 25.9% 26.4%

EBIT margin 20.9% 19.7% 16.8% 17.4% 17.7% 18.0%


ROE 17.4% 14.6% 13.5% 13.3% 13.2% 13.2%

ROCE 13.8% 12.3% 12.0% 12.0% 12.1% 12.2%

Equity ratio 70.8% 74.3% 76.3% 77.0% 78.9% 80.7%

Net debt 127.1 50.7 5.8 0.5 -5.2 -12.1

Working capital 409.5 431.0 459.9 480.1 525.3 575.9






Erste Group Research – Erste Sector Healthcare – 20 March 2013 Erste Group Research – Company Report Richter Gedeon | Pharmaceuticals | Hungary 20 March 2013


Richter Gedeon

Buy



Richter Gedeon | Phar maceuticals | Hungar y

20 March 2013

HUF mn 2012p 2013e 2014e 2015e

Net sales 326,702.0 354,242.9 377,883.5 407,523.8

EBITDA 77,409.0 82,289.1 89,517.3 102,796.8

EBIT 50,284.0 53,935.5 58,943.7 69,963.2

Net result after min. 50,777.0 51,102.0 54,621.2 63,394.1

EPS (HUF) 2,724.46 2,741.90 2,930.72 3,401.43

CEPS (HUF) 4,179.86 4,263.22 4,571.15 5,163.13

BVPS (HUF) 27,755.41 29,777.30 31,878.02 34,359.45

Div./share (HUF) 660.00 720.00 830.00 920.00

EV/EBITDA (x) 8.3 6.7 5.8 4.6

P/E (x) 13.3 12.2 11.4 9.8

P/CE (x) 8.7 7.8 7.3 6.5

Dividend Yield 1.8% 2.2% 2.5% 2.8%

31,00032,00033,00034,00035,00036,00037,00038,00039,00040,00041,00042,000

52 weeks

Richter Gedeon BUX (Rebased)


in HUF -13.3% -15.8% -7.9% -3.6%

Share price (HUF) close as of 18/03/2013 33,345 Reuters GDRB.BU Free float 74.1%

Number of shares (mn) 18.6 Bloomberg RICHT HB Shareholders Hungarian State (25.2%)

Market capitalization (HUF mn / EUR mn) 621,467 / 2,032 Div. Ex-date 07/06/12

Enterprise value (HUF mn / EUR mn) 553,813 / 1,810 Target price 45,265 Homepage: www.richter.hu

Cariprazine/Russia-driven investment story far from priced in

Our revised DCF-derived 12-month target price, factoring in the somewhat reduced operating profitability assumptions along with a changing timeframe, arrives at HUF 45,265 per share (vs. our previous target of HUF 50,460). After a technical knockout linked to the MSCI index exclusion, Richter’s share price recovery up to now has been rather fragile. Nonetheless, we believe that it is now time for strong long-term fundamentals to again come into play. We continue to think that Richter’s investment story remains very attractive, with the stock price reflecting only one side of the coin – the temporarily hiked costs – but not the other – namely the benefits stemming from the company’s R&D foray. With our revised target price suggesting 35.7% upside potential for the stock, we stick to our Buy recommendation.

The most important changes to our model include the following: 1) the somewhat less steep pickup in Esmya sales along with more subdued Polish sales, due to the discontinuation of the Avonex license agreement; 2) the more sluggish than envisaged US sales prospects for 2013; 3) higher sales & marketing expenses associated with a buildup of the Western European market presence; 4) fine-tuning of effective tax rate assumptions to more accurately reflect available tax allowances

In summary, we set a new consolidated net profit target for 2013 at HUF 51,102mn, on sales of HUF 354,243mn, down 7.0% and 1.8%, respectively, compared to our previous forecasts. For 2014, we envisage net profit at HUF 54,621mn (up 6.9% y/y), on sales of HUF 377,884mn (up 6.7% y/y). As before, the cariprazine US FDA approval-conditioned milestone represents positive upside to our 2014 estimates.

Analyst:






Changes in forecasts/outlook

Domestic market: Although the 2012 domestic market performance, with sales retreating 13.3% y/y, was slightly (by 1.3%) worse than we expected, the outlook is in line or potentially even slightly better than we originally assumed. Although there is no doubt that the ‘blind bidding’ auction system and other savings measures in the drug subsidy budget continue to have a negative impact on Richter, it is worth mentioning that, compared to its peers, Richter benefits from its sales mix, in particular from the fact that an important part of its product portfolio (namely oral contraceptives) is not subject to tightening reimbursement rules. The traditionally cautious initial guidance of CEO Bogsch envisages Richter’s domestic sales slipping a maximum of 5% and - in the best case scenario - remaining flat y/y in 2013. This compares with our original estimate of domestic sales of HUF 29.8bn and a drop of 5% y/y. Reflecting the revision of the comparative base to the actually reported preliminary 2012 sales data, our original sales target translates into a 3.7% y/y decline, still fully within the newly indicated guidance range. Hence, for the time being we feel no need to change our sales projections both for 2013 and the coming years. In summary, our 2013 domestic sales target remains at HUF 29.8bn. We continue to assume Richter’s domestic sales rebounding in 2014, returning to low single-digit growth of 2.5% y/y to HUF 30.5bn. Russia/CIS: Reflecting the relatively high comparative base (in particular, the pre-shipment element in 4Q11), the sales rise in Russia was tempered to 3.8% y/y in 2012 in ruble terms (and to 6.5% y/y in euro terms). Going forward, CEO Bogsch remains optimistic and anticipates Richter’s Russian sales advancing 5-10% y/y in 2013 (in ruble terms). With 2012 Russian sales broadly in line with our expectations and guidance pointing to a possible double-digit tempo, we decided to leave our earlier forecast for Russian sales in 2013 broadly unchanged at around EUR 371mn, corresponding to a 10% y/y rise. In addition, the company’s 2012 performance in other CIS markets remained robust and the guidance points to the fast pace being maintained in 2013. According to Bogsch, Richter’s 2013 sales in Ukraine are envisaged to expand 10% y/y in USD terms. All told, we opt to leave our recently revised target for Russia/CIS sales broadly unchanged at EUR 547mn in 2013 (translating into a 10% y/y rise in EUR terms). The Russian economic outlook (supported by steadily high oil prices) is still very promising and this, coupled with the relatively stable currency situation and further bolstered by the expansion of Richter’s local manufacturing base (with the doubling of the local Russian tableting capacity planned by 2015), should ensure that Richter’s sales in the Russia/CIS region will maintain their momentum in the medium term. For 2014, we set our sales target for Russia/CIS at some EUR 600mn, corresponding to sales growth of around 10% y/y. EU: In 2012, Richter’s total EU sales ended up a mere 1% behind our forecast. At the same time, while some territories even slightly surpassed our estimates (Romania by 1.2%), most of them lagged slightly behind (in particular, the EU-15, by 2.8%). A closer look at the presented sales structure reveals that the major reason was the relatively disappointing performance of the OC portfolio acquired from Gruenenthal, with sales of EUR 42.2mn, down 19.6% y/y. The company attributed the weak sales to price erosion, combined with initially high inventory levels, depressing sales in subsequent periods. While in 2012, sales of Esmya reached EUR 3.6mn (and hence were above our adjusted EUR 3.0mn target), they failed to live up to original expectations. Following EU registration in February 2012, in

Domestic market wounds are deep, but scope of deterioration becoming less serious over time Russia/CIS set to continue to shine brightly, bolstering top line tempo in coming periods





the course of 2012, Esmya was launched in Germany, the UK, Hungary, Poland, the Czech Republic and Austria, among others. Unfortunately, given the current healthcare cost containment measures in many European countries, obtaining reimbursement status proved to be more difficult than originally planned. While the company sticks to its original guidance, envisaging peak sales of Esmya at around EUR 100mn (potentially doubling to EUR 200mn, should the therapeutic indication be extended to long-term on-off treatment), the Esmya sales pickup is now projected to be slow. Consequently, we reduce our forecast here and, reflecting the latest guidance, we cut the expected contribution of Esmya to 2013 EU sales to EUR 15mn (below the earlier projected EUR 35mn). Although sales in Poland, following a strong rally in 4Q12, missed our forecast by just 1.1%, the outlook is less optimistic, in part due to the discontinuation of a license agreement for Avonex. All of this leads us to make adequate adjustments to our EU projections for 2013. We reduce our forecast for EU-15 sales from EUR 140.3mn to EUR 129.8mn and decrease our sales estimate for Poland from EUR 83.1mn to EUR 79.0mn. In summary, our new target for Richter’s sales to the EU in 2013 arrives at EUR 431.1mn, corresponding to a 6.8% y/y rise. We think that (helped by the Esmya sales acceleration) our EU sales forecast for 2014 of around EUR 465.7mn is realistic. US: Weighed down by the diminishing revenue stream from the profit sharing arrangement with Barr Laboratories on drospirenone, Richter’s US sales contracted for a third year in a row in 2012 (by 29.7% y/y to USD 71.7mn), a slightly less steep drop than assumed in the company’s guidance, anticipating Richter’s sales in the US plunging 40% y/y in USD terms in 2012. As before, there is still no significant turnaround on the near-term horizon (the cariprazine-based product is anticipated to hit the market only in 1H14). While the company’s 2012 sales fully matched our forecast, given the newly released guidance pointing to another 20-25% y/y sales contraction, we opt to cut our target for Richter’s US sales in 2013 from USD 64.5mn to USD 57.4mn (corresponding to 20% y/y decrease). Finally, we leave our recently revised exchange rate forecast unchanged. In our company update from February 2013, for 2013, we adjusted the average exchange rate from HUF 229.5/USD to HUF 235.0/USD and from an average exchange rate of HUF 278.0/EUR to HUF 297.5/EUR. For 2014, we revised our forecast from the average exchange rate of HUF 229/USD to HUF 240/USD and from the average exchange rate of HUF 275/EUR to HUF 290/EUR. After factoring in all of the above-mentioned changes, our consolidated sales target for 2013 arrives at HUF 354.2bn, slightly down from the previous forecast of HUF 360.6bn, with some HUF 41.8bn to be delivered by wholesale and retail operations and HUF 312.4bn to be contributed by the pharmaceutical business segment. For 2014, our new consolidated sales target is at HUF 377.9bn, out of which HUF 334.0bn is expected to come from the pharmaceutical segment and HUF 43.9bn from the wholesale and retail arm. In 2012, hampered by price erosion and the accounting for Esmya related amortization in its cost of goods sold amounting to HUF 1,791mn, Richter’s gross margin of 61.8% ended slightly below our estimate of 62.0%. Nonetheless, bolstered by the improving sales mix (ever-increasing share of high-margin Russia/CIS sales), complemented by the benefits from the weak forint, Richter’s gross margin going forward should stay at the relatively sound 62%+- mark. Based on the slightly weaker 2012 figure, we opt for a minor downward adjustment to our 2013 gross margin forecast, from 62.1% to 61.9%. For 2014, we fine-tune our forecast for the gross margin to 62.1% (marginally below the earlier projected 62.3%).

After factoring in all above-mentioned changes, our consolidated sales target for 2013 arrives at HUF 354.2bn Gross margin: Benefits from weak forint, increasing share of Russian sales to be partly compromised by price erosion





Changes to 2013 and 2014 consolidated forecasts Consolidated, IFRS 2013e 2014e

(HUF, mn) Now Before Change Now Before Change

Sales 354,243 360,592 -1.8% 377,884 388,463 -2.7%

Cost of sales 134,904 136,585 -1.2% 143,116 146,332 -2.2%

Gross profit 219,339 224,007 -2.1% 234,768 242,131 -3.0%

Sales & marketing costs 102,099 100,738 1.4% 107,183 106,960 0.2%

Admin. & general costs 22,849 23,979 -4.7% 24,373 26,027 -6.4%

R&D costs 42,155 42,730 -1.3% 42,890 44,091 -2.7%

Other income / expense 1,699 1,680 1.1% -1,378 -1,410 -2.3%

Operating profit 53,935 58,240 -7.4% 58,944 63,643 -7.4%

Net financial income 2,496 2,621 -4.8% 2,385 2,534 -5.9%

Taxation 5,643 6,086 -7.3% 7,053 7,941 -11.2%Minorities 314 193 62.8% 345 212 62.7%

Net profit 51,102 54,967 -7.0% 54,621 58,447 -6.5%

Gross margin 61.9% 62.1% 62.1% 62.3%

EBIT margin 15.2% 16.2% 15.6% 16.4%Net margin 14.4% 15.2% 14.5% 15.0%


Sales and marketing expenditures surged 17.2% y/y in 2012 to account for 28.4% of total sales in the period, ending 0.5% ahead of our expectations. Referring to the continuation of the buildup of sales and marketing infrastructure in Western European markets, related also to the Esmya market launch, amortization of marketing and patent rights acquired from Grünenthal (HUF 4,355mn on an annual basis), as well as expanding activities in Russia/CIS, the company’s guidance for sales & marketing expenses remains at the relatively high level of around 28-29% of consolidated sales for 2013. Consequently, we are forced to make adequate adjustments to our forecasts. For 2013, we now envisage sales and marketing costs at 28.8% (vs. the earlier projected 27.9%) of consolidated sales. For 2014, we assume another increase, albeit somewhat less pronounced, but still translating into a substantial hike in relative terms compared to our previous forecast (from 27.5% to 28.4% of total sales). The research and development cost development on a quarterly basis tends to be uneven, driven to a large extent by progress in R&D cooperation projects with Forest Laboratories. In 2012, R&D spending was up a hefty 35.1% y/y to HUF 38,790mn, corresponding to 11.9% of sales, only slightly (by 1.1%) above our projections. Reflecting in part the ongoing phase III clinical trials of Esmya in a new indication, the company’s guidance for 2013 envisages R&D costs accounting for around 12-13% of sales. Consequently, we have no reason to change our forecast and continue to project R&D expenses for 2013 at 11.9% of sales (or around HUF 42.2bn). For 2014, we anticipate R&D spending remaining at the same level in relative terms as in our previous forecast, i.e. 11.4% of sales. In 2012, reflecting the R&D-based relief, Richter’s home regulatory toll recorded in the P&L statement reached just some HUF 918mn, out of which medical rep fees amounted to HUF 431mn (under sales and marketing costs) and the 20% tax obligation payable in respect of turnover related to reimbursed sales in Hungary stood at HUF 487mn at the same time. Furthermore, similarly to the previous year, the 2012 performance was marked by relatively sizable one-offs – a milestone payment from Watson related to the commencement of phase III clinical trials for Esmya in the US

Lifted by Western European sales network expansion, Esmya market introduction, sales and marketing costs maintain pressure on operating profitability Reflecting advanced stages of R&D projects in cooperation with Forest Laboratories, R&D costs are envisaged at around 12-13% of sales in 2013

R&D-based relief to significantly lessen home market regulatory toll. Milestone payment upon US FDA approval represents positive bias to our forecast





and a milestone from Forest Laboratories connected to a small CNS R&D project totaling some HUF 3bn – which were only partly erased by negative expenses associated with accounting for changes in the likelihood of payments in respect to deferred liabilities to owners of PregLem (HUF 654mn). According to CEO Bogsch, based on the cariprazine product filing with the US FDA, a milestone from Forest Laboratories in the mid-teen USD million range (in other words, around USD 15mn) will be booked already in 1Q13. The next (and most likely even higher) milestone upon US FDA approval is anticipated either by the end of 2013 or in early 2014. Unfortunately, Bogsch remained tightlipped about the estimated size of this upcoming milestone payment to be paid to Richter by its partner. Consequently, we opt to leave any potential additional milestone proceeds from Forest Laboratories as an interesting upside. In summary, we stick to our recently revised other income/expense balance target of a positive HUF 1.7bn in 2013. While in 2013, the domestic industry tax burden is anticipated at around HUF 670mn (some HUF 430mn of which recorded under sales & marketing expenses), hence shrinking y/y, the Romanian industry tax toll is foreseen to remain relatively stable in a y/y comparison at around RON 13mn. In 2014, we envisage the other income/expense balance at a loss of HUF 1.4bn, but do not rule out that the outcome might be brighter, with the balance ending in black territory, should the company obtain the above-mentioned next milestone from its partner this year. Incorporating in particular the mounting sales & marketing expenses, along with a slightly less robust gross profitability margin, our new operating profit target arrives at HUF 53,935mn for 2013 (compared to the earlier estimate of HUF 58,240mn), corresponding to a consolidated operating profit margin of 15.2% (down from the earlier projected 16.2%). For 2014, with the sales & marketing costs burden getting relatively less sizable, we expect the EBIT margin to improve in a y/y comparison. We set the EBIT margin target at 15.6%, given that the lower starting base is still somewhat below our previous forecast of 16.4%. The Hungarian forint remains one of the most volatile regional currencies in the CEE region, with its often sharp movements reflecting the politically driven turbulence in the country’s macroeconomic environment. In addition, in the course of 2012, the currencies of Richter’s crucial regional export markets, such as the Polish zloty, Romanian leu and Russian ruble, witnessed sizable quarterly swings. In 2012, the unrealized financial gain amounted to HUF 5,747mn (vs. 2011 unrealized losses of HUF 13,025mn). The realized financial result stood at a negative HUF 4,861mn (vs. the 2011 gain of HUF 6,003mn), reflecting the firming of the Hungarian forint in a y/y comparison. Going forward, we anticipate that Richter’s financial result will continue to be volatile, in particular on the quarterly basis, with the reassessment of currency related trade receivables and payables resulting in ups and downs for Richter’s financial result. At the moment, we do not anticipate any need to account for impairment losses. Thus, we expect the share of associates to end in positive territory in 2013. While the recent forint volatilty prompts us to take a more cautious stance, the adjustment to our original forecast for net financial income for 2013 is not dramatic – from HUF 2.6bn to HUF 2.5bn. For 2014, we opt to leave our financial result forecast broadly unchanged at around HUF 2.4bn. Although the tax holiday came to an end in 2012, allowances related to investments (in particular, related to the Debrecen biotech plant construction) along with the tax shield related to PregLem/Esmya, sent the effective tax rate to just 2% in 2012 and stood well below our adjusted forecast (which did not calculate with the Esmya/PregLem related part).

Reflecting more sizable sales & marketing spending, we reduce our operating profit forecast for 2013 to HUF 53.9bn. For 2014, we set new EBIT target at HUF 58.9bn Financial result set to remain volatile, changing forint fortunes decisive for outcome We expect that in absence of Esmya/PregLem related tax shield 2013 net profit be flat y/y





Nevertheless, reflecting the latest company guidance, we do not include any Esmya/PregLem related tax relief going forward and assume that the effective tax rate (excluding local taxes) will be around 5-6% in 2013, rising to 7-8% in 2014 and to 10-12% from 2015 onwards. This translates into the overall tax rate of 10% in 2013 and 11.5% in 2014 (compared to our earlier forecast of 10% and 12% tax rates, respectively). In summary, our new consolidated net profit target arrives at HUF 51,102mn for 2013, corresponding to a mere 0.6% y/y increase. For 2014, we forecast Richter’s consolidated net profit at HUF 54,621mn (up 6.9% y/y, but down 6.5% compared to our previous estimate).

4Q12 results review Richter announced its 4Q12 results on February 7, 2013. Reflecting the low comparative base (burdened by one-off losses linked to the Protek and Hungaropharma write-offs), Richter’s 4Q12 net profit jumped 52.6% y/y. The rise was more sizable than expected by market participants, including us.

Consolidated sales review 4Q2012p 4Q2011 y/y 2012p 2011 y/y

Hungary (HUF mn) 6,689 7,600 -12.0% 30,932 35,683 -13.3%

USA (EUR mn) 19.8 23.2 -14.7% 55.8 73.3 -23.9%

EU (EUR mn) 100.0 100.2 -0.2% 403.7 389.0 3.8%

Russia, CIS (EUR mn) 133.6 130.4 2.5% 498.0 444.3 12.1%

Other (EUR mn) 18.2 16.2 12.3% 65.6 65.5 0.2%

Total export (EUR mn) 271.6 270.0 0.6% 1,023.1 972.1 5.2%


Total sales (HUF mn) 83,547 89,591 -6.7% 326,702 307,868 6.1%

Operating profit (HUF mn) 10,966 12,023 -8.8% 50,284 60,927 -17.5%

Net income (HUF mn) 13,686 8,966 52.6% 50,777 49,281 3.0%


Net margin 16.4% 10.0% 15.5% 16.0%

Source: Richter Gedeon

Domestic sales: Reflecting the mounting pricing pressures, Richter’s domestic sales performance in 4Q12 was sluggish, with sales plunging 12.0% y/y to HUF 6,689mn, sending the 2012 domestic sales figure to HUF 30,932mn, down 13.3% y/y Exports: Although the high comparative base put a brake on the y/y growth tempo, the export picture was slightly more optimistic. In 4Q12, Richter’s exports advanced 0.6% y/y to EUR 271.6mn. The shrinking of the drospirenone related revenue stream continued to weigh on sales in the US (sales were down 14.7% y/y to EUR 19.8mn in 4Q12). Due to the high comparative base in Russia, as well as in Ukraine and other CIS markets, the sales pace in Russia/CIS was dampened to 2.5% y/y in 4Q12. Nevertheless, reflecting the previous quarters’ robust performance, this translated into an excellent 12.1% y/y rise in total Russia/CIS sales (to EUR 498.0mn) in 2012. Despite the y/y pickup in Poland, the relatively high comparative base, along with the impact of austerity measures, put a lid on the company’s 4Q12 sales in the EU, which slid 0.2% y/y to EUR 100.0mn.





Profitability: The negative effect from the y/y expanding share of the low-margin wholesale and retail segment, the y/y slump in US sales revenues (including profit sharing) and the Esmya related amortization charges were combined in 4Q12 with the negatives stemming from the y/y firming of the Hungarian forint vs. the USD/EUR. Consequently, Richter’s consolidated gross margin deteriorated y/y, from 62.5% in 4Q11 to 61.6% in 4Q12. Hampered by climbing sales and marketing as well as R&D expenses, the operating profit margin stood at 13.1% in 4Q12 (down from the year-earlier 13.4%). For full-year 2012, it decreased to 15.4% (from 19.8% in 2011). Here, it is worth mentioning that the burden related to accounting for the time value of the deferred purchase price due to the previous owners of PregLem (linked to the upcoming Esmya registration) shrank to HUF 654mn in 2012 (from HUF 5,041mn in 2011). On the other hand, from 2012, the company started to feel the pain of the clawback in Romania (with related charges of RON 14.3mn, out of which RON 7.3mn was recorded in 4Q12). With unrealized financial income (lifted by a reassessment of trade receivables and payables and other currency related items) swinging y/y into the black and compensating for the deteriorating realized financial items balance, the financial result improved significantly y/y to profit of HUF 349mn (vs. an HUF 3.4bn loss in 4Q11). In addition, the year-earlier period was marked by losses stemming from Protek investment write-offs and impairment losses at Hungaropharma. Thus, bolstered further by accounting for a deferred tax, the bottom line jumped 52.6% y/y in 4Q12.

Valuation / Recommendation We have reviewed the parameters of our DCF model. In line with our previous sector report from September 2012, we use the methodology for setting equity risk premiums based on S&P long-term currency ratings. With no changes in Richter’s home country rating since our company update in February 2013, we stick to the equity risk premium of 7.55% for the explicit forecast period of 2013-17 and 7.0% for perpetuity. Furthermore, although the current macroeconomic situation in Hungary is still a bit shaky, yields on Hungarian 10-year government bonds have remained stable since the time of publication of our last Richter report. Consequently, we leave our risk-free rate assumption unchanged at 7.0% for the detailed forecast period of 2013-17 and at 5.0% for perpetuity. Consequently, our WACC is at 12.7% for 2013-17 and 11.5% for perpetuity. All told, reflecting the revised projections as well as changing timeframe, our DCF-derived 12-month target price arrives at HUF 45,265 per share, vs. our earlier target of HUF 50,460 per share. The lackluster YTD performance (with Richter’s share price down 7.9% (and lagging behind the BUX falling by 0.1%) demonstrates that the stock has been facing difficulties to get out of the doldrums, to where it was sent following its removal from the MSCI index. The related share overhang was permanently depressing the stock. Although the 4Q12 bottom line jump was well ahead of market expectations, the traditionally conservative guidance dampened the optimism of market participants once again. Nonetheless, we continue to believe that the punishment went too far and, while pricing in the costs associated with the R&D foray and Western European markets expansion, the share price fails to adequately reflect the rewards brought by this courageous move. As before, Richter represents one of the best opportunities in the still relatively turbulent Hungarian equity market context, allowing investors to benefit from the persistently weak Hungarian currency. With the majority of its costs in forint and high share of exports (exceeding 90% in 2012), Richter is one of the beneficiaries of the weak forint, lifting the

Our 12-month target price arrives at HUF 45,265 per share; with stock hovering around year lows (where it was sent by technical sell-off following exclusion from MSCI index), it offers excellent upside potential





export figure in HUF terms and boding well for solid profitability margins. In addition, with its strong position in the still dynamic Russia/CIS (delivering 44.1% of 2012 sales), Richter has solid backup not only for its top line growth, but also profitability margins, at least partly compensating for the temporary pressures stemming from the buildup of its Western European market presence, as well as hike in R&D costs linked to the advanced stages of clinical trials. The R&D efforts should bring more tangible results soon, shifting from burden to boon for the company’s business. The recent news flow confirms that Richter is on a good track, as it is currently the only CEE-based generics player to bring (in cooperation with its US partner Forest Laboratories) an original drug to market. Importantly, the related news flow should not take a break in the coming period. In December 2012, the cariprazine product filing for the first two indications (acute mania associated with bipolar I disorder and schizophrenia) with the US FDA by Forest Laboratories took place. Recently, CEO Bogsch confirmed that US FDA approval is anticipated at the end of 2013/beginning of 2014, with the US market launch to follow in 1H14. The success is to be accompanied by new milestone payments to Richter from its US partner. In our model, we calculate with the likelihood of the success of the project at 75% and the cariprazine contribution to our target price is around HUF 4,500 per share. As the product moves on its path to market, we plan to fine-tune our assumptions here, including lifting probabilities. In any case, the bias for Richter’s valuation is still on the upside. Furthermore, Richter’s future product pipeline contains more possible catalysts; cariprazine is currently being tested in additional indications, with the related news flow (bipolar disorder phase II clinical trials data in 4Q13, major depressive disorder phase II clinical trials data in 2Q14) set to provide additional catalysts to the stock price. The cariprazine product road map to the EU markets is fully in Richter’s hands. As the EU registration requires some additional trials, the product launch date in Europe is envisaged only in late 2015/early 2016. Nevertheless, the first relevant studies are already underway and Richter aims to ink a partnership contract for selling & distribution in selected key markets. In addition, the Esmya potential might be significantly higher than currently assumed, should the phase III clinical trials (initiated by Richter in 2012), aimed at expanding the indication for Esmya to a long-term on-off myoma treatment, be successfully concluded. Meanwhile, the company also initiated clinical trials for a 2-cycle treatment course (vs. the currently approved 1-cycle treatment) with registration estimated in 1Q14, followed by market launch in 2Q14. As for the Canadian authorities, the EU registration package is sufficient, an Esmya product launch by Richter’s partner Watson/Actavis is planned for 2H13. The US trials of Esmya conducted by Richter’s partner Watson/Actavis proceed as planned, with the targeted Esmya market introduction in the US in 2016, further shoring up product market potential. According to the company’s estimates, adding the long-term on-off indication may result in doubling peak European sales for Esmya (from the currently envisaged EUR 100mn to EUR 200mn). In our model, calculating with peak Esmya sales of EUR 200mn, we see Esmya contributing HUF 1,200 per share to our target price. Last but not least, the company is making steady progress regarding its presence in the biosimilars field. Similarly to other market participants, we lack visibility about the program and its benefits (and hence do not incorporate them into our valuation), and we acknowledge that they might

The R&D efforts should bring more tangible results soon, shifting from burden to boon for the company’s business Cariprazine product for the first two indications (acute mania associated with bipolar I disorder and schizophrenia): US FDA approval is anticipated at the end of 2013/beginning of 2014 Cariprazine is currently being tested in additional indications Esmya potential might be significantly higher than currently assumed





also be rather distant from the current perspective. We nonetheless deem them interesting to watch and adding attractiveness to Richter’s investment case in the medium to long term. All told, we continue to believe that Richter’ R&D news pipeline (providing interesting triggers in the foreseeable future) is far from adequately priced in at the currently depressed share price levels. With the share price offering 35.7% upside potential to our revised target price of HUF 45,265 per share, we confirm our Buy call on the stock.

R&D foray benefits to become more apparent soon, inviting more investors into play. We stick to our Buy call






Risk free rate 7.0% 7.0% 7.0% 7.0% 7.0% 5.0%


Beta 0.84 0.84 0.84 0.84 0.84 1.0

Cost of equity 13.3% 13.3% 13.3% 13.3% 13.3% 12.0%

Cost of debt 7.5% 7.5% 7.5% 7.5% 7.5% 5.5%



Equity weight 91% 91% 91% 91% 91% 93%

WACC 12.7% 12.7% 12.7% 12.7% 12.7% 11.5%

DCF valuation

(HUF mn) 2013e 2014e 2015e 2016e 2017e 2018e (TV)

Sales growth 8.4% 6.7% 7.8% 7.9% 10.9% 7.0%

EBIT 53,935.5 58,943.7 69,963.2 79,256.7 91,112.2 99,223.5

EBIT margin 15.2% 15.6% 17.2% 18.0% 18.7% 19.0%

Tax rate 10.0% 11.5% 13.0% 13.5% 14.0% 19.0%

Taxes on EBIT -5,393.5 -6,778.5 -9,095.2 -10,699.7 -12,755.7 -18,852.5

NOPLAT 48,541.9 52,165.2 60,868.0 68,557.1 78,356.5 80,371.0

+ Depreciation 28,353.6 30,573.6 32,833.6 35,293.6 37,753.6 37,753.6


+/- Change in working capital -2,020.5 -1,942.6 -2,509.3 -2,744.8 -4,129.4 -3,416.4


- Capital expenditures -32,125.7 -34,023.3 -34,754.6 -36,496.6 -37,933.6 -37,753.6

Free cash flow to the firm 42,749.3 46,772.9 56,437.7 64,609.2 74,047.2 76,954.6



Discounted free cash flow - Dec 31 2012 37,916.9 36,799.5 39,391.2 40,005.5 40,676.4 499,221.2

Enterprise value - Dec 31 2012 694,010.6

Minorities 3,214.0


Net debt -38,150.0


Equity value - Dec 31 2012 728,946.6


Cost of equity 13.3%12M target price per share (HUF) 45,265

12M target price per share (HUF) 45,265

Current share price (HUF) 33,345

Up/Downside 35.7%


45265 18.0% 18.5% 19.0% 19.5% 20.0%

10.5% 47,484 48,450 49,416 50,382 51,348

11.0% 45,400 46,305 47,211 48,116 49,021

11.5% 43,561 44,413 45,265 46,117 46,969

12.0% 41,928 42,732 43,537 44,341 45,146

12.5% 40,467 41,229 41,991 42,753 43,515

45265 2.0% 2.5% 3.0% 3.5% 4.0%

10.5% 45,265 47,211 49,416 51,939 54,851

11.0% 43,537 45,265 47,211 49,416 51,939

11.5% 41,991 43,537 45,265 47,211 49,416

12.0% 40,600 41,991 43,537 45,265 47,211

12.5% 39,342 40,600 41,991 43,537 45,265




WA

CC

WA

CC


PV of terminal

value72%





Income Statement 2010 2011 2012p 2013e 2014e 2015e(IAS, HUF mn, 31/12) 31/12/2010 31/12/2011 31/12/2012 31/12/2013 31/12/2014 31/12/2015

Net sales 275,312.00 307,868.00 326,702.00 354,242.87 377,883.50 407,523.76

Cost of goods sold -107,137.00 -114,529.00 -124,947.00 -134,904.20 -143,115.63 -153,492.39

Gross profit 168,175.00 193,339.00 201,755.00 219,338.67 234,767.87 254,031.36

SG&A -81,434.00 -103,527.00 -112,721.00 -124,947.37 -131,556.58 -138,785.32


Other operating expenses -24,088.00 -28,885.00 -38,750.00 -40,455.85 -44,267.60 -45,282.87

EBITDA 83,788.00 85,386.00 77,409.00 82,289.07 89,517.32 102,796.80

Depreciation/amortization -21,135.00 -24,459.00 -27,125.00 -28,353.62 -30,573.62 -32,833.62

EBIT 62,653.00 60,927.00 50,284.00 53,935.45 58,943.70 69,963.18

Financial result 5,123.00 -11,256.00 1,229.00 2,496.26 2,385.48 2,467.58


EBT 67,776.00 49,671.00 51,513.00 56,431.71 61,329.18 72,430.76

Income taxes -3,136.00 -119.00 -1,021.00 -5,643.17 -7,052.86 -9,416.00


Minorities and cost of hybrid capital -161.00 -172.00 285.00 313.50 344.85 379.34

Net result after minorities 64,479.00 49,380.00 50,777.00 51,102.04 54,621.17 63,394.09

Balance Sheet 2010 2011 2012p 2013e 2014e 2015e(IAS, HUF mn, 31/12)

Intangible assets 185,116.00 198,806.00 181,145.00 178,453.14 175,479.52 173,245.90

Tangible assets 144,674.00 155,630.00 158,996.00 163,231.00 172,131.00 179,531.00

Financial assets 29,694.00 25,148.00 37,791.00 38,735.78 39,704.17 40,696.77


Inventories 51,657.00 63,437.00 64,136.00 65,717.80 67,825.15 70,742.37

Receivables and other current assets 96,251.00 114,861.00 118,607.00 122,091.30 124,484.45 127,544.67

Other assets 0.00 0.00 0.00 0.00 0.00 0.00

Cash and cash equivalents 95,885.00 130,403.00 111,461.00 140,951.42 172,256.82 211,898.36

Total current assets 243,793.00 308,701.00 294,204.00 328,760.52 364,566.43 410,185.41

TOTAL ASSETS 603,277.00 688,285.00 672,136.00 709,180.43 751,881.12 803,659.08


Minorities 3,131.00 3,863.00 3,214.00 3,262.21 3,311.14 3,360.81



LT provisions 0.00 0.00 0.00 0.00 0.00 0.00

Interest-bearing LT debts 41,694.00 62,226.00 73,163.00 69,872.25 66,378.64 63,059.71

Other LT liabilities 57,410.00 30,065.00 21,183.00 20,971.17 20,761.46 20,553.84

Total long-term liabilities 99,104.00 92,291.00 94,346.00 90,843.42 87,140.10 83,613.55


Other ST liabilities 62,037.00 105,862.00 57,137.00 59,937.95 67,124.69 76,114.02

Total short-term liabilities 62,058.00 106,026.00 57,285.00 60,100.75 67,303.77 76,311.00


Cash Flow Statement 2010 2011 2012p 2013e 2014e 2015e(IAS,HUF mn, 31/12)

Cash flow from operating activities 74,674.00 77,469.00 21,058.00 78,311.11 84,275.11 94,843.68

Cash flow from investing activities -116,372.00 -39,462.00 -34,527.00 -32,125.75 -34,023.26 -34,754.64

Cash flow from financing activities 21,604.00 -5,251.00 5,720.00 -16,694.94 -18,946.45 -20,447.51

CHANGE IN CASH , CASH EQU. -17,694.00 43,051.00 -17,156.00 29,490.42 31,305.40 39,641.54

Margins & Ratios 2010 2011 2012p 2013e 2014e 2015eSales growth 3.0% 11.8% 6.1% 8.4% 6.7% 7.8%

EBITDA margin 30.4% 27.7% 23.7% 23.2% 23.7% 25.2%

EBIT margin 22.8% 19.8% 15.4% 15.2% 15.6% 17.2%


ROE 15.8% 10.7% 10.1% 9.5% 9.5% 10.3%

ROCE 17.0% 10.6% 10.0% 10.1% 10.6% 12.1%

Equity ratio 73.3% 71.2% 77.4% 78.7% 79.5% 80.1%

Net debt -54,170.0 -68,013.0 -38,150.0 -70,916.4 -105,699.1 -148,641.7

Working capital 181,735.0 202,675.0 236,919.0 268,659.8 297,262.7 333,874.4








Contacts

Group Research Head of Group Research Friedrich Mostböck, CEFA +43 (0)5 0100 11902 Major Markets & Credit Research Head: Gudrun Egger, CEFA +43 (0)5 0100 11909 Adrian Beck (Fixed income AT, CH) +43 (0)5 0100 11957 Benedikt Blum (Quant, Euro) +43 (0)5 0100 11961 Hans Engel (Equity US) +43 (0)5 0100 19835 Christian Enger, CFA (Covered Bonds) +43 (0)5 0100 84052 Mildred Hager-Germain (Fixed income Euro, US) +43 (0)5 0100 17331 Alihan Karadagoglu (Corporates) +43 (0)5 0100 19633 Peter Kaufmann (Corporates) +43 (0)5 0100 11183 Stephan Lingnau (Equity Europe) +43 (0)5 0100 16574 Elena Statelov, CIIA (Corporates) +43 (0)5 0100 19641 Thomas Unger; CFA (Agencies) +43 (0)5 0100 17344 Macro/Fixed Income Research CEE Head CEE: Juraj Kotian (Macro/FI) +43 (0)5 0100 17357 Chief Analyst: Birgit Niessner (CEE Macro/FI) +43 (0)5 0100 18781 CEE Equity Research

Head: Henning Eßkuchen +43 (0)5 0100 19634 Chief Analyst: Günther Artner, CFA (CEE Equities) +43 (0)5 0100 11523 Günter Hohberger (Banks) +43 (0)5 0100 17354 Franz Hörl, CFA (Steel, Construction) +43 (0)5 0100 18506 Daniel Lion, CIIA (IT) +43 (0)5 0100 17420 Christoph Schultes, CIIA (Insurance, Utility) +43 (0)5 0100 16314 Vera Sutedja, CFA (Telecom) +43 (0)5 0100 11905 Vladimira Urbankova, MBA (Pharma) +43 (0)5 0100 17343 Martina Valenta, MBA (Real Estate) +43 (0)5 0100 11913 Gerald Walek, CFA (Machinery) +43 (0)5 0100 16360 Editor Research CEE Brett Aarons +420 956 711 014 Research Croatia/Serbia Head: Mladen Dodig (Equity) +381 11 22 09 178 Head: Alen Kovac (Fixed income) +385 62 37 1383 Anto Augustinovic (Equity) +385 62 37 2833 Ivana Rogic (Fixed income) +385 62 37 2419 Davor Spoljar; CFA (Equity) +385 62 37 2825 Research Czech Republic Head: David Navratil (Fixed income) +420 224 995 439 Petr Bittner (Fixed income) +420 224 995 172 Head: Petr Bartek (Equity) +420 224 995 227 Vaclav Kminek (Media) +420 224 995 289 Katarzyna Rzentarzewska (Fixed income) +420 224 995 232 Martin Krajhanzl (Equity) +420 224 995 434 Martin Lobotka (Fixed income) +420 224 995 192 Lubos Mokras (Fixed income) +420 224 995 456 Josef Novotný (Equity) +420 224 995 213 Research Hungary

Head: József Miró (Equity) +361 235-5131 András Nagy (Equity) +361 235-5132 Orsolya Nyeste (Fixed income) +361 373-2026 Tamás Pletser, CFA (Oil&Gas) +361 235-5135 Zoltan Arokszallasi (Fixed income) +361 373-2830 Research Poland Head: Magdalena Komaracka, CFA (Equity) +48 22 330 6256 Marek Czachor (Equity) +48 22 330 6254 Adam Rzepecki (Equity) +48 22 330 6252 Michal Zasadzki (Equity) +48 22 330 6251 Research Romania Head: Mihai Caruntu (Equity) +40 21 311 2754 Head: Dumitru Dulgheru (Fixed income) +40 37226 1029 Chief Analyst: Eugen Sinca (Fixed income) +40 37226 1026 Dorina Cobiscan (Fixed Income) +40 37226 1028 Raluca Ungureanu (Equity) +40 21 311 2754 Marina Alexandra Spataru (Equity) +40 21 311 2754 Research Slovakia Head: Maria Valachyova (Fixed income) +421 2 4862 4185 Martin Balaz (Fixed income) +421 2 4862 4762 Research Turkey Head: Can Yurtcan +90 212 371 2540 Evrim Dairecioglu (Equity) +90 212 371 2535

M. Görkem Göker (Equity) +90 212 371 2534 Sevda Sarp (Equity) +90 212 371 2537 Sezai Saklaroglu (Equity) +90 212 371 2533 Nilufer Sezgin (Fixed income) +90 212 371 2536

Group Institutional & Retail Sales Institutional Equity Sales Core Markets Head: Brigitte Zeitlberger-Schmid +43 (0)5 0100 83123 Cash Equity Sales Hind Al Jassani +43 (0)5 0100 83111 Werner Fuerst +43 (0)5 0100 83121 Josef Kerekes +43 (0)5 0100 83125 Cormac Lyden, CFA +43 (0)5 0100 83127 Stefan Raidl +43 (0)5 0100 83113 Simone Rentschler +43 (0)5 0100 83124 Derivative Sales Christian Luig +43 (0)5 0100 83181 Sabine Kircher +43 (0)5 0100 83161 Christian Klikovich +43 (0)5 0100 83162 Armin Pfingstl +43 (0)5 0100 83171 Roman Rafeiner +43 (0)5 0100 83172 Institutional Equity Sales London Declan Wooloughan +44 20 7623 4154 Institutional Equity Sales Croatia

Damir Eror (Equity) + 385 62 37 2836 Zeljka Kajkut (Equity) +38 562 37 28 11 Institutional Sales Czech Republic Head: Michal Rizek +420 224 995 537 Pavel Krabicka (Equity) +420 224 995 411 Radim Kramule (Equity) +420 224 995 537 Jiri Smehlik (Equity) +420 224 995 510 Tomas Vender (Equity) +420 224 995 593 Institutional Sales Hungary Gregor Glatzer (Equity) +361 235 5144 Attila Preisz (Equity) +361 235 5140 Norbert Siklosi (Fixed income) +361 235 5842 Institutional Equity Sales Poland

Pawel Czuprynski (Equity) +4822 330 6212 Jacek Krysinski (Equity) +4822 330 6218 Emil Onyszczuk (Equity) +48 22 330 62 14 Grzegorz Stepien (Equity) +48 22 330 6211 Institutional Equity Sales Turkey Simin Öz Gerards (Head) +9 0212 371 2525 Mine Yoruk +9 0212 371 2526 Institutional Equity Sales Slovakia Head: Dusan Svitek +48 62 56 20 Andrea Slesarova (Client sales) +48 62 56 27 Saving Banks & Sales Retail Head: Thomas Schaufler +43 (0)5 0100 84225 Equity Retail Sales

Head: Kurt Gerhold +43 (0)5 0100 84232 Fixed Income & Certificate Sales Head: Uwe Kolar +43 (0)5 0100 83214 Treasury Domestic Sales Head: Markus Kaller +43 (0)5 0100 84239 Corporate Sales AT Mag. Martina Kranzl +43 (0)5 0100 84147 Karin Rattay +43 (0)5 0100 84112 Mag. Markus Pistracher +43 (0)5 0100 84152 Günther Gneiss +43 (0)5 0100 84145 Jürgen Flassak, MA +43 (0)5 0100 84141 Antonius Burger-Scheidlin, MBA +43 (0)5 0100 84624 Fixed Income Institutional Desk

Head G7: Thomas Almen +43 (0)5 0100 84323 Head Germany: Ingo Lusch +43 (0)5 0100 84111 Fixed Income International & High End Sales Vienna Jaromir Malak/ Zach Carvell +43 (0)5 100 84254 U. Inhofner/ P. Zagan/ C. Mitu +43 (0)5 100 84254 Fixed Income International Sales London Antony Brown +44 20 7623 4159





Antibiotice Rating history

19/09A

08/03H

12/09R

0.26

0.28

0.30

0.32

0.34

0.36

0.38

0.40

0.42

0.44

0.46

0.48

Jun 11 Sep 11 Dec 11 Mar 12 Jun 12 Sep 12 Dec 12 Mar 13

Target price 12 m fwd

Date Rating Price Target Price

12. Sep 12 Reduce 0.37 0.36

08. Mar 12 Hold 0.33 0.34

02. Feb 11 Accumulate 0.36 0.42

21. Jun 10 Hold 0.36 0.38

06. Nov 09 Reduce 0.38 0.38

Company description

Antibiotice Iasi is Romania' largest anti infective drugs producer

and the only producer of injectable cephalosporin, the company

ranking 10th on the Romanian pharmaceutical market with a 2.7%

market share. The company is strategic for the Romanian

healthcare system and sells almost 40% of output towards

hospitals. Antibiotice is also world's second largest producer of

active substance Nystatin, owing a market share of 25%. The

product portfolio weights towards Rx drugs which accounted for

some 80% of sales over the last three years.

Biofarm Rating history

19/09A

10/02H

08/03A

0.150

0.160

0.170

0.180

0.190

0.200

0.210

0.220

0.230

0.240

0.250




08. Mar 12 Accumulate 0.20 0.24

10. Feb 12 Hold 0.20 0.22

03. Aug 11 Accumulate 0.20 0.25

02. Feb 11 Hold 0.22 0.23

28. Jun 10 Accumulate 0.17 0.23

06. Nov 09 Hold 0.20 0.21

Company description

Biofarm was set up in 1924, being one of the oldest and important

Romanian drug producers. Company's drug portfolio consists

mostly of OTC drugs and nutritive supplements, which account for

more than 80% of sales. With few traditional brands and

affordable prices, Biofarm managed to consolidate its position on

few market niches such as digestive disorders treatment, cold/flu

treatment and liver protection.





Bioton Rating history

19/09H

0.040

0.050

0.060

0.070

0.080

0.090

0.100

0.110

0.120

0.130




29. Jul 09 Hold 0.30 0.31

29. Jan 09 Reduce 0.20 0.19

16. Jan 09 Under review 0.23

14. Jan 08 Hold 0.94 1.03

15. Jun 07 Accumulate 1.96 2.25

Company description

Bioton entered the Polish stock market in March 2005. While the

company was originally engaged in antibiotics manufacturing,

thanks to its investment in up-to-date human insulin technology,

insulin became the driver of its current success. Bioton is the only

company in the CEE region manufacturing modern human insulin,

and, given the still unsaturated insulin market in the region

(especially in Russia) and the company's distinctive price

competitiveness as well as expanding cooperation network,

Bioton's long-term prospects are promising. Its expansion targets

include China, India and other Asian markets.

Egis Rating history

02/11A

08/03B

12,000

13,000

14,000

15,000

16,000

17,000

18,000

19,000

20,000

21,000

22,000

23,000




08. Mar 12 Buy 15525.00 20455.00

02. Nov 11 Accumulate 17985.00 21500.00

16. Sep 11 Buy 15180.00 22000.00

29. Jul 09 Accumulate 17800.00 21785.00

27. Feb 08 Buy 18850.00 24400.00

24. Oct 06 Accumulate 26570.00 31120.00

26. May 06 Buy 28820.00 35600.00

17. Aug 05 Accumulate 17995.00 20400.00

20. May 05 Buy 16950.00 20450.00

18. Aug 03 Accumulate 7600.00 11250.00 Company description

Egis, the sixth-largest player in the Hungarian pharmaceutical

market by sales, already has a strategic partner – in contrast to

rival Richter. France's Servier bought 50.9% of Egis in December

1995. Despite this, Egis remains the focus of international

investors, who appreciate the company's steadily expanding

exports. Egis' cooperation with Servier accounted for 22% of

Hungarian company's consolidated sales in 2010/11.





Krka Rating history

35

40

45

50

55

60

65

70

75

80

85




30. Nov 07 Buy 113.58 139.50

02. Apr 07 Accumulate 83.05 96.00

Company description

Krka remains one of the best long-term investment opportunities

for foreign and domestic institutional investors on the Ljubljana

Stock Exchange (LJSE). With a trading volume of EUR 173.1mn

in 2011, Krka ranked as the most liquid Slovenian stock on the

LJSE. Traditionally viewed as a Russian player (closely following

Richter, in absolute terms), the company has made considerable

progress in Western European markets, exploiting the expired

patents of internationally best-selling drugs.

Richter Gedeon Rating history

25,000

30,000

35,000

40,000

45,000

50,000

55,000




09. Jun 11 Buy 34605.00 45500.00

29. Jul 09 Accumulate 35550.00 41900.00

10. Aug 07 Buy 36250.00 46000.00

15. Feb 07 Accumulate 40700.00 46310.00

24. Oct 06 Hold 44000.00 45225.00

19. May 06 Accumulate 42700.00 49350.00

13. Jun 05 Hold 28920.00 29200.00

11. Nov 04 Buy 22400.00 26650.00

10. Nov 04 Accumulate 22400.00 29067.00

11. May 04 Buy 20115.00 26650.00

06. Aug 03 Accumulate 18100.00 19438.00 Company description

Richter Gedeon is Hungary’s largest pharmaceutical exporter. Its

niche portfolio strategy, with a focus on gynecological products, is

bringing sizable gains in Western markets, namely the US

(partnership with Teva / Barr Labs). Richter’s traditionally strong

position in Russia/CIS and CEE is another key asset of the

company. Richter ranks among the most liquid shares on the

BSE.





Important Disclosures THIS DOCUMENT MAY NOT BE TAKEN, TRANSMITTED OR DISTRIBUTED INTO THE UNITED STATES, CANADA, AUSTRALIA OR JAPAN OR TO ANY U.S. PERSON OR TO ANY INDIVIDUAL OUTSIDE CANADA, AUSTRALIA OR JAPAN WHO IS A RESIDENT OF THE UNITED STATES, CANADA, AUSTRALIA OR JAPAN OR TO THE PRESS IN THESE COUNTRIES

General disclosures

All recommendations given by Erste Group Research are independent and based on the latest company, industry and general information publicly available. The best possible care and integrity is used to avoid errors and/or misstatements. No influence on the rating and/or target price is being exerted by either the covered company or other internal Erste Group departments. Each research piece is reviewed by a senior research executive or agreed with a senior analyst/deputy (4-eyed principle). Erste Group Compliance Rules state that no analyst is allowed to hold a direct ownership position in securities issued by the covered company or derivatives thereof. Analysts are not allowed to involve themselves in any paid activities with the covered companies except as disclosed otherwise. No part of their compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or views expressed by them contained in this document. Erste Group may engage in transactions with financial instruments, on a proprietary basis or otherwise, in a manner inconsistent with the view taken in this research report. In addition, others within Erste Group, including strategists and sales staff, may take a view that is inconsistent with that taken in this research report.

Disclosure Checklist

Company ISIN Disclosure

Antibiotice ROATBIACNOR9

Biofarm ROBIOFACNOR9

Bioton PLBIOTN00029

Egis HU0000053947

Krka SI0031102120

Richter Gedeon HU0000067624

Disclosures of potential conflicts of interest relating to Erste Group AG, its affiliates, subsidiaries (together “Erste Group AG”) and its relevant employees with respect to the issuers, financial instruments and/or securities forming the subject of this document are valid as of the end of the month prior to publication of this document. Updating this information may take up to ten days after month end.





Description of specific disclosures

Erste Group rating definitions

Buy

Accumulate

Hold

Reduce

Sell

> +20% to target price

+10% < target price < +20%

0% < target price < +10%

-10% < target price < 0%

< -10% to target price

Our target prices are established by determining the fair value of stocks, taking into account additional fundamental factors and news of relevance for the stock price (such as M&A activities, major forthcoming share deals, positive/negative share/sector sentiment, news) and refer to 12 months from now. All recommendations are to be understood relative to our current fundamental valuation of the stock. The recommendation does not indicate any relative performance of the stock vs. a regional or sector benchmark.

Distribution of ratings

Coverage universe Inv. banking-relationship

Recommendation No. in % No. in %

Buy 45 24.2 4 20.0

Accumulate 47 25.3 5 25.0

Hold 49 26.3 7 35.0

Reduce 12 6.5 2 10.0

Sell 9 4.8 1 5.0

N.R./UND.REV./RESTR. 24 12.9 1 5.0

Total 186 100.0 20 100.0 Explanation of valuation parameters and risk assessment Unless otherwise stated in the text of the financial analysis/investment research, target prices in the publication are based on either a discounted cash flow valuation and/or comparison of valuation ratios with companies seen by the analyst as comparable or a combination of the two methods. The result of this fundamental valuation is adjusted to reflect the analyst's views on the likely course of investor sentiment. Whichever valuation method is used there is a significant risk that the target price will not be achieved within the expected timeframe. Risk factors include unforeseen changes in competitive pressures or in the level of demand for the company’s products. Such demand variations may result from changes in technology, in the overall level of economic activity or, in some cases, from changes in social values. Valuations may also be affected by changes in taxation, in exchange rates and, in certain industries, in regulations. Investment in overseas markets and instruments such as ADRs can result in increased risk from factors such as exchange rates, exchange controls, taxation, political and social conditions.





Disclaimer This research report was prepared by Erste Group Bank AG (”Erste Group”) or its affiliate named herein. The individual(s) involved in the preparation of the report were at the relevant time employed in Erste Group or any of its affiliates. The report was prepared for Erste Group clients. The information herein has been obtained from, and any opinions herein are based upon, sources believed reliable, but we do not represent that it is accurate or complete and it should not be relied upon as such. All opinions, forecasts and estimates herein reflect our judgment on the date of this report and are subject to change without notice. The report is not intended to be an offer, or the solicitation of any offer, to buy or sell the securities referred to herein. From time to time, Erste Group or its affiliates or the principals or employees of Erste Group or its affiliates may have a position in the securities referred to herein or hold options, warrants or rights with respect thereto or other securities of such issuers and may make a market or otherwise act as principal in transactions in any of these securities. Erste Group or its affiliates or the principals or employees of Erste Group or its affiliates may from time to time provide investment banking or consulting services to or serve as a director of a company being reported on herein. Further information on the securities referred to herein may be obtained from Erste Group upon request. Past performance is not necessarily indicative for future results and transactions in securities, options or futures can be considered risky. Any forecasts or price targets shown for companies and/or securities discussed in this document may not be achieved due to multiple risk factors including without limitation market volatility, sector volatility, corporate actions, the unavailability of complete and accurate information and/or the subsequent transpiration that underlying assumptions made by Erste Group AG or by other sources relied upon in the document were inapposite. Not all transactions are suitable for every investor. Investors should consult their advisor, to make sure that the planned investment fits into their needs and preferences and that the involved risks are fully understood. Neither Erste Group AG nor any of its respective directors, officers or employees accepts any responsibility or liability whatsoever for any expense, loss or damages arising out of or in any way connected with the use of all or any part of this document. Erste Group AG may provide hyperlinks to websites of entities mentioned in this document, however the inclusion of a link does not imply that Erste Group AG endorses, recommends or approves any material on the linked page or accessible from it. Erste Group AG does not accept responsibility whatsoever for any such material, nor for any consequences of its use. This document is for the use of the addressees only and may not be reproduced, redistributed or passed on to any other person or published, in whole or in part, for any purpose, without the prior, written consent of Erste Group AG. The manner of distributing this document may be restricted by law or regulation in certain countries, including the United States. Persons into whose possession this document may come are required to inform themselves about and to observe such restrictions. By accepting this document, a recipient hereof agrees to be bound by the foregoing limitations. Additional notes to readers in the following countries: Austria: Erste Group Bank AG is registered in the Commercial Register at Commercial Court Vienna under the number 33209m. Erste Group AG is authorized and regulated by the Austrian Financial Market Authority (FMA) (Otto-Wagner Platz 5, 1090, Vienna, Austria) Germany: Erste Group Bank AG is authorised for the conduct of investment business in Germany by the Austrian Financial Market Authority (FMA) and subject to

limited regulation by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin). United Kingdom: Erste Group Bank AG is regulated for the conduct of investment business in the UK by the Financial Services Authority (FSA). This document is

directed exclusively to eligible counterparties and professional clients. It is not directed to retail clients. No persons other than an eligible counterparty or a professional client should read or rely on any information in this document. Erste Group AG does not deal for or advise or otherwise offer any investment services to retail clients. Czech Republic: Česká spořitelna, a.s. is regulated for the conduct of investment activities in Czech Republic by the Czech National Bank (CNB) Croatia: Erste Bank Croatia is regulated for the conduct of investment activities in Croatia by the Croatian Financial Services Supervisory Agency (CFSSA) Hungary: Erste Bank Hungary ZRT. and Erste Investment Hungary Ltd. are regulated for the conduct of investment activities in Hungary by the Hungarian Financial

Supervisory Authority (PSZAF). Serbia: Erste Group Bank AG is regulated for the conduct of investment activities in Serbia by the Securities Commission of the Republic of Serbia (SCRS). Romania: Banka Comerciala Romana is regulated for the conduct of investment activities in Romania by the Romanian National Securities Commission (CNVM). Ukraine: Erste Bank Ukraine is regulated for the conduct of investment activities in Ukraine by the Securities and Stock Market State Commission (SSMSC). Poland: Erste Securities Polska S.A. is regulated for the conduct of investment activities in Poland by the Polish Financial Supervision Authority (PFSA). Slovakia: Slovenská sporiteľňa, a.s. is regulated for the conduct of investment activities in Slovakia by the National Bank of Slovakia (NBS). Turkey: Erste Securities İstanbul Menkul Değerler A.Ş. is regulated for the conduct of investment activities in Turkey by the Capital Markets Board of Turkey. As

required by the Capital Markets Board of Turkey, investment information, comments and recommendations stated here, are not within the scope of investment advisory activity. Investment advisory service is provided in accordance with a contract of engagement on investment advisory concluded between brokerage houses, portfolio management companies, non-deposit banks and clients. Comments and recommendations stated here rely on the individual opinions of the ones providing these comments and recommendations. These opinions may not fit to your financial status, risk and return preferences. For this reason, to make an investment decision by relying solely to this information stated here may not bring about outcomes that fit your expectations. Switzerland: This research report does not constitute a prospectus or similar communication in connection with an offering or listing of securities as defined in Articles 652a, 752 and 1156 of the Swiss Code of Obligation and the listing rules of the SWX Swiss Exchange. Hong Kong: This document may only be received in Hong Kong by ‘professional investors’ within the meaning of Schedule 1 of the Securities and Futures Ordinance (Cap.571) of Hong Kong and any rules made there under. © Erste Group AG 2013. All rights reserved.

Published by Erste Group Bank AG, Börsegasse 14, 1010 Vienna, Austria Head Office: Vienna Commercial Register No.: 33209m Commercial Court of Vienna Phone +43 (0)5 0100 - ext.

Erste Group Homepage: www.erstegroup.com On Bloomberg please type: EBS AV and then F8 GO



http://dict.leo.org/ende?lp=ende&p=DOKJAA&search=Czech&trestr=0x401

http://dict.leo.org/ende?lp=ende&p=DOKJAA&search=Republic&trestr=0x401

http://dict.leo.org/ende?lp=ende&p=DOKJAA&search=Czech&trestr=0x401

http://dict.leo.org/ende?lp=ende&p=DOKJAA&search=Republic&trestr=0x401

erste bank - cee sector reports_ erste sector healthcare

Documents

revised target price

revised target price

recent share price correction

guidance erste

ongoing share buyback

cee pharma stocks

hungarian pharma companies

interesting news flow