>GLENMARK PHARMACEUTICALS (CITI)

Upgrade to Hold: Worst Appears Behind

■ Upgrade to Hold (2M) — We believe the risk reward is more balanced post the recent underperformance & lower risk on R&D, leading us to lower risk rating to Medium. We reduce FY10/11 core biz EPS estimates by 9%/5% (building in a slower pace of recovery) but raise TP to Rs250 (roll over to 15x Sep '10E).

■ Lower risk; More reasonable valuations — We were worried about the risk from Oglemilast-related newsflow. With that behind us, and following a c.17% fall in the last two weeks, we believe risk is lower. At c.12x FY11E EPS, there appears to be no upside built in for R&D, while all R&D cost is expensed. We thus view the risk on Glenmark to be similar now as that in most other generics stocks.

■ Encouraging trends in the base biz — Growth has picked up in all markets in 1QFY10, as credit availability and currencies stabilized, leading to a smart QoQ rise in financials. We believe the worst is behind, with forecast sales and PAT FY09E-11E CAGR of 19% and 35% respectively. Cash flow is set to rise, as capex and working capital are reined in, allowing Glenmark to correct its high leverage.

■ Don’t rule out R&D — Despite setbacks on two of its lead NCEs, Glenmark’s R&D pipeline could be a key value driver. Its capabilities have been validated by three deals with large partners (income: US$117m). Progress on melogliptin and crofelemer would be key to watch out for. With our view that no value is currently built in for R&D in the stock, this could provide a clear catalyst.

■ Why not a Buy? — There are multiple moving parts in Glenmark's biz. While early signs on the core biz indicate that the worst may be behind, it is difficult to gauge the pace of recovery. R&D is another factor that could swing margins either way. Thus, while more positive than before, we await confirmation that the early signs of recovery are sustainable before getting more constructive.

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