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Better operating leverage drives earnings

API capacity expansion on track

* Ipca Laboratories (IPCA) delivered a marginally better-than-expected 3QFY21 financial performance, led by higher revenues in the Generic/Institutional Anti-Malaria segment as well as improved profitability in its subsidiary (Onyx Scientific) and associate company (Tropic Wellness). Capacity enhancement remains on track for the API business. Opex remains controlled for the Domestic Formulation (DF) segment.

* We raise our earnings estimate by 4%/2% for FY21/FY22, but lower our estimates by 7% for FY23, factoring in a) recovery in the outlook for Branded Generics, b) increased business opportunity in the Institutional segment, c) a capacity enhancement exercise in the API segment, and d) higher tax rate FY23 onward. We value IPCA at 24x 12M forward earnings to arrive at Target Price of INR2,420. We remain positive on IPCA on the back of its outperformance (v/s industry) in the Chronic therapies of Cardiology/Pain and established presence across the manufacturing value chain. Reiterate Buy.

Inferior product mix effect more than offset by controlled opex

* 3QFY21 sales were up 16% YoY to INR14.1b (our estimate: INR13.8b), led by growth in exports in Institutional / API / Generic Formulations.

* Institutional export sales expanded 3x YoY to INR1.4b (10% of sales). API rose 23% YoY to INR3.5b (25% of sales). Generics Formulations exports grew 12% YoY to INR2.2b (15% of sales). DF sales grew 8% YoY to INR5.2b (37% of sales). Branded exports declined 31% YoY to INR775m (6% of sales). Other operating income / Revenue from subsidiaries grew 17% YoY to INR1b.

* The gross margin (GM) contracted 160bp YoY to 63.4% due to a change in the business mix.

* Despite decline in GM, the EBITDA margin expanded ~350bp YoY to 26% on strong operating leverage (other expenses / employee costs were down 340bp/170bp YoY). EBITDA grew 34% YoY to INR3.7b (our est.: INR3.5b).

* Adj. PAT was up 34% YoY to INR2.7b (our estimate: INR2.5b).

* For 9MFY21, sales / EBITDA/ adj. PAT grew 20%/78%/88% to INR43b/INR13.2b/INR9.6b.

Highlights from management commentary

* IPCA has guided for 10% YoY growth in Branded export sales for FY21, driven by healthy recovery in Russia and CIS in 4QFY21.

* IPCA has guided for 13–14% YoY growth for DF sales in FY22, adjusted for on-time Hydroxychloroquine (HCQS) sales in FY21.

* The company aims to achieve 69% gross margins and an EBITDA margin of 25–26% over the next 12–15M.

* IPCA indicated annual capex of INR3.5–4b would continue for the next two years.

* It has applied for two products under the PLI scheme.

Valuation and view

* We raise our earnings estimate by 4%/2% for FY21/FY22, but lower our estimates by 7% for FY23, factoring in a) a better outlook for Branded (exports/DF) Generics, b) improving prospects in the UK business, c) an increased order book in the Institutional segment, d) a capacity enhancement exercise in API, and e) higher tax rate in FY23, depending on the use of MAT credit.

* We expect an earnings CAGR of 26% (FY20–23), supported by a sales CAGR of 14%/16%/35%/19% in DF/API/Institutional/Generics, and 610bp margin expansion on a better product mix and operating leverage.

* We value IPCA on a 24x 12M forward earnings basis to arrive at Target Price of INR2,420. We remain positive on IPCA on the back of a) a capacity increase to benefit from robust demand in API, b) a superior performance in DF, c) product launches in its own label in the UK, and d) increased backward integration. Reiterate Buy

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