Lack of launches / COVID disruption leads to weak 1QFY22
New launches – key for business revival
* Strides Pharma (STR) reported unexpected operational loss in 1QFY22 on lower demand, higher competitive intensity in US Generics, and low operating leverage. This was exacerbated by the impact on production and supply due to a severe second COVID wave in Bengaluru.
* As a quick mitigation plan to increase product launches, it aims to acquire a portfolio of differentiated ANDAs, including 20 already commercialized products and a manufacturing facility from Endo Pharma in the US. The acquisition would double the approved product portfolio and add differentiated products and manufacturing capabilities for STR.
* Considering (a) sharp price erosion in the base portfolio for the US market, (b) a disappointing 1QFY22 performance, and (c) gradual improvement expected from 2HFY22, we expect STR to witness loss in FY22. Hence, we lower our EPS estimate for FY23 by 20%. We value STR on an SOTP basis (EV/EBITDA of 11x for Regulated Markets, 7x for Emerging Markets / Institutional) and add an investment value of 33% stake in Stelis (recent conclusion of Series B/C funding pegs post-money valuation at USD350m). Maintain Buy.
Price erosion / COVID disruption leads to EBITDA loss
* 1QFY22 revenue was down 12% to INR6.9b (our est: INR8.8b) on multiple macro headwinds from the recent wave of COVID-19.
* US sales were down 19% YoY to INR3b (44% of sales). Other regulated market (OTR) sales were down 14% YoY to INR2.2b (32% of sales). Emerging Market sales were up 11% YoY to INR1.7b (24% of sales).
* The gross margin (GM) contracted ~1200bp YoY to 49.3% on lower realization for its products.
* The EBITDA margin contracted ~2740bp YoY to (-8%; our est: +18%) on a sharp reduction in operating leverage (employee costs / other expenses up 680bp/850bp YoY as a percentage of sales).
* STR reported EBITDA loss of INR554m (our est: positive EBITDA of INR1.6b).
* STR recorded exceptional loss of INR915m on account of forex loss, sales returns, inventory write-downs, and other expenses related to Ranitidine.
* Adjusted for the same, STR reported loss of INR1.4b (our est PAT: INR529m).
Highlights from management commentary
* Despite weak 1QFY22 US sales and 2QFY22 also expected to be weak, STR guided for 10–15% YoY growth in US sales for FY22, led by new launches, including the products acquired from Endo.
* STR would pay USD24m to Endo for a basket of ANDAs and the manufacturing facility at Chestnut Ridge, NY.
* Adjusted for overlapping products, STR would have a basket of 100 approved products and thus double the portfolio offering by Strides.
* Mark Womack, who joined as MD & CEO of Stelis, would bring his expertise and leverage his contacts from his time in vaccine CDMO; this would aid expansion in Stelis.
* A healthy order book across markets in OTR provides the confidence that normalcy would return in 2QFY22.
Valuation and view
* We cut our earnings estimate for FY22/FY23, factoring in near-term headwinds in US sales growth. We believe the recently announced acquisition in the US adds much-needed differentiated products to STR’s offerings. We expect strong growth in the OTR business, led by higher volumes and recovery in the EM business, supported by global sales opportunities in the Endo portfolio.
* We roll our price target to INR840 on a 12M forward SOTP basis (EV/EBITDA of 11x for Regulated, 7x for EM/Institutional segment) and add the investment value of Stelis. We maintain Buy on STR as we believe current headwinds are transitional and higher revenue from increased product offerings would further improve operating leverage – thereby improving profitability going forward.
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