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Enhanced effort required to improve return ratios going forward

* Our Annual Report analysis of Cipla indicates robust improvement in return ratios over FY18-22. Notably, there had been an improvement in ROE in FY21 (+400bp YoY) to 14.1% and it sustained at similar levels in FY22.

* Over FY18-20, Cipla’s earnings were largely flat. However, the efforts across key geographies aided by limited competition products in the US generics, COVID (FY21), and cost optimization measures led 34% earnings CAGR over FY20-22.

* Further, improved working capital requirement and reduction in debt have enhanced the financial health of the company.

* Going forward, we expect 15% earnings CAGR over FY22-24, led by 19%/6%/ 13% sales CAGR in the US/Domestic Formulation (DF)/EU, respectively. We value Cipla on an SOTP basis (23x 12M forward base earnings and add NPV of INR40 for g-Revlimid) to arrive at our TP of INR950.

* We maintain our Neutral rating on the stock due to stable return ratios over the next two years. The current valuation adequately factors in the earnings upside over the next couple of years

DF/US – key growth drivers; SAGA/EM also catching up in growth terms

* Cipla posted 9%/12.6% sales CAGR over FY18-20/FY20-22, respectively. DF/US remained at the forefront to drive growth over FY18-22 with each segment exhibiting sales CAGR of 11%/18%, respectively. In addition to prescription (Rx) portfolio, Cipla gained notable traction in trade generics/ consumer health (25%/49% sales CAGR over FY18-22, respectively).

*/ While price erosion continued to hurt the base portfolio, new launches reported healthy growth in the US segment. Particularly, respiratory products garnered sales of USD169m in FY22 from just USD11m in FY17.

*  The growth was moderate during FY18-20 in SAGA, emerging markets (EMs) and Europe (EU). The reduced tender business in Africa and higher competition in ARV space impacted SAGA business adversely. Geopolitical tensions and currency volatility hurt EM business over FY18-20.

* However, there has been a steady improvement over FY20-22 in EM/ SAGA segments. The enhanced effort to ramp-up private market segment within SAGA and the increasing share of direct-to-market (DTM) enabled better growth prospects in the SAGA/EM segments.

Efforts continue towards improving capital efficiency

* Dupont analysis indicates 410bp improvement in ROE to 14.5% in FY22. This was primarily led by better asset turn and considerable margin expansion. The EBITDA margin was steady over FY18-20.

* Increased contribution from niche launches in the US generics, reduction in tender business and better operating leverage augmented Cipla’s profitability over FY20-22.

* From net debt of INR20b in FY18, Cipla turned cash surplus (of INR41b) by end-FY22.

Current valuation captures earnings upside over the next two years

* Cipla continues to focus on enhancing patient experience through digital analytics, superior execution in prescription (Rx) products, increasing distribution for Tx and improved brand recall in consumer health segment. It is also working on expanding the peptide offering in the US generics segment. The management continues to focus on increased DTM share and add newer geographies within the EM segment. Consequently, we factor in 15% earnings CAGR over FY22-24E.

* We continue to value Cipla at 23x (in-line with its three-year average P/E multiple) 12M forward base earnings and add g-Revlimid NPV of INR40 to arrive at our TP of INR950. While the earnings outlook remains encouraging, the valuation provides limited upside from current levels, we believe. Hence, we maintain our Neutral rating on the stock.

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