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Weak Q4; on track to sustain higher margins

Cipla reported weak Q4FY21 performance due to shelf stock adjustment of Albuterol in US and muted India growth. However, we believe growth and margin would improve in coming quarters led by growth recovery in India and ramp-up in US sales. We expect EBITDA margin of 22-23% will sustain in the future vs level of 17-19% historically. Consolidated revenues grew 5.3% to Rs46.1bn (I-Sec: Rs50.6bn), EBITDA margin was up 80bps to 17.3% and adjusted PAT grew 33.1% to Rs4.1bn (I-Sec: Rs6.3bn). Gross margin was impacted by 200bps due to certain inventory adjustments and shelf stock adjustment of Albuterol with entry of new competitor. The company has increased Remdesivir supplies by 5x which would help in driving strong growth in coming quarters. Recent rally in stock has capped the upside and hence we downgrade Cipla to ADD from Buy.

* Muted revenue growth: India business revenue grew 4.5% YoY with 6.0% growth in the branded business led by chronic portfolio. We expect growth to rebound in coming quarters with higher sales of COVID-19 related drugs and recovery in industry growth. COVID-19 related drugs contributed ~4% of total sales in FY21. US revenues stood US$138mn, down 2.1% QoQ, despite strong traction in generic Albuterol. Sales in emerging markets grew at 4.1% and that in South Africa (incl. Global Access) business at 1.8% in US$ terms but 10% in constant currency terms. Overall, the growth had been week during the quarter but we don’t see any structural issues and growth should recover in coming quarters.

* One-off adjustments impacted margins: EBITDA margin improved just 80bps YoY to 17.3% vs estimate of 22% due to one-time impact of 200bps on gross margin and lower revenue growth. Gross margin was impacted by certain inventory adjustments and shelf stock adjustment of Albuterol. We expect EBITDA margin to sustain at 22- 23% over FY22E-FY23E with improving revenue mix and cost control initiatives. High value launches in US like generic Advair can provide upside.

* Outlook: We expect revenue/EBITDA/Adj. PAT to CAGR at 8.2/9.5/12.2% over FY21-FY23E on high base of FY21 which had ~4% revenue contribution from COVID-19 portfolio and higher cost savings. The company turned net cash in FY21 and FCF generation of >Rs20bn/year over the next two years will further strengthen the balance sheet. We are positive on management’s renewed focus on India business, cost control initiatives and focus on RoCE. We expect RoIC to improve to 17.0% in FY23E from 9.4% in FY20.

* Valuation and risks: We largely retain our estimates and remain positive on the stock considering increasing proportion of India sales, improving margin profile and strengthening balance sheet. However, recent rally in stock has capped the upside, hence, we downgrade it to ADD from Buy with target price of Rs966/share based on 25xFY23E earnings and Rs28/share for Revlimid. Key downside risks: Regulatory hurdles, forex fluctuations and lower growth in India market

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