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High costs suppress margins

Sanofi India’s (SANL) Q2CY22 performance was below our estimates on the profitability front. Revenues declined 11.4% YoY to Rs7.0bn (I-Sec: Rs.7.1bn) due to divestment of the nutraceutical business and brands. EBITDA margin contracted 830bps YoY and 450bps QoQ to 23% (I-Sec: 26.5%) due to negative operating leverage and fixed costs amidst lower revenues. In the past few years, the company’s growth and profitability were fuelled by power brands. We remain positive on SANL given its high exposure in the fast-growing chronic therapy in domestic formulations, strong balance sheet with deep cash reserves, and strong brand equity built over the years. While we expect near-term performance to be modest, the recent correction in stock price (~10% in past 6 months) keeps valuations reasonable. Maintain ADD with a revised target price of Rs7,072/share (earlier: Rs7,955).

Business review: Revenues declined 11.4% YoY and 1.1% QoQ due to muted performance in key brands and seasonality. Gross margin fell 240bps YoY and 330bps QoQ led by elevated raw material prices. Employee expenses decreased 7.1% YoY, partly on account of the recent divestments, but SANL has managed to keep employee expenses in check over the past few quarters. SG&A spend grew 30.1% YoY and 2.4% QoQ. Hence, EBITDA margin declined 830bps YoY (-450bps QoQ). We expect the margin to be under pressure in the coming quarters owing to the inflationary environment.

* Key products performance: As per secondary sales data, SANL reported 5% YoY decline in Q2CY22. Enterogermina reported double-digit growth of 22.4% YoY, while Avil and Frisium reported single-digit growth YoY. On the other hand, Clexane and Combiflam saw double-digit decline of 30.2% and 12.2% YoY, respectively. Lantus and Allegra sales declined 7.2% and 2% respectively. While high chronic segment contribution (>60% of domestic sales) supported performance in the past few quarters, recovery in acute therapies is required for growth.

* Outlook: We expect revenue/EBITDA/PAT CAGRs of 5.2%/4%/4.1% over CY21- CY23E with declining contribution from exports. We lower our revenue estimates by ~2-3% to factor-in the quarterly variances. We lower our earnings estimates by ~4% for CY22E-CY23E to account for the margin pressures. Despite the high inflationary environment, we expect EBITDA margin to remain at ~25% over CY22E-CY23E, with rising contribution of domestic revenues lifting margins gradually.

* Valuations and risks: We change our earnings multiple from 28x to 26x to factor-in the lower growth rate. Recent corrections in the stock price (~10% in past 6 months) keeps valuations reasonable. Maintain ADD with a revised target price of Rs7,072/share based on 26x CY23E EPS (earlier: Rs7,955/share based on 28x CY23E). Key downside risks: addition of key drugs in NLEM, product concentration, government intervention, and presence of unlisted promoter company.

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