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Steady Q2; US growth remains a concern

Cadila Healthcare (Cadila) reported Q2FY22 results broadly in line with our estimates, though margins were higher on account of lower R&D and S,G&A. Revenue (ex Animal health business) grew 3.4% to Rs37.8bn (I-Sec: Rs37.2bn) driven by India formulations. US sales grew 2.5% QoQ led by volume gain ex mesalamine products and new launches. Adj EBITDA margin was up 50bps YoY to 22.7% (I-Sec: 21.0%) driven by lower R&D and SG&A. Adjusted PAT (ex Animal health business) grew 70.0% to Rs5.8bn (I-Sec: Rs4.7bn) led by higher EBITDA. Successful commercialization of ZyCoV-D vaccine remains the near term trigger, but we don’t expect it to be significant valuation driver. Considering significant correction in stock price, we upgrade it to HOLD from Reduce.

* Business outlook: India formulations business grew 11.6% YoY (17% excluding the institutional sales of covid related products) driven by key brands and new launches. US sales grew 2.5% QoQ to US$202mn (I-sec: US$205mn) led by volume gain in ex-mesalamine products and new launches. 2HFY22 is expected to remain under pressure due to likely competition in Asacol HD, however, ramp-up in transdermal products, injectable and high value launches would help in pick-up from FY23 in sales, but USFDA resolution on Moraiya facility remains critical. Consumer wellness grew at steady 12.5% YoY. EMs grew robust 47.8% led by volume traction. While API sales were down 16.1% YoY. Adj EBITDA margins improved 50bps YoY led by lower R&D and SG&A spend being partially offset by 300bps YoY decline in gross margin due one-time inventory provision for COVID related products (1.2% impact) and adverse product mix. We expect the margin to remain stable at ~21-22% over FY22E-FY23E.

* Key Concall Highlights: 1) US business growth is expected to be muted in nearterm and may decline in Q4 amid price erosion and competition, 2) Management expects 5% growth with 50+ launches in FY23 subject to clearance of Moraiya facility 3) Aspiration of reaching US$250mn sales each from vaccine and injectable portfolio in next 3 years, 4) Guided Rs8-9bn capex for FY22, and 5) expects cost optimization measure likely to improve 80-100 bps margins in FY23

* Outlook: We expect revenue/EBITDA/PAT CAGRs of 3.8/4.3/3.9% respectively, over FY21-FY23E. Lower earnings growth is due to lower revenue growth, rise in S,G&A expenses, though interest cost will be reducing. The company reduced net debt substantially through divestment of animal health business to Rs4bn from Rs35bn in FY21. Ramp-up in ZyCoV-D vaccine could provide upside in near term.

* Valuations and risks: Given significant correction in stock price, we upgrade Cadila to HOLD from Reduce with a revise target of Rs510 (earlier Rs505) based on 22xFY23E EPS and an NPV of Rs26/share for ZyCoV-D. Key upside risks: prolonged use of COVID-19 vaccine with higher quantities and early resolution of Moraiya facility. Key downside risks: competition in US and regulatory hurdles.

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