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Escalated operating cost hurts profitability

Domestic formulation – a saving grace

* IPCA reported a miss on 2QFY23 earnings, led by lower-than-expected sales of the API segment and higher operational cost for the quarter. IPCA continued its growth momentum in domestic formulation (DF) segment in 2QFY23 as well.

* We cut our EPS estimates by 15% each for FY23/FY24 factoring in: a) escalated logistics/power cost, b) reduced demand in API segment, and c) gradual pick-up in the UK business. We value IPCA at 24x 12M forward earnings to arrive at our TP of INR1,000.

* While the near-term performance may be impacted adversely by cost pressures and front-loading of field force cost in DF segment/opex related to Dewas facility, IPCA remains well-placed to deliver healthy outperformance than the industry in the DF segment. With normalization of inventory in the channel and availability of new facility, we expect API business to recover over medium term. Maintain BUY.

Operational costs outpace revenue, lowering operating leverage for 2Q

* In 2QFY23, sales grew 4% YoY to INR16b (est: INR16.4b)

* DF sales grew 10% YoY to INR7.7b (48% of sales).

* Exports (branded formulation) rose 33% YoY to INR1.2b (8% of sales). Exports (institutional sales) grew 22% YoY to INR770m (5% of sales). Exports (generics formulation) increased 4% YoY to INR2b (12% of sales).

* API sales declined 15% YoY at INR3b (19% of sales).

* Revenue from subsidiaries declined 4% YoY to INR1.2b (7% of sales).

* Gross margin (GM) contracted 70bp YoY and stood at 64.1% due to raw material inflation.

* EBITDA margin contracted 800bp YoY to 17% (est: 21.5%), due to lower GM and higher operational costs (employee cost/other expenses up 75bp/650bp YoY as % of sales).

* EBITDA declined 29% YoY to INR2.7b (est: INR3.5b).

* Adj. PAT for the company declined 31% YoY to INR1.9b (est: INR2.2b), due to higher tax rate.

* In 1HFY23, revenue grew 2.5% to INR32b while EBITDA/PAT declined 31%/41%, respectively, to INR5.5b/INR3.4b.

Highlights from the management commentary

* IPCA guided for an overall sales growth of 9-10% YoY for FY23.

* Given muted demand and increased competition, management indicated marginal 2% YoY growth in API sales for FY23.

* India business gross margin has been consistent at 67-68%.

* USD as a currency accounts for 60% of exports business while other currencies contribute 40%.

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