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Margin pain ending; reinstate BUY from ADD

Result Synopsis

IPCA reported a largely in-line revenue and margin quarter as 9-17% growth across domestic and branded markets was offset by rebound in costs on YoY basis. IPCA has spent bulk of the last few quarters, like most other pharma cos, under the shadow of elevated COGS coupled with revival of fixed and promotional expenses. On a 3-year CAGR, staff and other expenses are now clocking 13-15% rise annually between 9m FY20 (pre- Covid clean base) and 9m FY23 which makes us believe fixed expenses have largely completed their catch up on the low marketing/promotional expense phase of FY21/22. Current fixed cost structure would include 1) Dewas related costs 2) at least part costs of 1500 MRs hired in last few quarters 3) higher than average freight and one-time testing expenses related to impurity. We reckon most of these costs are reversible in nature on top of a softening COGS scenario which can add ~150-200bps to gross margin. While 4Q should see some impact from full impact of NLEM-led reduction, possibility of price hikes again from April’23 linked to WPI would offset some of the decline. API business is also expected to rebound strongly as inventory overstocking runs off and IPCA enjoys scale in its API business thereby aiding margin recovery. We expect a strong rebound in FY24/25 margin as wash out year for earnings draws to a close. We had downgraded IPCA to ADD in our Q1 FY23 update on back of limited near term catalysts (lack of margin traction in FY23, inflated costs). We reckon most of these have played out and a likelihood of fixed costs growth tapering off, API rebound on the cards and gross margin improvement have emerged as key triggers in FY24/25. While we cut FY23/24 estimates by 20-35% in light of stilllingering margin weakness in Q3, believe reversal in some of the factors that plagued the company in FY23 could be in the offing; upgrade to BUY from ADD with target PE of 25x on FY25 EPS for an unchanged TP Rs1,100.

Result Highlights

* In line revenue quarter though margin weakness still persists

* Domestic growth 9% YoY and branded growth at 17% YoY; anti-malarial decline and weakness in cardiac is pulling down India business

* Gross margin had slight decline QoQ as higher cost inventory works its way

* Fixed expenses ramp up continue YoY though likely end of any further sharp rise

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