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Subdued quarter on expected lines

Ipca’s (IPCA) Q3FY22 revenue/EBITDA was 2%/3% below consensus estimate. Weak API and generic exports partly offset by 23% YoY India growth. EBITDA margin at 21.7% hit by power and freight increase.

While we accept near-term challenges like slow recovery in UK, shrinking API margins, higher raw material and power and freight cost, Ipca’s domestic strength, API leadership, vertically integrated model and cost optimization are likely to lead to a recovery in FY23. Domestic outperformance is likely to ease gross margin pressure. We reduce our FY23 EPS by 6% to factor in elevated opex and salesforce expansion that yields a target price of INR1220 (from INR1265). Maintain ‘BUY’.

Q3FY22 takeaways: Q2 trends mirrored

The trends seen in Q2: i) Weak generic and API exports. ii) Industry leading domestic (also seen in Q3). Domestic grew 23% YoY, highest growth in the sector. However, generic exports were weak due to an inventory glut in EU, slow UK recovery and sartan led decline in the export API business. Strong India contribution meant that gross margins improved to 65.1%. Whole opex was under control, increase in freight and power costs led to 21.7% reported EBITDA margin.

Near-term challenges mask long-term growth prospects

Industry-wide issues like rising raw material costs, burgeoning power and freight expenses and Ipca-specific issues like sartan impurities and lower prices, weak EU business are likely to impact Ipca for the next few quarters. However, Ipca has started to enter into new API contracts. India business continues to outperform across therapies, branded business is on a steady footing and sound cost control that enables the company to report 20%-plus margins, despite ~INR1bn of fixed cost on plants with low utilisation at present due to no US sale. Ipca’s vertically integrated business model will enable it to capture API opportunities as 25% capacity is added through its Ratlam and Dewas plants. Thus, while we acknowledge pressures on the API business and gross margins, Ipca remains well-placed for a recovery.

Outlook and valuation: Long-term potential intact; maintain ‘BUY’

Despite challenges in FY22, that is likely to report a decline due to the factors mentioned above, Ipca is well positioned to report low-teens CAGR as its revenue trajectory remains intact. Our INR1,220 target price is based on 25x Jun-23E earnings. Maintain ‘BUY/SO’.

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