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Strong DF business offset by weak exports/API performance

Higher RM/logistic costs to keep margins in check over near term

* Ipca Laboratories (IPCA) delivered an in-line 2QFY22 at the operational level, but earnings were below expectations due to higher depreciation / tax rate for the quarter. The strong show in the Domestic Formulation (DF) segment was offset, to a large extent, by the muted Exports Formulation and API segments, which dragged down margins on a YoY as well as QoQ basis.

* While we expect the DF business to sustain the robust growth momentum over the medium term, we reduce our FY22E/FY23E EPS by 6%/3%, factoring in a) near-term challenges in the API business, b) elevated key starting materials/logistic costs, and c) moderation in the Export Formulations business outlook. We continue to value IPCA at 24x 12M forward earnings to arrive at our TP of INR2,600. We remain positive on IPCA on the back of a) superior execution in DF and Branded Generics exports, b) capacity expansion in API over the medium term, and c) better traction in the Institutional Anti-Malarial segment. We maintain a Buy rating on the stock.

Geographic mix change affects profitability

* Ipca’s 2QFY22 sales were up 14% YoY to INR15.4b (our estimate: INR14.8b).

* DF sales grew 30% YoY to INR7b (45% of sales) and Branded Formulation exports 4% YoY to INR955m (6% of sales), while Generic Formulation exports were almost flat YoY at INR1.9b (12% of sales). API sales declined 6% YoY to INR3.6b (23% of sales). Institutional export sales declined 23% YoY to INR630m (4% of sales).

* Other operating income and revenue from subsidiaries grew 68% YoY to INR1.3b.

* The gross margin (GM) contracted 270bp YoY to 64.8% on a change in the geographic mix and increased raw material costs, to some extent.

* The EBITDA margin contracted at a lower rate of 150bp YoY to 24.9% (our est: 26.8%) on reduced other expenses (down 170bp YoY as % of sales).

* EBITDA grew 7% YoY to INR3.8b (our estimate: INR4b).

* Adj. PAT grew 8% YoY to INR2.7b (our estimate: INR3b).

* 1HFY22 revenue was up 7% YoY to INR31b, whereas EBITDA/PAT was down 15%/17% YoY to INR8b/5.8b.

Highlights from management commentary

* IPCA indicated it would deliver much better YoY growth in Domestic Formulation for FY22 v/s the earlier guidance of 16–18%.

* IPCA highlighted some moderation in the Europe Formulation/API business in 2HFY22.

* IPCA has deferred its EBITDA margin guidance given the sharp increase in certain raw material and solvent costs, and the varying scope in different geographies to pass these on to the customer.

* The API business was impacted by pricing pressure in Valsartan. The API outlook is expected to remain muted over the near term, as IPCA is revalidating its process to address the issues related to Azido impurities in Losartan.

Valuation and view

* We reduce our FY22E/FY23E EPS by 6%/3%, factoring in a) Sartans-led issues impacting the API business outlook, b) a gradual pickup in the Europe business given weak demand, and c) the limited scope to pass on the recent surge in raw material / supply chain costs.

* Adjusted for the one-time Hydroxychloroquine Sulfate (HCQS) business in FY21, we expect a 17% earnings CAGR over FY21–23E, largely led by strong sales growth in the DF segment.

* We continue to value IPCA at 24x 12M forward earnings to arrive at our TP of INR2,600.

* We remain positive on IPCA on the back of a) volume-led outperformance in DF, b) better business prospects in API, led by capacity additions and cost efficiencies over the medium-to-long term, and c) better traction in the Institutional Anti-Malarial segment. We maintain our Buy rating.

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