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Margin recovery delayed but may not be denied

Result Synopsis

Sequent continued with sequential recovery after what is likely to be a bottom for revenues in Q1 FY23 with sales up 11% QoQ and ~5% YoY. API business rebounded with ~13.5% cc growth QoQ though YoY still down ~3% as customers still appear cautious in inventory replenishment. Europe continues to be plagued with demand issue compared to last year run rate though QoQ recovery is visible with ~11% rise in sales. Currency impact on emerging markets including Turkey persists with cc growth nearly twice that of reported rise in revenues.

More than topline (up 10% YoY amidst a tough environment for API stocking), Sequent continues to disappoint on margin front with little relief from still high COGS. Inability to get price hikes in API business (or at most getting after a long lag) and lack of any meaningful traction is hurting API segment. Formulations, though more amenable to price hike, have their own demand and currency issue in Europe and Turkey respectively. Overall, we reckon, after management guidance, expectation of a quick climb back to comfortable double digit margin have been pushed by a year which would create earnings phase in the interim, wherein EBIDTA growth would not be faster than topline. We cut FY24 estimate sharply as margin assumption is reduced from ~13% to 10% along with tweaking of below EBIDTA line item. Also bring in FY25 forecast and, while we still remain positive despite the sharp cuts, reckon recovery is firmly delayed by a year; roll over to FY25 forecast and retain BUY with revised TP Rs130, based on unchanged 35x FY25 EPS. Why 35x for such a struggling business? We believe some of the factors like elevated COGS, demand issues in Europe and API overstocking could reverse in the coming year which could bring traction in earnings, not fully captured when compared to historical gross margin/OPM.

Result Highlights

Sequent reported 11% QoQ growth and ~5% YoY growth; formulations up 5% QoQ in constant currency basis driven by strong quarter for Europe with 11% cc QoQ

API business up ~14% QoQ in cc possibly reflecting some long sought after price hikes as well and likely CDMO supply to animal health co

Gross margin improved to 42%, up 70bps QoQ reflecting better API growth and better realization mix

Excluding yet another quarter of several one-offs and ESOP charge, OPM came in at ~7.4%, up 300bps QoQ

Company reported a loss on back of forex loss, ESOP expenses and other write-offs

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