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Gradual recovery; valuations comfortable

Solara Active Pharma’s (Solara) Q2FY23 performance was below our estimates across all parameters. Revenue declined 15.7% YoY (+2.5%QoQ) to Rs.3.4bn (ISec: Rs.3.5bn) with slow recovery in non-regulated markets. EBITDA margin was down 970bps YoY (+430bps QoQ) to 8.1% (I-Sec: 10.5%). Solara reported a loss of Rs100mn during the quarter. It remains confident of a strong recovery H2FY23 onwards. While we believe near-term performance would remain under pressure due to business volatility and cost inflation, gradual recovery in demand H2FY23 onwards and comfortable valuations support the positive thesis. Maintain BUY with a revised target price of Rs520/share (earlier: Rs488/share).

* Business review: Solara’s reported revenue declined 15.7% YoY (+2.5% QoQ) to Rs3.4bn (~80% of historical levels). Regulated market grew 26.4% YoY (on a low base) and 2.5% QoQ with gradual recovery of demand in key products. Emerging markets declined 49% YoY, but grew 2.5% QoQ indicating gradual demand recovery. As per the management, H2FY23 will see healthy growth led by strong volumes in both regulated and emerging markets and it remains confident of achieving historical revenue run-rate by fiscal year end. Gross margin grew 330bps QoQ led by higher contribution of regulated markets (~66% in Q2FY23). EBITDA margin stood at 8.1% in Q2FY23 against 17.9% in Q2FY22 due to negative operating leverage. It expects to file 6 new DMFs (2 from Vizag) in H2FY23. New products accounted for ~11% during the quarter. The company has identified 3 key strategic priorities for FY23 – 1) revive base business and grow profits, 2) recalibrate R&D for efficient investment and 3) enhance capacity usage at Vizag.

* Key concall highlights: 1) Company targets return to historical revenue run-rate and mid-teen EBITDA margin by Q4FY23, 2) gross margin to reach ~50% by end of FY23, 3) Ibuprofen: Pricing environment has largely stabilised, 4) net-debt/ EBITDA to be ~5x in FY23 and ~2.5-3x in FY24.

* Outlook: We introduce FY25 estimates and expect revenue/EBITDA CAGR of 11.2%/55.3% over FY22E-FY25E led by recovery in base business and new launches. The company is likely to generate FCF of ~Rs6.8bn over FY23E-FY25E. Return ratios will improve, but remain below ~10%.

* Valuation and risks: We cut revenue and EBITDA estimates by 3-4% and 6-7%, respectively, over FY23E-FY24E to factor in slower-than-expected recovery in the business. While near-term pressures due to business volatility and cost inflation may impede growth, gradual recovery in demand H2FY23 onwards and comfortable valuations support the positive thesis. Maintain BUY with a revised target price of Rs520/share based on 9xSep’24E EBITDA (earlier: Rs488/share on 9xFY24E EBITDA). Key downside risks: Higher competition, cost inflation and regulatory hurdles.

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