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US segment drags overall performance

Recovery witnessed in non-US markets

* STR reported a lower than expected performance in 2QFY22 due to continued headwinds in the US business. Sales in other regulated markets witnessed a recovery, with an 18% YoY growth.

* With the completion of Endo products and facility acquisition, STR will have a diversified US portfolio, with a lower proportion of Acute products as well as differentiated products such as hormones, Nasal Sprays, Gels, Modified Release products, and controlled substances, which are less susceptible to price shocks like that seen in 1HFY22. Other regulated/emerging markets are expected to continue their strong growth trajectory.

* Considering: a) a gradual recovery in volumes in the US base business from 3QFY22 onwards, b) addition of the Endo product portfolio from 1QFY23E, c) a continued growth trajectory in emerging markets/other regulated markets, and d) improved operating leverage, we expect STR to bounce back from an estimated earnings loss in FY22E to clock a PAT of INR1.9b in FY23E. We value STR on a SoTP basis, with an EV/EBITDA of 11x/8x for its regulated/emerging markets, 7x for the Institutional segment, and add investment value of its 33% stake in Stelis (recent conclusion of Series B/C funding pegged at a post money valuation of USD350m). We maintain our Buy rating with a TP of INR580 per share.

Operational loss reduces considerably on a QoQ basis

* Revenue fell 9% to INR7.2b (est. INR7.7b) in 2QFY22, led by a 38% YoY decline in US sales (INR2.5b; 35% of sales). This was offset to some extent by an 18%/32% YoY growth in other regulated/emerging market sales (INR2.8b/INR2b; 39%/26% of sales).

* Gross margin (GM) contracted by ~610bp YoY to 55%. However, GM improved by 570bp on a QoQ basis.  EBITDA margin contracted by 2,000bp YoY to touch -0.1% (est. +1.5%). However, it reached near operational breakeven v/s -8% in 1QFY22. EBITDA margin improved by 790bp on a QoQ basis.

* STR posted an operational loss of INR11m (v/s our EBITDA estimate of INR115m). However, the same improved from an operational loss of INR554m in 1QFY22.

* It recorded an exceptional loss of INR724m on account of a forex loss, sales return, write-down of inventory, impairment on disposal of a facility, and restructuring expense. Adjusting for the same, STR reported a loss of ~INR990m (v/s our loss estimate of INR836m)

Highlights from the management commentary

* The management targets an annual revenue of USD225-250m from the US in FY23, of which its acquired product portfolio is expected to contribute USD50m.  It maintained its guidance of launching 5-6 products per quarter from its combined portfolio in the US.

* It will diversify its combined portfolio with additional Chronic products from the Endo portfolio. Around 13 products are controlled substances and over 60% is the proportion of Chronic products in the Endo portfolio.

* Full benefits from the Endo portfolio would begin from 1QFY23. The US business is in a gradual recovery mode, as pricing-related headwinds are stable since the first month of 3QFY22.

* STR has secured a contract to manufacture Sputnik Light from RDIF. It can manufacture up to 400m doses between Sputnik and Sputnik Light.

* Stelis is reasonably confident of getting the first dose of Sputnik V right, with several scale-up batches now being manufactured. Vaccine revenue is expected to start accruing from 4QFY22, subject to government allowing vaccine exports.

Valuation and view

* Considering the continued headwinds in the US, due to a sharp price erosion in its base portfolio, and dismal 1H performance, we expect STR to deliver an earnings loss in FY22E. With an improvement in the base business in the US over the next 2-3 quarters and acquired products’ contribution from 1QFY23E, we expect STR to be in the black in FY23E, with a PAT of INR1.9b.

* We value STR on a SoTP basis, with an EV/EBITDA of 11x/8x for its regulated/emerging markets, 7x for the Institutional segment, and add investment value of its 33% stake in Stelis (recent conclusion of Series B/C funding pegged at a post money valuation of USD350m).

* We maintain our Buy rating on STR as we believe the worst of the impact in the US business is over. Improvement in base business volumes, acquired product contribution from FY23E, strong recovery in other regulated markets, and better operating leverage will put STR back on the growth path in FY23E, with a much improved US product offering. We maintain our Buy rating with a TP of INR580 per share.

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