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Slower US/Africa biz drag down earnings

Robust growth outlook for other regulated market business

* Strides Pharma (STR)’s 3QFY21 performance came in below estimates due to the COVID-related impact on the US and Africa biz. Recovery in the Other Regulated (OTR) business was led by healthy volume traction. At the strategic level, STR would de-merge its Biotech business under Stelis Biopharma and intends to list this, thereby unlocking value for shareholders.

* We cut our earnings estimate by 19%/7%/5% for FY21/FY22/FY23, accounting for weak Flu season related demand in the US and slower offtake of medicines related to Acute therapies in the Africa business. We roll forward our TP to INR980 on an SOTP basis. We remain positive on a healthy product pipeline in regulated markets, new product additions in the Institutional segment, and an improving outlook for Stelis. Maintain Buy.

Change in product mix leads to decline in profitability

* STR’s 3QFY21 sales were up 13.6% to INR8.3b (our est.: INR8.7b).

* Emerging Market (EMs) sales were up 61% YoY to INR1.5b (18% of sales). OTR sales were up 37% YoY to INR3b (36% of sales). US sales declined 16% YoY to INR3.9b (46% of sales). Adjusted for Ranitidine sales in 3QFY20, US sales grew 10% YoY.

* The gross margin (GM) contracted 650bp YoY to 57.9% due to a change in the product mix.

* The EBITDA margin was down 550bp YoY to 19.2% (our estimate: 21%) due to lower GMs, partially offset by lower other expenses (-110bp as a % of sales).

* EBITDA was down 12% YoY to INR1.6b (our estimate: INR1.8b).

* PBT before one-off expenses was down 22% YoY to INR854m.

* STR reported net exceptional loss of INR131m on account of the write-down of inventory/other expenses due to the Ranitidine recall (INR476m). This was partially offset by gains from exchange on foreign currency loans, derivatives, and deferred consideration (INR360m).

* Adj. PAT was down ~40% to INR458m (our est.: INR785m).

* For 9MFY21, sales/EBITDA was up 13%/4%YoY to INR24b/INR35b, but adj. PAT declined 7.4% YoY to INR1.5b.

Highlights from management commentary

* Aditya Puri would be the Chairman of the Stelis board. STR’s promoter has committed USD50m for growth toward Stelis. Overall, USD100m would be needed to fund all of its programs over the next three years.

* Stelis is on track to achieve breakeven in FY22. STR would complete its already committed investments in Stelis before Mar’21.

* Stelis’ post-money valuation from the last transaction is USD155m.

* STR has decided not to invest in the Injectables platform under Steriscience.

* US sales guidance is now at ~USD220m for FY21.

* Effective tax rate would be 10–12%.

* Net debt reduced by INR643m QoQ to INR13b.

Valuation and view

* We cut our earnings estimate by 19%/7%/5% for FY21/FY22/FY23, factoring in subdued demand for some products in US Generics and tepid sales in the Acute portfolio of EM on account of COVID.

* Overall, we expect a 53% earnings CAGR over FY20–23, led by a 9% sales CAGR in the US, 22% sales CAGR in OTR, and 37% sales CAGR in EM – supported by 230bp margin expansion.

* We roll our price target to INR980 on a 12M forward SOTP basis (EV/EBITDA of 12x for the Regulated / Other Regulated segment, 8x for the Institutional segment). We remain positive on STR on the back of its continued focus on broadening product offerings in regulated markets and an improving outlook for the Biotech business under Stelis. Maintain Buy.

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