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Weak Q1; operating deleverage hits harder

Strides Pharma Science (Strides) reported disappointing performance in Q1FY22 with lower revenue across businesses impacting margins. Revenue declined 12.0% YoY to Rs6.9bn (I-Sec: Rs9.1bn) due to fall in US and other regulated markets. This was primarily on account of covid related disruptions affecting demand and supplies and double digit price erosion.

This also led to operating deleverage as expenses were at normal levels which along with drop in gross margin resulted in negative EBITDA. The company announced the acquisition of manufacturing facility of Endo Pharmaceuticals New York for US$24mn along with ~20 commercialised products across nasal sprays, controlled substances, hormones, etc. We believe performance would improve from H2FY22 but impact of price erosion would remain. Downgrade to HOLD.

* Revenue decline led by regulated markets: US revenues dropped 29.3% QoQ to US$41mn due to impact of double-digit price erosion, exit from few contracts where price erosion was even higher and covid-19 related supply disruptions. Price erosion has accelerated and is likely to continue. We expect quarterly revenue run-rate to gradually increase with improving base business while integration of Endo will add sales from Q3FY22.

Other regulated markets also witnessed 14.4% YoY drop due to lower prescriptions in EU/UK on account of 2nd wave of covid and also delay in supplies. Africa reported a growth of 1.2% YoY. Institutional business grew 19.8% YoY (-33% QoQ) led by commercialisation of product combination TLD. Regulated markets (US and EU) are likely to witness rebound in H2FY22.

* Negative margin due to price erosion and operating deleverage: EBITDA margin came at (8.0)% vs expectation of 19.0% due to large miss in revenue and ~10% drop in gross margin. Gross margin drop was due to significant decline in regulated market sales. We expect EBITDA margin to turn positive in Q2FY22 and normalise to ~18-20% by Q4FY22.

* Outlook: We expect FY22 to be muted with revenue and earnings declining YoY due to very weak Q1FY22 with FY23E witnessing material improvement. Overall, we expect revenue/EBITDA/PAT CAGR of 6.7/8.3/21.3% over FY21-23E. We have incorporated acquisition of plant from Endo in our estimates which would help in ramping-up US sales from H2FY22. Management guided for normal level sales and margins to be back in H2FY22E.

* Valuations and risks: We lower revenue/EBITDA estimates by 7-12/9-58% to factor in reduced base of US sales, increased operating expenses and negative EBITDA reported in Q1FY22. We downgrade it to HOLD from Add with a revised target of Rs720/share based on 17xFY23E EPS and Rs117/share for Stelis investment (earlier: Rs906/share). Key upside risks: faster ramp-up in US sales and reversal in price erosion. Key downside risks: Regulatory hurdles, delay in new launches and pricing pressures in the US.

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