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Sharp recovery in margin

Valuation more than adequately factors in an upside in earnings

* LPC delivered a beat on profitability for 2QFY23, led by certain niche launches, a favorable currency movement, and reduced R&D spends. After three quarters of a downtrend, the company has exhibited a sharp up move in EBITDA margin.

* We have tweaked our FY23/FY24 EPS estimate (down 3%/up 5.5%) to factor in: a) a meaningful shift in g-Spiriva sales in FY24, b) ongoing cost optimization measures, c) and sustained growth momentum in RoW markets. We continue to value LPC at 22x 12M forward earnings to arrive at TP of INR680.

* The earnings revival is currently hinged on a few limited competition products and is not broad based across segments. The current valuation adequately factors in an upside in earnings, with LPC trading at 65x FY23E EPS of INR11 and 31x FY24E EPS of INR23. We maintain our Neutral rating on the stock.

Overall operational cost remains in an uptrend in 2QFY23

* Revenue was stable YoY at INR41b (est. INR40b) in 2QFY23.

* US sales declined by 7% YoY to INR13b (down 14% in CC terms to USD159m; 33% of sales). US sales rose 31% sequentially to USD159m in 2QFY23. EMEA sales grew 10% YoY to INR4b (9% of sales). Domestic Formulation (DF) sales grew 3% YoY to INR16b (39% of sales). Sales from its growth market grew 28% YoY to INR4.5b (11% of sales). API sales declined by 7% YoY to INR2.5b (6% of sales).

* Gross margin (GM) contracted by 160bp YoY to 58.7%.

* EBITDA margin contracted at a higher rate of 410bp YoY to 10.5% (est. 7.2%), largely due to a reduced operating leverage (other expense grew 240bp YoY as a percentage of sales).

* As a result, EBITDA declined by 27% YoY to INR4.3b (est. INR3b).

* Adjusted for forex gain of INR188m, PAT stood at INR1.2b.

Highlights from the management commentary

* LPC maintained its margin exit run-rate guidance of 16-18% (including Spiriva) by 4QFY23 and expects to further improve the same from FY24.

* Some of the niche products expected to be launched are g-Spiriva (subject to approval), g-Darunavir, g-Diazepam gel, and g-Nascobal.

* LPC has addressed the queries raised by the USFDA in its recent CRL issued on its g-Spriva application. It has filed for a priority review as well.

* While the acquisition of Brovana and Xopenex are EPS accretive, the management intends to improve profitability over the next couple of years by shifting to manufacturing in-house.

* The flu season in the US is expected to remain strong in CY22, driving better business prospects for g-Tamiflu and other Anti-Infective products of LPC. Even the scope of the API business is expected to improve on account of the same.

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