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Better show in India/Brazil offset by weak US sales

Wait continues for USFDA inspection

* Torrent Pharma’s (TRP) operational performance in 2QFY22 was slightly below our expectations. The growth momentum in the Domestic Formulation (DF) and Brazil businesses was offset by a muted show in the US business and a higher tax rate. A recovery in the US business remains contingent upon regulatory compliance at its key sites.

* We reduce our FY22E/FY23E EPS estimates by ~3.5% each to factor in the delay in resolving USFDA compliance issues at its key sites. We value TRP at 25x 12-month forward earnings to arrive at our TP of INR2,900.

* TRP remains on track to outperform in the branded generics market of India/LATAM. TRP’s plan to make inroads into the Trade Generics segment will create further growth opportunities in the DF segment. However, the company’s overall return ratios could remain suppressed until its US generic business continues to be impacted by regulatory hurdles. Also, the stock’s current valuation adequately factors in TRP’s near-term growth. Hence, we maintain our Neutral rating.

Product mix/lower operating leverage impacts margins

* TRP’s revenue for 2QFY22 grew 6% YoY to INR21.4b (our est: INR21.9b). Brazil revenue was up 21% YoY to INR1.6b (7% of sales; 20% in CC terms). India sales grew 13% YoY to INR10.9b (51% of sales), ROW sales were up 9.5% YoY to INR2.2b (10% of sales), and Contract manufacturing sales remained flat YoY at INR1.4b (7% of sales). Germany sales were down 4% YoY (EUR29m; 12% of sales) and US sales fell 13% YoY (USD35m; 13% of sales).

* Gross margin contracted by 30bp YoY to 72.2% due to product mix change.

* Consequently, EBITDA margin also contracted by 60bp YoY to 30.9% (our estimate: 31.5%) due to higher employee costs (+20bp YoY as % of sales).

* EBITDA was up 3.8% YoY to IN6.6b (our est. INR6.9b).

* PAT increased at slower rate of 2% YoY to INR3.2b (our est: INR3.5b), due to higher tax expenses on account of MAT credit utilisation and INR160m provision for earlier periods.

* For 1HFY22, Revenue/EBITDA/PAT grew by 5%/10%/2% to INR42.6b/INR13.3b/INR6.5b.

Highlights of management commentary

* TRP witnessed price/volume /new product growth of 8%/7%/4% YoY in the DF segment. Patient footfalls have now normalised, and TRP expects the double-digit growth to continue in the coming quarters

* Gross margin contracted due to 1) US price erosion impact of 0.3%, 2) inventory provision impact of 0.5% and 3) India product mix impact of 0.2%. TRP’s inventory provision should reduce and the India business mix should improve, thereby driving gross margin expansion going forward.

* Given the reduced travelling restrictions, TRP expects USFDA inspection to take place at its sites over the medium-term.

* In Germany, four large wholesalers have merged into two in order to streamline inventory, resulting in a temporary sales decline.

Valuation and view

* We reduce our FY22E/FY23E EPS estimate by ~3.5% each, largely to factor in a delay in ANDA approvals due to regulatory issues at the Indrad/Dahej facilities.

* We continue to value TRP at 25x 12-months forward earnings and roll our TP to INR2,900.

* We expect TRP to record 14% earnings CAGR, led by 13%/9%/7%/3% CAGR in DF/Brazil/Germany/US sales, and 80bp EBITDA margin expansion due to lower opex in DF after the sales force rationalisation.

* We maintain our Neutral rating as the stock’s current valuation adequately factors in the improving outlook for TRP in its key markets.

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