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Washed-out quarter; blurred outlook

Solara Active Pharma’s (Solara) Q3FY22 performance was way below our and consensus estimates, making the quarter a complete washout. Revenues, EBITDA and PAT fell 76.5%, 181.1% and 310.3% YoY, respectively, mainly due to: 1) writeback of one-time inventories in less regulated markets; 2) sharp decline in ibuprofen volumes and realisation; and 3) decline in covid product sales. Though Solara expects most of the lost sales to be recovered in Q4FY22, we expect its near-term performance to remain under pressure due to both demand and price volatility in key products, and cost inflation. We are positive on long-term outlook considering: 1) its presence only in the API and CRAMS space thereby removing any potential conflict with clients, 2) dominant market share in key products, and 3) strong regulatory track record. However, amid back-to-back disappointed results and uncertainties about near-term growth outlook, we downgrade the stock to REDUCE (from Buy) with a revised target price of Rs908/share.

Business review:

Solara’s revenues in Q3FY22 were sorely disappointing amid: 1) write-back of one-time of inventories worth Rs1.2bn-1.3bn in less regulated markets mainly due to shift from distributor model to direct sales; 2) sharp fall in ibuprofen sales (down to 1/3rd of normal volumes) due to demand decline and sharp price erosion; 3) delay in approvals; and 4) moderated demand for covid therapeutics. Besides, demand for some products declined in the regulated markets. Company expects most of these issues to be a quarterly blip and large part of the lost sales to be restored in Q4FY22 and normalised by H2FY23. Apart from negative operational leverage, margins too were hit due to higher raw material prices and logistic costs.

Key concall highlights: 1) Management expects Rs4mn-4.5mn of sales in Q4FY22; 2) guided for gross margins at 50-54%3) ibuprofen sales are likely to remain under pressure in the near term; 4) shareholder approval of Aurore merger is expected in Q1FY23; 5) 10-12 USFDA filings likely in FY22.

Outlook: We estimate Solara to report revenue / EBITDA / PAT CAGRs of 18.1% / 8.3% / 0% over FY21-FY24E. Margins are expected to decline 550bps over FY21- FY24E given higher base, pricing pressure in key products, and near-term cost inflation. RoE and RoCE would be constrained due to the merger with Aurore and decline in margins

Valuation and risks: We cut revenue and EBITDA estimates by ~13% and ~32-30% for FY23E and FY24E respectively due to demand and pricing pressures in key products and cost inflation. Amid back-to-back disappointing results and uncertainty about the near-term growth outlook, we downgrade the stock to REDUCE (from Buy) with a revised TP of Rs908/share based on 11x Sep’23E EBITDA. Key upside risks: faster than expected recovery in key products, and better than estimated improvement in margins

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