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Weak quarter; import alert remains an overhang

Shilpa Medicare (Shilpa) reported Q1FY22 results below our estimates due to decline in API sales and significant jump in operating costs, partly on account of USFDA related remedial measures. Revenue grew 6.5% YoY to Rs2.4bn (I-Sec: Rs2.5bn), EBITDA margin dropped 1,610bps YoY to 13.4% (I-Sec: 20.5%) and adj. PAT was down 96.1% to Rs16mn. Formulations revenue was up 50.8% YoY to Rs936mn with incremental sales from EU, however, APIs declined.

The company is implementing the remedial measures post import alert at Jadcherla formulations unit and has incurred additional expenses of Rs182mn on the same. We expect these expenses to continue in near future. We believe performance would remain weak in near-term until USFDA resolution, though contract manufacturing of Sputnik V vaccines will provide some upside. Maintain SELL.

* API sales drop, EU drove formulations growth: Revenue grew 6.5% YoY to Rs2.4bn during the quarter. This was primarily driven by higher sales in EU, with incremental sales in US from the three exempted products post import alert. We believe import alert would remain an overhang in near to mid-term for US formulations business as new approvals would get delayed. However, the company is trying to increase sales in EU to offset the impact. API business declined 11.8% YoY. The proportion of low margin CRAMS business will continue to reduce. The company has signed an another CDMO contract which would start contributing to revenue from Q2FY22. Shilpa has also received approval from DRDO for manufacturing of 2DG.

* Cost base increases significantly: EBITDA margin was down to 13.4% due to material rise in operating costs despite lower revenue. Gross margin also dropped due to change in revenue mix. Lower revenue has resulted in negative operating leverage which coupled with increased SG&A costs resulted in sharp drop in EBITDA margin. We expect the margin to revert to ~21-22% level once revenue base increases in coming quarters.

* Outlook: Considering the import alert at formulations facility and reducing CRAMS business, the revenue growth would be limited to 8.9% CAGR over FY21-FY23E. We assume import alert will be resolved over the next 24-30 months with growth improving thereafter (FY24E onwards). The company has signed manufacturing agreement with Dr. Reddy’s Lab for 100mn doses annually for three years which would provide near term upside. We value this opportunity at Rs46/share based on three years supplies.

* Valuations and risks: We maintain our estimates and remain cautious on outlook for profitable growth. We model revenue/EBITDA/PAT CAGR of 8.9/13.4/16.6% over FY21-23E. Maintain SELL rating on the stock with a target price of Rs387/share based on 20xFY23E earnings and Rs46/share for vaccine manufacturing. Key upside risks: early resolution of import alert, high value launches in formulations and early success in biosimilars.

Valuations

We expect Shilpa’s earnings to be 16.6% over FY21-FY23E with a revenue growth of 8.9% and stable EBITDA margins over the period on a low base. The announced import alert would remain a hurdle for the key growth segment of oncology formulations over the medium term as anecdotal evidence suggests it would take more than two years for the company to clear the regulatory issues.

We believe performance would remain weak in near-term until USFDA resolution, though contract manufacturing of Sputnik vaccines would provide some upside. Hence, we maintain SELL with a target price of Rs387/share based on 20xFY23E and Rs46/share for vaccine manufacturing (earlier: Rs336/share). The stock currently trades at 38.8xFY22E and 35.2xFY23E earnings and EV/EBITDA of 27.1xFY22E and 24.5xFY23E. The company has traded at an average PE of 33.0x one-year forward earnings over the past five years.

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