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Growth comes at the cost of margins

Shilpa Medicare (Shilpa) reported Q2FY22 results above our estimates on revenue front, though net profit was lower due to restricted margins and higher tax out go. Revenue grew 5.9% YoY to Rs3.0bn (I-Sec: Rs2.4bn), however, amid negative operational leverage. EBITDA margin dropped 660bps YoY to 18.0% (I-Sec: 17.0%) and adj. PAT was down 68.4% YoY to Rs143mn. API revenues grew 9.4% YoY to Rs1.9bn and formulations revenue grew 3.5% YoY to Rs911mn with incremental sales from EU. The company is implementing the remedial measures post import alert at Jadcherla formulations unit and has incurred additional expenses of Rs46.5mn on the same. We believe performance would remain weak in near-term until USFDA resolution, though contract manufacturing for both Sputnik V and ZyCoV-D vaccines will provide some upside. Maintain SELL.

* API drives growth: Revenue grew 5.9% YoY to Rs3.0bn driven by 9.4% growth in API business. Despite Import alert, formulations revenues grew 3.5% owing to higher sales in EU and continued sales from the three exempted products in US. 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 grew 9.4% YoY. The proportion of low margin CRAMS business will continue to reduce. In addition to manufacturing contract for Sputnik V vaccine, the company has also entered in an agreement with Cadila for production-supply of the ZyCov-D vaccine drug substance.

* Cost base increases significantly: EBITDA margin was down to 18.0% due to material rise in operating costs including incremental expenses for import alert remediation. We believe higher revenue is being generated at lower margins. We expect the margin to revert to ~20-21% level once revenue base increases in coming quarters, particularly in formulations business.

* Outlook: Considering the import alert 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 18-24 months with growth improving thereafter (FY24E onwards). Sputnik V manufacturing agreement with Dr. Reddy’s Lab for 100mn doses annually for three years would provide near term upside. We value this opportunity at Rs43/share. Apart from this, recent ZyCov-D manufacturing agreement with cadila is also likely to provide additional upside.

* Valuations and risks: We decrease earnings estimates by 2-6% for FY22E-FY23E due to dilution of shares amid recent fund raise and remain cautious on outlook for profitable growth. We model revenue/EBITDA/PAT CAGR of 12.8/15.2/19.0% over FY21-23E. Maintain SELL rating on the stock with a target price of Rs410/share (earlier Rs387) based on 22xFY23E earnings and Rs43/share for vaccine manufacturing. Key upside risks: early resolution of import alert, high value launches in formulations and early success in biosimilars.

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