LPC’s Q3Fy18 revenues were in line with our estimates, with the US showing stable signs. However, gross margins contracted 240 bps further , leading to a ~5% Ebitda miss (adjusting for forex loss) and 18% PAT miss, despite tight cost control. While LPC is making solid progress with its pipeline given a weak near-term pipeline, we expect a meaningful recovery only from H2FY19. Reiterate Reduce with a revised target price of Rs 840/share (vs Rs 870 earlier).
Gross margins disappoint
LPC’s US sales show signs of stabilisation, and at $213 mn, exceeded our estimates by $8 mn, helped by a strong flu season for its core anti-infectives portfolio, continued pick-up in Gavis post the initial haircuts (+31% y-o-y) as well as stable Glumetza/Fortamet sales, though Fortamet and Methergine remain vulnerable to imminent competition. Domestic formulations segment missed estimates with 8% y-o-y growth (11% adjusted for GST), while other divisions were mixed as EU and RoW missed estimates, while South Africa and Japan outperformed. Gross margins further contracted by 240 bps, driven by inferior US product mix, and inferior geographic mix (lower domestic sales). Management guided to tight cost control and focus on efficiencies across, which was reflected in flat SG&A and R&D costs, after adjusting for Rs 820 mn forex loss. While reported Ebitda missed our estimate by 15%, adjusting for the forex loss, the miss was lower at ~5% and largely driven by the gross margin miss. Further one-time tax adjustment of Rs 360 mn on account of US tax code changes resulted in PAT miss being higher at 43% and 18%, even when adjusted for forex loss and tax charges.
FY19 to be a blank year though solid pipeline building for FY20/21
LPC management remains optimistic on the US market, and suggested that pricing is finally bottoming out with several product discontinuations in the past six months by leading players, though a sharp recovery seems unlikely. LPC’s near-term launch pipeline is weak, with Ranexa exclusivity being the only major generic launch expected in FY2019, apart from Solosec in the branded space. We expect levothyroxine to be a near-term wildcard (March 2018 TAD) . Over the past year, LPC has stepped up focus on R&D, particularly in the inhalation space, where it filed ProAir. It has also initiated a pivotal clinical endpoint trial for Spiriva Handi-haler ($1.9 bn US sales).
Valuations discounting the FY20 recovery
We cut our FY2018 EPS by 12% to take into account Q3FY18 results (6% adjusted for forex loss and tax adjustments). Our FY2019-20 estimates remain largely unchanged. Post the sharp correction, LPC is now trading at 22X FY2019e and 17.2X FY2020e EPS, though EV/Ebitda multiples are now more reasonable at ~11X FY2019e and ~9X FY2020e EV/Ebitda. Reduce with revised target price of `840/share, valuing LPC at 18X FY2020e EPS (21X ex-levothyroxine).