We downgrade Cipla from Neutral to Underperform (U/P) as we believe that the current 70% valuation premium to peers is not justified especially due to several downside risks to market earnings growth expectations. Our non-consensus U/P rating is largely driven by likely delays in key product launches in the US which we believe has not been factored in by street, despite management guidance over past 1-2 months. Moreover we believe the Ebitda margin expansion over next two years could also be lower than market expectations.
Despite strong growth, US likely to disappoint market estimates
We believe that street’s growth estimates for Cipla’s US business are not fully factoring in (i) approval risks of key respiratory products: clinical trials have got delayed and recently Mylan’s ANDA for gAdvair also got delayed, (ii) delay in launch of several complex generics (earlier expected from Q4FY17). While 12-15 launches/year may drive 32% CAGR in US, meaningful profit contribution now likely only from FY20e.
Margins: post 600 bps expansion, further growth difficult
While market is building in gains of 300 bps of Ebitda margin expansion over FY17-19e, we believe that relatively easier levers have already been utilised. Further expansion may accrue through more difficult levers. But this is likely to be offset by rising R&D spends due to respiratory clinical trials.
Expensive among peers
At 28x 1 year forward P/E, Cipla’s 70% premium to the sector is not justified as (i) 45% of incremental growth assumptions are led by US. (ii) SOTP-based valuation of segments also leads to a 21x P/E target. Though 60% of Cipla’s profits accrue from branded generic (Gx) markets which deserve premium valuations, we prefer Torrent Pharma due to (i) comparatively attractive valuations, (ii) lower dependence on US for incremental growth .
Downside risks to market hopes
We expect consensus downgrades over the next few quarters. Despite management guidance of likely delay in several key launches in US, we believe that the street has not factored in adequately the consequent impact on FY18-19e EPS expectations. Moreover in contrast to our earlier expectations of start of clinical trials for key respiratory products by Q4FY17e, Cipla has not yet initiated trials for any respiratory product apart from gProventil.