The US FDA has issued a warning letter (WL) to Cipla’s Goa plant with regard to GMP deviations noted during a facility inspection conducted in September 2019. The FDA had earlier issued an OAI (official action initiated) status for the Goa plant in January 2020, which is now escalated to WL (OAI means the FDA found objectionable GMP deviations and recommended regulatory action for that plant). Goa is Cipla’s key plant for the US market that attributed 25-30% of its US sales in FY19 and accounts for c33% of pending 87 ANDAs.
WL adds to Cipla’s challenge to get new approvals: Even before the Goa WL, Cipla was seeing fewer new approvals of late (10 approvals in FY20 ytd vs 27 in FY19) and with the WL withholding approvals, challenges increase. Its base US sales have stabilised at $130-135m per quarter recently and we do not expect much change in US sales in the near-to-medium term on limited visibility around growth drivers. Apart from gProventil and gNasonex, most other known pipeline products for FY20-22 are competitive in nature. For differentiated products, execution so far has been subpar on: (a) delay in FDA approval and (b) delay in launch. In key older products (e.g. gVoltaren gel, gSenispar tablet, gAloxi injection etc), it continues to face rising competition and adverse market changes (e.g. Rx to OTC switch for gVoltaren).
Ebitda margin expansion depends on US scale-up: Cipla improved Ebitda margins by c250bp over FY17-19 on the back of cost-control initiatives, capital reallocation (deprioritised biosimilars) and transition of US business to DTM (direct-to-market) sales from low-yielding B2B sales. After reaping low-hanging fruit, a further expansion in Ebitda margins will depend on new launches led by a scale-up of US sales. Cipla has faced multiple challenges across key business segments and it announced a four-pronged restructuring plan for long-term sustainable growth in Q3FY20.
Downgrade to Hold: While we earlier liked Cipla for its stable outlook in focus markets, India and South Africa, we now believe it will be a tall task for Cipla to turn around US sales that are required to improve profitability. Thus, we downgrade Cipla to Hold as we look for improved execution of US sales. We adjust sales, costs and other line items per current outlook which leads to 2-6% cuts in our FY21-22e EPS estimates. We lower our valuation multiple to 18x (from 20x) on uncertainties around US sales scale-up and we update our CoE assumptions per house view. As a result, our fair value TP goes to Rs 450 (from Rs 525).