Glenmark Pharma rating – Buy: Sustained rise in cash flows key to rerating

By: |
August 30, 2021 3:30 AM

Estimates tweaked to factor in listing of API subsidiary; ‘Buy’ maintained with an unchanged TP of Rs 757

We think with the tight leash on costs, particularly on R&D spending, Ebitda margin has scope to improve over time. We think with the tight leash on costs, particularly on R&D spending, Ebitda margin has scope to improve over time.

We revise our earnings model to factor in the listing of the API subsidiary Glenmark Life Sciences (GLS IN, Not rated) and Q1FY22 earnings. Our earnings forecast revisions are marginal, with FY22F/23F EPS revised 0%/-0.8%. In FY22F, the contribution from Fabiflu was lower than we had expected, negated by a one-time gain from the stake sale in GLS. In FY22F our estimates are adversely impacted by higher raw material cost. We also introduce FY24F estimates.

We factor in mid-to-high single-digit growth in revenues over FY22-24F, with Ebitda margin in the range of ~19-20%. We think with the tight leash on costs, particularly on R&D spending, Ebitda margin has scope to improve over time.

The India business faces headwinds of a higher base (Fabiflu) and increased competition in SGLT2 and DPP4 inhibitors. In the US, we conservatively factor in modest annual addition of $15-30 mn in sales and have not factored in contribution from Ryaltris. In the near term, we expect revival in RoW markets and Europe as COVID-19 pandemic restriction eases.

Investors have been concerned about weak free cash flow generation and sticky net debt, reflected in a lower valuation multiple. We are more concerned about sustainable free cash generation. Net debt, though high compared to peers, is manageable, in our view, as net debt to Ebitda in FY21 was at 0.5. GNP brought down net debt through divestments, which have not led to value unlocking, in our view. Expansion in valuation multiples or value unlocking is now dependent on two vital factors: (i) a sustainable improvement in free cash flows and (ii) fund-raising in loss-making segments, particularly in the innovation subsidiary, Ichnos. Management indicated its intention to improve cash flow by controlling capex and R&D expenditure. On Ichnos, our expectations around fund-raising and value unlocking remain low.

Tight leash on capex and R&D could help deliver sustained progress in cash flows We factor in net debt reduction of Rs 16.4 bn in FY22F, in line with management guidance. The company raised Rs 15 bn from Glenmark Life Sciences IPO, of which ~Rs 12 bn+ is retained post taxes and offer expenses. The company intends to control capex and R&D spend to improve cash flow generation. If executed, the free cash flow should rise significantly.

We arrive at TP of Rs 757 based on SOTP (unchanged). We value the base business ex the impact of innovation R&D spending at 15x Mar’22 adjusted EPS of Rs 68.4 (Rs 1,026). We assess the negative impact of innovation R&D spending at Rs 269/sh. We ascribe 10x to innovation R&D spending (unchanged).

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