Gland Pharma stock seen underperforming after acquiring France's Cenexi

Lack of near-term visibility on profitability for the core business is another concern about Indian firm

Investors were not too enthused on Wednesday after Gland Pharma (Gland) said it is acquiring Cenexi, a French drug maker, at an enterprise value of 230 million euros (about Rs 2,000 crore).

Gland’s stock was down 5.4 per cent in trade on worries that the company’s first overseas acquisition dilutes margin and will weigh on earnings.

The operating profit margins of Cenexi, which makes ampoules, pre-filled syringes and vials and has expertise in sterile dosage forms, have improved over the last two years, but are still short of Gland’s profitability. Cenexi’s margins in the first half of calendar year 2022 (H1CY22) are at 19 per cent, compared to Gland’s standalone margins at 31.5 per cent for the same period.

Gland plans to scale up margins by improving efficiency, shift some products from Cenexi sites to itself, accelerate technology transfers and enhance capabilities of plants in France and Belgium.

Kotak Institutional Equities’ Alankar Garude and Samitinjoy Basak believe that despite such strategies, Cenexi’s operating profit margin profile is unlikely to scale up to Gland’s level soon due to the high cost of European manufacturing. The brokerage has a ‘reduce’ rating as it believes that the deal has limited benefits for Gland.

Cenexi’s revenues have remained flat over the last three years, as margins expanded from 9.7 per cent in CY19 to 12.5 per cent in CY21. Margins improved to 19 per cent in H1CY22, but the company indicated that these are not regular levels.

The valuation of the acquisition, which will account for a fourth of Gland’s consolidated turnover and 15 per cent of its operating profit in FY24, were reasonable. The company purchased Cenexi at just over 1.2 times its CY21 sales and 10 times its operating profit in line with valuations of generic peers. In addition to cross-selling opportunities the acquisition is expected to expand Gland’s presence in European markets increasing its share of the geography from 5 per cent now to 13 per cent.

Cenexi’s capabilities in hormones, suspensions and controlled substances would help Gland to expand its offerings to its customers, said Motilal Oswal Research. The brokerage has a ‘buy’ rating on Gland’s stock and has increased the earnings estimates to factor in the additional business from the acquisition. The company has contracts with three companies for biologic products, expanding its presence in this space.

Given the lack of clarity on pace of revenue and earnings growth in the near term and lower margin profile in the long term most brokerages have reduced the earnings multiple for Gland. The stock is trading at 20 times its FY24 earnings estimates and is available below the target prices of most brokerages. Investors should, however, await a clear trajectory on revenue growth and margin profile before considering the stock.