Margin expansion crucial for Cipla's stock

Continued efforts on growth in global markets is positive and will accrue benefits over time

Cipla continues to strengthen its global footprint. Wednesday's acquisition of Anmarate (Pty) Ltd in South Africa and Cipla USA entering into a collaboration with MEDRx a few days ago are steps in this direction. Such moves will help Cipla report healthy top-line growth, but analysts say improvement in profitability is equally crucial.

The acquisition of Anmarate will add to Cipla's strengths in South Africa, which contributes 13 per cent to its revenues. The US collaboration is to take further the development and commercialisation of MRX-4TZT.

To bolster the US generic business, Cipla has completed two acquisitions last year. It is on course for achieving year target of 20-25 ANDAs (abbreviated new drug applications), having filed 21 ANDAs during first nine months of FY17, including nine Para-IV (some being first-to-file or exclusivity opportunity). The US market accounts for a tenth of revenues, and should see its share rise further.

With efforts in the US, the Street remains confident on Cipla's respiratory portfolio. Filings are being made in the US, and the company has some approvals in Europe. The latter contributes five per cent to revenue and with UK regulator giving nod for seretide inhaler launch, Cipla can reap up to $40 million in annual revenues. The benefits may take a while to accrue. Manoj Garg and Ashish Kumar at Bank of America-Merrill Lynch say there are approval risks for key respiratory products as clinical trials have got delayed. Further, they point to delay in launch of several complex generics (earlier expected from Q4FY17) and feel though 12-15 launches per year may drive 32 per cent compound annual growth in US sales, meaningful profit contribution is likely only from FY20.

Margins are crucial because profitability, along with stable growth and no US regulatory issues, has helped stock do better than peers in 6-12 months. Ebitda margins have grown from 16.7 per cent in June 2016 quarter to 18.6 per cent in December 2016 quarter. Though expansion was also aided by lower research and development (R&D) costs, sustainability is important.

BofA-ML says easier levers, business rationalisation and cost optimisation, have already been used over last few quarters, but further expansion may accrue through more difficult levers such as operating leverage and product mix which can be offset by rising R&D spends (from seven per cent of sales to nine per cent) due to respiratory clinical trials. Any disappointment on margin front could hurt the stock’s valuation, which is higher than peers’.