IPCA Labs: Strong prospects, attractively valued

Resolution of FDA issues a key positive for the stock and should be sorted in FY16, so investors should be patient

With the shadow over it of the US Food and Drug Administration (FDA), the IPCA Laboratories stock has been an underperformer, losing about 10 per cent in six months. In comparison, the BSE Healthcare peer index has been among the highest sectoral gainers, with a return of 43 per cent.

The correction in the stock has been for a reason and the FDA hurdle would remain for a couple of quarters. Yet, for investors with a long-term view the stock offers good potential. FY15 sales growth will be fllattish or grow at single digits, given the lack of sales to the US. However, analysts expect sales to revive in FY16, with an estimated growth of 20 per cent. The stock has gained 14 per cent over the month from its 15-month intra-day low, as investors look out for value buys. It is still trading at an attractive valuation of 15 times its FY16 estimate and should offer a decent return as exports take off.

While exports have been a disappointment, domestic growth continues to be strong. Domestic formulation sales are a little over a third of overall revenue and for the quarter ending September, these were up 19 per cent over a year, to Rs 328 crore. The strong performance has led to an upward revision in the domestic growth forecast by the company, to 17-18 per cent for the current financial year from 15-16 per cent earlier.

The domestic business has been a key growth driver for IPCA as the company changed focus from the low margin anti-malarial segment to focus on higher margin chronic/lifestyle diseases. More than half its domestic formulation sales come from the latter and related therapy areas such as diabetes, the central nervous system, cardiovascular system, pain management and dermatology products. Angel Broking's Sarabjit Kour Nangra believes domestic formulations are its cash cow and should grow at an annual rate of 16.5 per cent over FY14-16.

The key trigger, however, would be sorting the US FDA issues, which began this August. After the latter's Form 483 observations (issued when observed conditions or practices during an inspection indicate a product's manufacturing process could be in violation of FDA’s requirements) for the Ratlam unit, the company had voluntary stopped supply of the drugs to the US market. Ratlam is the company's only FDA-approved plant and stoppage of supply to the US has impacted formulation and API (Active Pharmaceutical Ingredient) sales to that region. For FY14, these were Rs 300 crore or 10 per cent of sales.

  The stoppage has impacted its financial performance, with exports for the quarter down 23 per cent year-on-year to Rs 402 crore. Delay in anti-malarial shipments also impacted exports and the share of exports to revenues are down to 52 per cent in the quarter from 60 per cent in FY14. While the company has also received Form 483 observations for its Indore plant, it has indicated these are not as serious as the observations for Ratlam.

The FDA review process for Ratlam are expected to take another quarter. Analysts expect these issues to be sorted in FY16 and estimate exports to grow by 10 per cent in FY15 and 25 per cent in FY16.

While this mid-sized company is backward-integrated, with healthy return ratios, a strong balance sheet and good prospects, investors would have to be patient. For, any adverse outcome on its plant would impact exports and extend the overhang beyond the first half of calendar year 2016.