 "Cipla – short term pain despite strong base")
Cipla surprised the market with a sharp drop of 69% in its quarterly net profit, much below the expectations of analysts. The stock touched a new 52-week low, falling over 7% but recovered some ground later in the day. The stock closed 4.97% lower at Rs 470.
Commenting on the results, Edelweiss said there was deterioration in every expense line but more worrying was the management’s commentary which pointed at a sudden change in its business model.
Post results conference call by the company’s management failed to enthuse analysts who have reduced the pharma company’s growth estimate and target price.
Cipla’s trouble started from the top – its revenue. The company missed analysts' expectation by 8-12 per cent. Though the company posted a 15.8 per cent domestic sales growth, it was helped by a deferment of sales of Rs 150 crore from the third quarter. Export growth of only 2.8 per cent was on account of a delay in integration of Invagen, the company it recently acquired and is now Cipla’s subsidiary.
More shocking was the performance at the operating level. The company posted a paltry 6.7 per cent operating margin, less than one-third it normally posts. Cipla’s management pointed out that the reduction in margin was on account of a cleaning up exercise which resulted in multiple write-offs. Inventory reduction impacted margins by 2.1 per cent, non-moving inventory were written-off which had a 1.3 per cent impact.
Rationalisation of geographies made a dent of 2.1 per cent while higher R&D spends punched a 2.2 per cent hole and one-off regulatory costs purged away 1.3 per cent of the profits.
But even after adjusting for various write-offs, Cipla’s operating performance was below analysts’ expectation by 450-500 basis points. Religare in its results review says that during the third quarter results, the company guided for a base business margin of 17-18 per cent, but the fourth quarter, numbers are clearly lower. Cipla has missed analysts’ expectations by 30 per cent at the EBITDA level for the year.
However, there were some positives in the numbers too. Cipla’s management in its concall said that US sales have more than doubled, growing at 117 per cent to $321 million in FY16, thanks largely to exclusivity of gNexium and gPulmicort, which has already got normalised in the fourth quarter. The company intends to complete integration of the two recent acquisitions, InvaGen and Exelan, which will drive US sales growth. Further, it is launching 8-10 ANDA along with 5-6 from InvaGen’s portfolio in FY17.
However, there is more pain for Cipla shareholders in the near future. The company’s Indore plant has been issued form 483 warning which analysts feel will delay its new drug launch. Further, the restructuring which has had an impact in the fourth quarter will continue for some more time. Cipla is in the process of business restructuring from a direct?to?market model to business-to-business (B2B) model. It is rationalising its products in Europe.
Philip Capital feels that these initiatives could hurt the growth in the near term. To strengthen its drug pipeline, it has enhanced R&D spend in Q4 to 8.2 per cent of sales and guides for similar spend ahead (in FY16 it was around 6.5 per cent). Sales would be impacted by 2-3 per cent on account of Indian government measures of banning drugs and reducing prices of essential medicines.
But can an investor expect better days ahead? The company has a healthy pipeline of 78 ANDAs for US with around 20 to be added in FY17 in respiratory and oncology divisions. The company’s management has guided for a 15-20 per cent growth at the operating profit level over the next three years.
Edelweiss in its financial estimates has projected flat earnings per share (EPS) of Rs 19.3 for FY17 as compared to 18.8 in FY16. But in FY18, the broking firm feels Cipla can post an EPS of Rs 24. Though there is short to medium term pain in Cipla, its strong base, recent acquisition and higher R&D spends, suggests better returns for a patient investor. Which probably explains the muted reactions in the market.
