Cipla reported a muted PAT of INR809mn in Q4FY16 as it posted mere 6.7% EBITDA margin. There was deterioration in every expense line including gross margin (down 600bps YoY), employee cost (up 28% YoY) and R&D expense (jumped to 8% of sales). More worrying was management commentary which pointed to a diametric turn towards B2B strategy from its earlier stated transformation to DTM in European markets. Post Invagen consolidation, which entails 25% EBITDA margin, Cipla estimates ~16-18% EBITDA margin on mid teens revenue growth over the next 2-3 years. We see at least 20% cut in consensus estimates for FY17 and FY18. Maintain ‘HOLD’ with reduced TP of INR480 (20x FY18E EPS; INR500 earlier).
No improvement in core margin even post 3 years
While Cipla met its FY16 revenue guidance, reported EBITDA margin fell to 6.7% with every expense piece disappointing. While gross margin has worsened to lowest in past 2 years, employee expenses shot up 28% YoY. India sales (39% of sales) grew 16% YoY; South Africa (~12% of sales) declined 15% YoY in constant currency. According to the company, while Invagen was consolidated for ~40 days, its business contribution during the quarter was lower at ~20 days due to channel inventory. Cipla believes that its FY16 base margin, excluding Nexium’s limited competition benefit as well as one-off expenses during FY16, will be ~16-18%. Factors like incremental R&D spending and regulatory changes like the Bonus Act are hardly non-core, in our view.
Design for growth and profitability far from shape
Cipla seems to have taken a U-turn with the decision to return to DTM strategy from B2B and exit from certain EU markets with commensurate headcount cut. While Invagen may help the company gain a more solid base of ~USD400mn in US, we believe growth and profitability are unlikely without niche launches, which unfortunately are not yet in sight. Except India, none of the major businesses are stable growth engines; in fact, many of these are diluting value.
Outlook and valuations: Glum outlook; maintain ‘HOLD’
Long-term outlook on Cipla remains unclear versus peers. UK MDI approval does not seem exciting enough given that launched products do not seem to be doing well commercially. The company also has outstanding Form 483 for its Indore facility, which is a risk. Hence, we prune FY17/18E EPS 4%/3%. We maintain ‘HOLD/SP’.
