Lupin: Under pressure - Hold

The stock’s valuation is now attractive, but uncertainty in the US market is a concern

The Indian pharmaceutical industry has been going through a tough phase over the last couple of years. While the Nifty 50 index has gained over 15 per cent in absolute terms over the last two years, the Nifty pharma index has fallen nearly 33 per cent.

Major pain points such as regulatory issues in the US market and pressure on drug pricing in the key markets have continued to weigh on the revenue and earnings of pharma companies. That, in turn, has soured investor sentiment towards pharma stocks and led to significant correction in their prices.

A few fundamentally-sound pharma stocks such as Lupin have corrected more than 40 per cent over the last one year as a result of these ongoing issues.

The significant fall in the prices has made the stock attractive from a valuation perspective. At the current price, the stock trades at 21 times its trailing 12-month earnings — at around 30 per cent discount to its three-year historical price-to-earnings average.

While the valuation is attractive, uncertainty continues in the US market. Until that is sorted out, it is best to avoid fresh exposure. Investors can, however, continue to hold the stock given its strong product pipeline, shift in focus to high-margin complex generics and good prospects in the domestic business.

US business under pressure

Lupin’s US business, which accounts for about half the company’s revenue, has been contracting for the last few quarters due to price erosion in its base business caused by channel consolidation and increased competition. The company has reported a sharp sequential decline of 13 and 16 per cent in the March and June quarters of 2017, mainly due to expiration of exclusivity on Glumetza — one of the key generics in its US metformin portfolio (prescribed for diabetes). Launched during February 2016 in the US, the generic product enjoyed exclusivity for one year and helped to increase US revenues by 38 per cent in 2016-17. This helped offset the loss caused by price erosion in the US during that period. However, the revenue from Glumetza witnessed a fall over the last two quarters due to increased competition.

Lupin’s US business is likely to remain under pressure in the near term due to tough pricing environment in most products in the US generics market, lack of meaningful high-value launches and slow ramp-up of GAVIS, its US subsidiary. Apart from Minastrin 24Fe that enjoys exclusivity currently, there is no other First to File (FTF) opportunity available for the company.

However, the company is confident of recovery in US growth in FY-19 on the back of new launches, including FTF opportunities. With 45 FTF products, including 23 exclusive FTF opportunities, Lupin has one of the strongest ANDA pipelines among peers.

The company plans to launch 30-35 products in the next 12-18 months in the US, of which three to four will be FTF launches, including Ranexa (treats chest pain), Moviprep (stimulates bowel movements) and Moxeza (treats bacterial conjunctivitis). Further ramping up of its GAVIS portfolio especially Methergene — the drug used in post-delivery treatment and potential launch of Levothyroxine (treats hypothyroidism), Tamiflu (treats influenza) and Fosrenol (treats kidney disease) should provide leg-up to the company’s revenue from FY19 onwards.

The company is focusing on building a pipeline in niche products with limited competition and high barriers, such as inhalation, biosimilars and complex injectables. Further, the shift in the strategy towards acquiring specialty and niche technological platforms for the regulated markets from its earlier strategy of geographical expansion should help the company prop up its business significantly.

Channel consolidation, a risk

The management has guided single-digit price erosion in the US business for the rest of FY18. Channel consolidation — with major US purchasing groups entering into sourcing tie-ups — has led to price erosion in the past. While the downside risk from this has been waning, any new sourcing tie-ups could lead to another round of price erosion.

Lupin is well-placed on the regulatory front compared to its peers. Recent months witnessed a host of inspections across its various facilities. The inspections at the Pithampur and Aurangabad facilities concluded without any observations and the company hopes for regulatory clearance in the next couple of months. The clearance for Goa and Indore facilities from the USFDA is also expected in a month. Earlier clearance of facilities will accelerate product approvals and launches of the company.

Domestic business

The formulations business in India that accounts for 25 per cent of Lupin’s global sales has registered flat growth year-on-year during the June quarter. Despite the challenges in the recent periods, including demonetisation, GST impact and regulatory hurdles, the company has guided for a growth of over 15 per cent in FY18 in the domestic market. Given its domestic portfolio which is skewed towards the high-margin chronic segment, the overall revenue of the company is well supported. During the first quarter of FY18, revenue from India stood at ₹932 crore.

Lower R&D guidance

The company has lowered its R&D spend for FY18 (around ₹2,000 crore) to 12 per cent of total revenue from 13.5 per cent in FY17. With a focus on cost control, the company has decided to reduce the R&D spend on drug discovery while rationalising its pipeline and getting a financial partner for its biosimilar development.

The company reported a consolidated revenue of ₹17,120 crore and consolidated net profit of about ₹2,558 crore in 2016-17, recording a growth of 24 per cent and 13 per cent y-o-y, respectively.

During the June quarter, the consolidated net sales decreased by 12 per cent to ₹3,807 crore, while the consolidated net profit dropped by 59 per cent to ₹358 crore. Operating margin narrowed to 21 per cent during this quarter, from 32 per cent in the same quarter last year.

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