IPCA Laboratories

Margins on an improving trajectory

14 November 2022

IPCA’s 2Q was below expectations; the underperformance was largely due to sluggish API demand
and several costs impacting the P&L as the corresponding revenue is likely to accrue in 2-3 quarters.
2Q’s gross margins improved 150bps sequentially on easing raw material inflation- a trend which is
likely to improve margins further in 2H. The elevated costs impacting the P&L are: (1) MR additions;
(2) New Dewas (API) facility; (3) Plants under Import Alert operating at low utilisations awaiting
inspection; (4) Normalisation of marketing spends; and (5) Higher tax rate of 28-29%. The first two
reasons have aggravated margin pressures which will gradually ease as operating leverage plays out.
We believe IPCA remains among the fastest growing domestic company (1.5x IPM growth guidance)
with ~50% revenues coming from the pain segment. In 2Q, pain therapy grew 12% while IPCA’s
growth was 21%YoY. The management has lowered API guidance to -2% (vs.5% earlier) while
maintaining earlier guidance for other business segments and margins for FY23. We marginally cut
our estimates by 4-5% for FY24-25 to factor in higher operating costs. We believe IPCA has many
triggers which will play out in 3-4 quarters such as higher domestic growth due to new MR addition,
API boost from Dewas facility, moderation in cross currency headwinds whilst benefitting from
Rupee depreciation, lower cost inventories improving near-term gross margins and EBITDA margin
rebound. The option value of US FDA inspections and subsequent resolution of IA will provide
additional support not built in-to our earnings. Accordingly, we maintain BUY with a Sep’23 Price
Target of INR 1105.

•  Margin pressure persists; to ease as operating leverage plays out: The management, after
a subdued 2Q and despite apparent margin weakness, maintained their FY23 guidance
whilst only tweaking their guidance for export API. The guidance is as follows: (1) Domestic
formulations growth seen at 12-13%YoY; (2) Export promotional business growth seen at 13-
15%; (3) Export generic business to see 5% growth due to gradual recovery in UK; (4)
Institutional business to see decline of 8-10% due to high anti-malarial sales last year; (5) API
business to marginally decline 2% due to sluggish demand in Asia and LATAM (healthy
demand in Europe and India). Overall revenue guidance is 9-10% while EBITDA margin
guidance is unchanged at 21% (including other income). Tax rate guidance FY23 onwards is
28-29% further impacting profitability. During 2Q, gross margins improved 150bps
sequentially as raw material eased. The management alluded to easing cost pressures
expected to benefit the subsequent quarters. The high costs aggravating margin pressures
are MR addition, Dewas facility and IA facilities. The corresponding revenue from new MRs
and APIs facility would ease these margin pressures over the next 3-4 quarters. Accordingly,
operating leverage from the same makes margin improvement inevitable.
•  Domestic performance encouraging, export APIs disappoint: Domestic formulations grew
10%YoY (3% miss), ex-anti-malaria 13%YoY growth which is expected to continue. IPCA
expects the benefit of MR addition to come in subsequent quarters whilst maintaining
market beating performance across therapies (except cardiovascular). Pain contributes over
50% to revenues (where IPCA grew 21%YoY outperforming market by 9%). India business
continues to generate 67-68% gross margin consistently. Export formulations missed
expectations in 2Q due to miss in export API (particularly Asia and LATAM) on account of
sluggish demand and customer order rescheduling which offset outperformance in Branded
formulations and institutional business. As 60% business is in USD, the company is
 benefitting from the Rupee depreciation (current realisation rate 79.85) and will continue to
benefit if Rupee maintains current levels. However, cross currency headwinds impacted
balance realisations albeit the impact is expected to reduce going forward as guided by the
management. The Silvassa plant, which is working at 15- 20% utilisation, is expecting UK
MHRA approval soon. The SEZ Indore facility is operating at 35-40% levels catering to
Australia, Canada, South Africa and European markets.
• FY24 levers intact: Domestic growth guidance, ex-antimalarials is 17-20% for FY23. Domestic
business will grow even further post addition of two new divisions- rheumatoid arthritis and
cardiovascular with total 1,200 field force addition. Dewas facility will start validation
process for 5-6 APIs, get audited by regulatory authorities (incl. US FDA) in FY23 with
minimal contribution catering to a few EM markets. Meaningful contribution is expected
mid-FY24 onwards with a 2-3 year ambition of reaching INR 20bn. On the two site
compliances, management alluded that IPCA has already submitted all responses from their
end and have requested US FDA for an inspection. Any resolution and formulation sales
from US in FY24/FY25 could be an upside risk to our estimates. IPCA is also in the process of
integrating Lyka Labs by modifying their facilities and getting US FDA approval, penetrating
ROW markets and focussing on injectables which is expected to happen gradually. Margins
are expected to reach 24-25% over 3 years. The company is also contemplating to set up a
facility in Aurangabad for continuous manufacturing.