FDA spectre haunts Lupin investors
Investor fears centre around Lupin's Goa facility, which has important products lined up for the US market
Lupin’s FY17 sales growth is expected to be good but investors appear to be holding back, awaiting clarity on how the US drug regulator moves ahead on two facilities, whose inspections resulted in adverse observations. The company’s share did not rise much on Thursday, despite better-than-expected March quarter results.
Investor fears centre around its Goa facility, which has important products lined up for the US market. The concern is if the regulator is not convinced by Lupin’s response, the pending approvals of generic drugs manufactured at this site may get affected. The company is arming itself against that risk by arranging for site transfers for some products, which takes time and costs money.
Lupin expects a good year ahead in FY17, notwithstanding this risk. In FY16, sales increased by 8.7% to ₹ 13,701.6 crore as a slow pace of generic approvals in the US market limited growth in the first half. But sales growth in FY17 will be well over 20%, according to Ramesh Swaminathan, chief financial officer and executive director of Lupin.
Looking at its March quarter results and last year’s low base, that target is achievable. Sales rose by 34% to ₹ 4,091 crore in the March quarter over a year ago as the company benefited from US generic market launches. A significant one was generic Glumetza—an anti-diabetes drug—launched in February, with a six-month exclusivity period, which ends in August. Thus, it will get a sizeable bump in the June quarter as well, which will then taper from the September quarter once the other generics enter the market.
Also, the acquisition of US-based Gavis was formally completed in March; its full effect will be visible in FY17. It can contribute about $120 million in annual revenue— ₹ 807 crore at current exchange rates—based on its run-rate in the December quarter. The bigger benefit from this acquisition is when more generic products from its pipeline hit the market.
Lupin’s US market is likely to see robust growth in FY17 and lift overall growth as it contributes nearly half of overall sales. The risk is if the US Food and Drug Administration (FDA) does something to dent those expectations.
Among the other markets, India did well in the March quarter but the ban on fixed-dose combinations and the growing basket of drugs under price control worry Lupin, too. Another key market, Japan, saw good growth, although this was due to currency movements. In constant currency terms, Lupin expects a better showing in FY17, especially from the acquired business of Irom.
Coming back to this quarter, while sales grew by 34%, material costs grew by only 12.3%, chiefly because of exclusivity period revenues from generic Glumetza. Employee costs and other expenses saw sizeable increases. Still, its operating profit rose by 73.2% over a year ago, with the margin rising by 7.1 percentage points from a year ago, and by 8 percentage points sequentially.
The sequential increase in margin is likely to start tapering from the June quarter.
FY17 will also see a few costs increase. One is amortization of goodwill due to the Gavis acquisition, to the tune of $50 million, or ₹ 336 crore. Second, acquisition-related debt will see interest costs increase, as total debt has increased by ₹ 6,648 crore. Product launches in the US have also led to a substantial increase in its working capital days, to 143 in the March quarter from 123 in the preceding one. Lastly, research and development expenditure rose to 12.5% of sales in the March quarter, compared with 11.6% in the preceding quarter. This proportion could even increase in FY17.
But these factors are not unexpected. The risk is if its sales growth is not as strong as expected as these costs will then be spread over a smaller base. The pace of new product launches in the US market will be a key determinant.
Lupin’s net debt to equity is at 0.6 times, which is manageable. Although there is still some expectation among investors about the company’s inorganic growth plans, stretching its balance sheet further at this stage appears unwise. FY17 may be better off as being a year of consolidation rather than of taking new risks.
Since mid-March, Lupin’s shares are down by 11.3%, although they have recovered from the low levels of 29 March. On Thursday, its shares rose by only 1.4%, although the March quarter results were better than expected.
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