Cipla Ltd’s investors were unprepared for its results. The pharmaceutical company reported a 16.1% decline in profit in the September quarter to 366 crore from a year ago (18% decline sequentially). If that was not bad enough, the management said profits may remain at these levels in remaining two quarters of FY19.

While that prepares investors for what lies ahead, the company’s shares took the inevitable beating, as the Street recalibrated earnings’ forecasts. Its shares have fallen by 12% this week after the results, compared to Friday’s close.

Cipla’s domestic sales declined by 1% from a year ago, partly due to a higher base, due to restocking after the goods and services tax roll-out in July 2017. This high base effect will be visible to some extent in the current quarter too. A late start to the season for anti-infectives also affected growth, with sales picking up only in September. That may mean December quarter sales could look better. India contributes two-fifths of revenue.

Now, North America contributes to a fifth of revenue but is crucial for growth and profitability, making it a focus area. The US did relatively well with sales rising by 12% from a year ago. It could have done better but its business-to-business segment (where it partners with a third party) did not do as well. Price erosion affected sales growth. But the direct business (where Cipla sells by itself) did well and aided growth. The direct business is expected to do well, with launches supporting growth.

The company’s Global Access segment saw a slump in its tender business across markets (supplies to global public health programmes) due to funding-related issues. This affected growth during the quarter.

Cipla said it also lost some revenues to supply-related issues, costing it revenues close to 100 crore in the quarter. What’s worse, these were of products that were relatively high margin, meaning profitability took a worse hit than sales did. This too could take a quarter or two to resolve. While the company did not give details, it said the bottleneck was due to changes being made for better growth in future.

While overall revenue declined by 1%, mainly held up by the US business, the company’s cost of materials declined by 9% and gross margins improved as a result. Product mix was the main reason, as higher contribution from US sales and lesser from the low-margin tender business would be the main reasons. But employee costs rose and so did other expenses, as Cipla pushed ahead with costs related to marketing, and research and development.

The company also said that while rupee depreciation gave some benefit, it was not much and was offset by higher input and fuel costs. That’s why its Ebitda (earnings before interest, tax, depreciation and amortization) margin declined by 2.2 percentage points over a year ago and by 93 basis points sequentially. The management added that adjusting for some items, margins rose sequentially.

While some of Cipla’s problems appear temporary such as the high base effect in India and the supply chain issue, others such as the lull in the tender business are uncertain. Even when temporary, resolution could take longer than expected. Meanwhile, fixed costs need to be serviced. A new worry could be the impact of US sanctions on countries where the company generates revenue. All these reasons are, perhaps, why the management may have guided for flat profits. Investors may think the warning came too late but at least next time they won’t be caught napping.

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