Lupin Ltd’s shares gained 2.4% on Monday, although they slipped off their day’s highs, after the company surprised the Street by reporting better-than-expected profitability.

The drug maker’s September quarter Ebitda margin rose by 2.9 percentage points sequentially to 23.9%. While its sales rose by a mere 1.8% sequentially, operating profit expanded by 15% while net profit increased by 27%. Ebitda is short for earnings before interest, tax, depreciation and amortization.

Margins increased despite the continued pricing pressure in its US business. Revenue from North America, the largest market for Lupin, was down 15% sequentially and 31.9% from a year ago.

But the rest of the regions did well. India, the second largest market, saw strong growth in sales, indicating recovery post implementation of the new goods and services tax. Importantly, as one analyst with a domestic broking firm pointed out, growth in its India business is coming on a reasonably strong second quarter last fiscal year. Other emerging markets and Latin America also did well, registering a sequential growth of 22% and 9.9%, respectively.

What aided the surprise improvement in profitability? Employee costs, manufacturing and other expenses softened on a sequential basis. A notable part of the savings came from reduction in research spends. Investment in research stood at 12.2% of sales, down from 13.1% in the June quarter and 13.6% in the year-ago September quarter. The company expects R&D (research and development) expenses to be stable at September quarter levels. Further, it sees savings from cost rationalization measures, which may help margins to sustain in the second half of the fiscal year, even though launches of new drugs can push up expenses.

On the revenue front, India is expected to continue to clock double-digit revenue growth in the rest of FY18. But pricing pressure and consolidation of the trade channels in the US means revenue from the region is expected to remain under pressure, crimping sales outlook for the current fiscal year.

But the silver lining is that Lupin believes the worst is over and the US market situation should not deteriorate further. It expects price erosion to be in high single-digits (9% or so) but it also sees limited headroom for price cuts from manufacturers’ point of view, which could bring stability to the US market. And as new products (some have been launched and others are set to be introduced in the rest of the fiscal year) begin to contribute meaningfully to the US business, the company expects to return to the growth path in the next fiscal year. While its commentary may provide comfort to investors, much depends on whether the pricing environment plays out as expected, and if the plant-related regulatory issues are resolved successfully.

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