Shares of Glenmark Pharmaceuticals Ltd lost 2% last week after it reported subdued performance for the March quarter. With this, the stock has lost one-fifth of its value so far in 2019.

Revenues and operating profit grew 11-13% in the March quarter. The company’s management has guided for 10-15% revenue growth in FY20 and said that costs will be contained. While this would clearly aid profitability, the optimistic commentary has not cut much ice with investors.

That is because performance in the March quarter, while optically decent, masks the challenges in the key US market. Revenues in the US dropped 10% sequentially due to pricing pressure and lower sales. As competitive intensity remains high, Glenmark expects sales in North America to grow in mid-single digits.

Moreover, the guided improvement in profitability can be a challenge unless the company finds a partner to share drug development costs, warn analysts.

“...(rationalization of manpower cost and R&D) could be an uphill task as Glenmark commences trials for (drugs under development)," Edelweiss Securities Ltd said in a note. “With 8% of sales spent on R&D for specialty and innovation, these costs are set to rise till Glenmark finds a suitable minority investor." R&D is research and development.

Third is debt. The company’s net debt at 2.2 times FY19 operating profit is uncomfortable. It is trying to lower its debt burden, but has had limited success.

To give a leg-up to the process, Glenmark reorganized itself into three separate entities—one focusing on drug development, second on active pharmaceutical ingredients and third on the generic, specialty drug business. This way, it plans to curtail its R&D expenses.

But, till the time the new entity finds a partner, Glenmark will have to bear the costs. Further deleveraging through business reorganization hinges on asset monetization, which is a time-consuming exercise. High costs, meanwhile, leave limited scope for debt repayment.

“The company continues to struggle to generate meaningful cash at current levels of operational profits. Given the current cash flow trends, we believe Glenmark will find it difficult to achieve material reduction in its net debt levels over the next two years," Sharekhan Ltd said in a note. “Meaningful debt reduction can be achieved if the company is able to generate cash flows through some corporate actions and/or from any large out-licensing deals."

The concerns are weighing on earnings expectations, with some analysts even paring their earnings estimates. Valuations at about 15 times FY20 earnings estimates are not expensive. But much of the recovery story hinges on asset monetization and debt reduction. Perhaps this shows why investors have been cautious about Glenmark’s guidance.

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