Mumbai: Lupin Ltd’s stake sale in its Japanese subsidiary Kyowa Pharma has provided a dose of optimism to investors. The sale is expected to free-up capital that will enable the company to strengthen its balance sheet and pare down debt. That lifted the stock 2.33% in early trade today.

Lupin Ltd is selling its 99.82% stake in the subsidiary for a consideration of 3,702 crore in enterprise value, which is considered reasonable. The Japanese generics business environment has become tough lately. Japan government increased the number of price cuts in Japanese drugs from about once in five three years to twice a year.

This hampered margin growth in its Japanese subsidiary. Additionally, analysts note outsourcing to its Indian counterpart has not happened at a higher pace. Hence, operating synergies were restricted. Besides, analysts also note that Lupin’s supply to Kyowa is less than 10%, which is not expected to have a material impact on earnings due to future supply deals.

But what the deal is expected to do is generate about 2100 crore post-tax cash, which will be used to pare down debt and strengthen operations. This will make the balance sheet healthier and provide opportunities for Lupin to pursue inorganic growth.

“The proceeds will be used to reduce debt, and for growth capital and inorganic opportunities in India and the US. Net debt-equity will stand at 0.1 times post the deal as against 0.4 times in FY19. Kyowa accounted for 11% of sales and 13% of FY consolidated Ebitda" said analysts at Emkay Global Financial Services in a note to clients.

Going forward, Ebitda margins should remain at about the same levels. Profitability, though, is expected to improve. Additional free cash flows may see the company pursuing inorganic opportunities, and could also help improve its valuation multiple on the bourses.

"Profitability is also likely to improve post the Japan exit. We increase our target multiple due to likely improvement of balance post-deal and strong free cash flow," said ICICI Direct in a note to clients.

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