'Neutral' ratings on Cipla Ltd shares: HSBC

Feb 24 2014, 15:23 IST
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SummaryHigher operating expenses to curb margin improvement

Q3 miss significant: Cipla reported Q3 net profit at Rs 2.8 bn (-16% year-on-year), 23% lower than HSBCe (estimates) of Rs 3.7 bn on the back of higher operating expenses. During the quarter, Cipla has consolidated Cipla Medpro South Africa for the full period. Net sales at Rs 25.8 bn were broadly in-line, though export formulations were 7.5% above the estimates. Ebitda margins at 17.2% excluding other operating income were below expectations on the back of higher staff and R&D expenses (part of other expenses). Other income includes forex gain of Rs 400m.

Operating costs creating a new base: Staff costs in quarter have increased 56% y-o-y to 15.8% to sales. Even after excluding the Rs 160m Esop (employee stock option plan) contribution, costs are higher by 8%. Other expenses including R&D are up 36% y-o-y, 14% over estimates. The company has attributed this increase to recruitment of new talent (Sameer Goyal from GSK joins as country head-India) and an increase in R&D, which is now 4.5% to sales. Additionally, full consolidation of Cipla Medpro in the quarter has impacted margins.

Filings picking up, but launches are likely back-ended: Cipla is confident of greater efficiency and a large number of filings in future. As per the management, 60% of critical filings are on track. In the US, it filed 10 products in 9M (nine months) and received approval for six products (including gXopenex, $200m market, launch pending). It filed six products in the quarter; a total of 35 ANDAs (abbreviated new drug applications) are pending approval now. Of these 35, 17 ANDAs are under Ciplas name. We believe many of these product launches may be back-ended.

Valuation and risks: We downgrade Cipla to Neutral from OW (overweight) as we believe operating costs have a new higher base going forward on account of higher operating expenses related to increased focus on R&D and Medpro integration. Higher operating expenses will keep margin improvement under check. Also, we believe that key stock drivers like the launch of combination inhaler products in developed market is a bit far off for Cipla and the managements ongoing effort to increase process efficiency will take time to fructify.

We roll forward our target price to Dec-14 from Sep-14 and value Cipla at 20x (unchanged, in-line with the current sector average) Dec-15 EPS (earnings per share) of Rs 22 to arrive at consolidated TP (target price) of Rs 440

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