Richter Gedeon - Setting The Alarm Bells Ringing

 

Gedeon Richter - Earnings Revision
Rating: Accumulate (unch.)

Target price (12-month): HUF 5,800 (prev. HUF 6,100) 

Current share price: HUF 5,220

 

Richter reported rather ugly Q1/19 underlying operating numbers last Friday, denting early investor optimism for the stock. After adjusting reported Q1 EBIT for one-off sales-related milestone of USD 25.6 mn received from Allergan, clean pharma EBIT margin stood at only 8.3% on our estimate, and even lower at only ca. 2% (i.e. all time low) if all royalty and one-off milestone income generated on Vraylar during the first quarter is taken out. The clear weakness in the underlying EBIT margin has primarily been driven by declining high-margin Russian sales, the loss in Esmya sales, serialization costs as well as by increasing cost (wage) pressures in the CEE countries. 

Richter published its new sales and margin guidance for 2019, in which it has reiterated its expectation for 2-3% total revenue growth. Also importantly, Richter maintained guidance for its FY19 reported EBIT margin at 12% even after including all potential positive impacts of Vraylar on its total sales (i.e. any potential increase in ongoing royalty on Vraylar sales in the U.S. together with one-off sales-related milestone received from Allergan in Q1/19 and perhaps further milestone and additional sales if the indication for bipolar I depression is approved by the FDA (due later this May), though additional milestone would be only a single-digit number in USD million at best on our estimate.

We expect revenue in Vraylar (for existing primary indications of schizophrenia and bipolar mania) to be around USD 570 mn in 2019 (meaning 17% growth YoY if realized). We note that Vraylar sales (TRx) growth is still outstanding (nearly 70% YoY but flat QoQ in Q1/19) and is clearly faster than Allergan predicted at the time of the drug launch. We also stress that we have not yet incorporated any of the potential positive impact of the indication of bipolar I depression (DB) into our earnings model. We project DB could add another USD 300-500 mn to peak sales in Vraylar in the next decade. If approved, the DB indication should be worth around HUF 400 a share suggesting a 7% increase in our current TP of 6,100 if everything else remains constant. If the BD indication for Vraylar is not approved, we presage a sharp sell-off coming in the stock conceivably sending the share price below HUF 5,000. The US cariprazine patent will expire in March 2027.

We anticipate that Vraylar will likely account for more than 50% of total EBIT this year vs. 36% in 2018. Our estimate points to the fact that Richter is increasingly relying on this one product (and Allergan’s sales skills), suggesting that it should sooner or later undertake a restructuring to modify its financial and operational aspects of its business while continuing to rejuvenate the top management and making sizeable acquisitions amid margins pressures in its generics business and core markets, in our opinion. We note that net cash and equivalents (including tradable securities) on Richter’s B/S amounted to ca. HUF 700 a share at the end of March 2019, accounting for ca.13% of the current share price. If leveraged optimally, we believe Richter would be able to acquire a pharma company (expanding in the specialty pharma landscape) whose annual revenue are similar to its current net sales (ca. EUR 1.4 bn).

We maintain our estimate for Richter’s net sales at HUF 460 bn for 2019 and HUF 476 bn for 2020. However, we cut our EBIT estimates for both 2019 and 2020 from HUF 67 bn and HUF 70 bn to HUF 59 bn and HUF 65 bn, respectively, due to a very poor gross and EBIT margins performance in Q1/19.

We trimmed our estimates for 2019 gross margin from 57.5% to 56.6% (2018: 57%) due to decreasing high-margin Russian sales growth (partly because of pre-shipments in Q4/18 and lower capacity utilization for serialization; 2) unexpected slowdown in high-margin Chinese revenue growth; 3) higher low-margin wholesale activity (ca. 20% of cons. sales) gaining traction gradually; 4) increasing pricing pressure and sluggish OC market in EU, 5) FX headwinds and 6) increasing cost of regulation (serialization cost, in particular) and higher wages in CEE countries. What could turn to be tailwind, however, is the growing royalty income believed to be received from Allergan and Recordati on the growing sales of Vraylar and Reagila in the U.S and EU, a decrease in the amount of sales proportional royalties and crawl-backs, as well as amortization in respect of Esmya, advancing Bemfola sales, and even higher gross margin on wholesale YoY in 2018 (from 9% to 9.5%), explaining why we expect slightly higher gross margin in 2020 (57.5%).

We anticipate that EBIT margin should average at 12.8% in 2019 (vs. our prev. est: 14.4%) and improve to 13.7% in 2020 (vs. our prev. est: 14.6%)on the back of higher royalty on Vraylar revenue. Meanwhile, we expect S&G and R&D expenses to be remain in the neighborhood of 27% and 9-10% of cons. sales in line with management guidance.

We also reduce cons. net income estimates for 2019 from HUF 64.5 bn to HUF 57.1 bn and also for 2020 from HUF 69.3 bn to HUF 64.6 bn, implying an EPS of HUF 307 (+81% YoY) and HUF 346 (+13% YoY) vs. previously expected HUF 346 and HUF 371, respectively.

Valuation: Richter is trading at a 2019 EV/EBITDA multiple, based on our earnings estimate, of 9x, which is ca. 40% lower than historically.

We reduce our 12-m TP estimate from 6,100 a share to HUF 5,800, yet implying a 11% upside potential from the current share price. In our sum-of the parts valuation model we value cariprazine at HUF 950 per share not including the positive impact of a potential patient extension to bipolar depression for Vraylar. We believe Richter has become a little bit oversold in a major sell-off of the stock after the disappointing Q1/19 earnings report. We maintain our Accumulate rating on the share. We expect the FDA to approve the BD indication for Vraylar at the end of May.

 

 

Attila Vago
Senior Analyst

CONCORDE SECURITIES LTD.

Hillside
55-61 Alkotás street, H-1123 Budapest.
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MEMBER OF THE CONCORDE GROUP

 

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