Cipla's Q2FY18 results (Neutral) - Cost control drives profit surprise

Q2FY18 result highlights

• Revs came lower at Rs40.8bn vs est Rs39.4bn. Domestic sales grew +12% yoy vs est +10%. On a alike to like basis India grew at +19%. US sales were Rs6.18bn (-4% qoq) vs est of Rs6.8bn; API at Rs2.13bn (+64%) was sharply ahead aided by supply of ARV products.
• EBITDA came at Rs8.04bn vs est of Rs7.08bn; 19.7% margins vs 18% est. Other op income came at Rs942m vs est Rs700m. Gross margins 61.1% vs est 64%; GMs are down 460bps qoq despite lower India Revs. Adjusting for one off GMS came in at ~63.5% (higher R&D batches and GST reclassification) broadly inline with est.
• EBITDA was driven by savings in the overheads cost (-1% yoy /+1% qoq) and lower R&D spends. Cost control continues to be a key focus.
• Both higher other income (Rs1.13bn vs est Rs300m) and higher depreciation (Rs.3.02bn vs est Rs2.2bn) were driven by ~$11m one off. PAT came in at Rs4.35bn vs est 3.71bn

 Key positives: Domestic and API sales; overhead cost control

Key negatives: Weak US growth; lower GMs 

Impact on financials: Maintain FY18 /19 earnings

Valuations & view

While Cipla’s 1HFY18 earnings trends have been positive, we continue to remain cautious given the lack of consistency across last few quarters. Cipla’s financial performance has been a disappointment over FY13-17 as revenue growth has failed to match investments in simultaneously establishing front-end across multiple markets and stepping up R&D investments. With the new management team working on trimming costs, early signs of profitability turnaround are visible as reflected in FY17 EBITDA margins of 17%. Scale-up in relatively US business ($400m in FY17) through launch of niche ANDAs from FY18 onwards should add to this momentum. However, imperative to enhance its relatively muted R&D spends (~Rs10bn vs >Rs20bn spends by peers) will cap the improvement in margins even from the current low base. While Cipla presents an interesting turnaround story, these positives are adequately captured in the current valuations of 23.6x FY19E earnings (11-14% FY18/19 ROCE) given near term challenges in domestic / US markets and Cipla’s erratic revenue / EBITDA growth history. Maintain Neutral.