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Lupin's Q3FY19 results (Underperformer) - Licensing income boosts profits; US begins to stabilize

Q3FY19 result highlights

• Lupin’s revenues were higher at Rs45.05bn vs est of Rs41.8bn driven by higher opt income of Rs1.27bn and licensing income of Rs2.1bn.
• Base revenues stood at Rs41.7bn vs est of Rs40.6bn. US sales improved qoq to $194mn (Q2 - $171m) vs est of $190mn. India stood lower at Rs11.9bn (+11%) vs est of Rs12.2bn (+14% yoy). APAC stood higher at Rs6.9bn vs est of Rs6.3bn.
• GMs came significantly lower at Rs61.6% vs est of 63%. Mgt attributed 1.5% drop to forex losses.
• Consol EBITDA – Driven by licensing fee, it came inline at Rs7.5bn with 16.7% margins (vs est of Rs7bn; margins of 16.6%). Base EBITDA (ex-OOI and licensing fee) stood lower at Rs4.2bn (10% margins) vs est of Rs5.8bn (14.2% margins). Mgt indicated that base EBITDA was impacted by Rs1.57bn forex loss – spread across line items; adjusted for it, base EBITDA was in-line
• Adj PAT stood lower at Rs1.9b vs est of Rs2.8bn. Reported loss of Rs1.5bn led by exceptional item of Rs3.42bn
• Solosec sales of $3m flat qoq with total branded sales of $8m
• Goa/Indore USFDA resolution expected by 1HFY20 vs FY19 end earlier 

Key positives: Higher other operating income; licensing income

Key negatives: Weak US branded sales; lower GMs, higher SG&A cost and tax rate

Impact on financials: We have reduced our FY19/20/21 earnings est by 38%/9%/5% to account for lower US sales and higher taxes. FY19 earnings are further impacted by the Rs3.4bn charge.

Valuations & view

With 35% decline in US sales along with ~1000bps reduction in EBITDA margins over FY17-19e, Lupin’s profitability has shrunk dramatically over the last couple of years. While the US business has likely bottomed now, the recovery is likely to be gradual. There is limited visibility on meaningful new generic launches (barring gLevothyroxine and gRanexa) in the US over the next 3-4 quarters limiting chances of a sharp recovery. While Lupin has begun to increase R&D focus on high-value segments like complex generics, biosimilars and speciality to counter these challenges, it will take time to play out. Given these issues, successful scale-up of Solosec, combined with approval for gProair and biosimilar Enbrel remain key to any meaningful earnings revival even in FY20-21. Given the near-term earnings challenges combined with significant FY20-21 earnings sensitivity to a successful Solosec launch, along with timely gProair approval/launch, we see limited margin of safety at current valuations (21x FY21E). Maintain Underperformer rating with a target price of Rs820.