Cheplapharm Arzneimittel : The situation is opaque: Better take your money and leave

We listen now for several quarters to management’s explanations what is going wrong and how they intend to fix the problems, but each quarter comes with a surprise. This time, in an extremely weak Q3 24, it is not only about the supply chain but also “integration and sales issues”. The increasing scope of challenges questions a bit if Chepla has the right systems, processes and setup in place, which is worrisome. The new management outlook for the next quarters, which speaks of “decreases of LFL performance and leverage to stay elevated”, is more than just irritating us. Previously it was said that Q4 24 or Q1 25 should see a recovery. The current headwinds end also all hopes around an IPO in the future in our view. Chepla is rather a future Private Equity case, once it passes the current headwinds. Founder, owner, and former CEO Sebastian Braun will return as Co-CEO. He will obviously handle the supply chain challenges.
Based on our model and no real visibility on short-term performance (due to a lack of guidance), we assume that the depressed EBITDA level will not rebound quickly and be not enough to maintain the current rating profile. Negative rating actions by Moody’s and S&P must be expected. Having said this, the reported EBITDA level in an “ex-acquisitions” scenario should generally allow for recurring levered free cash flow generation (still solid +/- EUR 300m p.a.) and as such represents a source of de-leveraging, even if the structural decline rate of the off-patent portfolio reduces to less than the historical -3.5% p.a. Indeed, management said in the earnings call that the actual decline rate is at -10% now, so extremely underperforming the old organic contraction regime. Given the pressure on the bonds, investors have obviously renewed fears around the business model and ignore the levered FCF potential. But we ask why should an investor just wait and see the bonds further deteriorating? Finding buyers with that kind of newsflow is maybe challenging, we admit though.
We have long defended the business model and we still believe that it is generally working – Chepla provided evidence in the last two decades, no doubt about this. But things do not work right now and there is an idiosyncratic element at Chepla we fear, because other “Pharma outsourcers” do not experience the same degree of headwinds. We cannot explain this, but just determine this by comparing Chepla with a bunch of other Pharma names in European High Yield. These face (supply chain) challenges here and there, too, but not to the same extent.
As there is no clarity at all where Chepla stands in terms of headwinds and the recovery route (timing and sustainability) is uncertain, we change our Credit Opinion to Negative (vs. Stable) and adopt Reduce recommendations on the outstanding euro bonds vs. Neutral on the 2027, 2028 and 2030 fix notes and vs. Buy on the 2030 floater. The latter was a Buy because it carries a high cash interest burden and at the point in time we issued the Buy recommendation a call would have worked on a YTW basis for investors. We think that Chepla cannot and will not be able to come to market anytime soon and the recent headwinds made this instrument sticking out again. But we believe more widening can be expected (keep also the ECB agenda in mind in terms of the interest income profile of the floater). The current risk-return reward across the curve is not tempting yet. At one point it could.