gross margin improving, but slowly; M&A trigger may come first

Krka’s 4Q results were a positive surprise both in terms of sales – 4Q16 revenues of EUR 322m beat our forecast by 7%, thanks to the strong performances in Russia and Germany – and gross margin (51.9% vs. the 48.4% expected). Partially offsetting this was elevated marketing and R&D costs, which we believe were related to the rollout of new drug indications (e.g., oncology) from last quarter. Management reiterated that the gross margin should recover only slowly, as the cost of higher inputs are absorbed into prices, but did confirm that it could recover to the high 50% levels throughout the course of 2018E. This is perhaps a little slower than indicated previously, but it is positive, we believe, that management is clearly indicating a recovery. The outlook does seem more positive than in November: the worst of the price compression experienced last year is, apparently, over and new products for 2H17E should improve the story, as could potential M&A/JV announcements in the coming months. We stand by our recommendation after the disastrous 3Q numbers, i.e., not to sell into an extremely illiquid market, but take the 2016 dividend and wait for the story to improve, which we believe it may do in the next few quarters.