WOOD Flash – Krka: huge 3Q miss, FY16E net guidance cut by one-third, but promises to maintain DPS

We did not expect much from Krka’s 2016E earnings, and it has certainly delivered. This quarter, the scissors bit deeply into Krka’s volumes-driven business model, with revenues falling 6% yoy on pricing pressure, but COGS growing 11%, in line with the higher volume sales. Specifically, the costs of goods and materials (about two-thirds of total COGS) rose by 24% in 3Q, after having declined by 12% in 1H16. As a result, Krka’s 3Q gross margin dropped to just 47% vs. 55.1% in 3Q15 and 56.8% in 1H16. We are still not entirely clear on the specific cause here, but clearly this mismatch between selling and input prices will not adjust overnight, impairing the earnings outlook for the next several quarters at least, in our view, and the company has cut its FY16E net profit guidance by over one-third.
Cushioning this is management’s reassurance that it will raise the 2016E and 2017E DPS in absolute value, regardless of the drop in earnings (this implies a current yield of c.4.8%). In view of the stock’s low liquidity (6M ADTV just EUR 385k) and dividend cushion, we are temped to wait and see the earnings impact of over 15 new drug launches next year and potential value-accretive M&A – especially when the stock trades at a 16E EV/EBITDA of just 7x, or a 35% discount vs. its peers. In the near term, however, and not for the first time, the stock will be testing investors’ patience for it to deliver on its potential.