Ipca Labs: Boiling issues

Investors can divest their holdings in the stock of Ipca Laboratories. The stock lost almost 11 per cent around 10 days back, after it reported that the Global Fund, Geneva, had decided not to source Artemisinin based Combination Therapy (ACTs) used for treating malaria, from it. The company became ineligible as a few of its facilities had received warning letters from the US drug regulator in January 2016.

The impact of this development on revenue is estimated to be between ₹150 and ₹200 crore in FY2017. Anti-malaria drugs accounted for 24 per cent of the company’s formulation exports in FY15.

The company’s woes started in July 2014 when its facility at Ratlam received adverse observations after a US FDA inspection. Due to acute shortage in the US, four APIs manufactured at Ratlam were excluded from the import ban. In March 2015, two other facilities that were manufacturing formulations at Pitampur and Silvassa received observations from the regulator.

Our buy rating in late February hinged on the resumption of the export order to the Global Fund.

Besides adding to the topline growth, the order would have also improved margins and sentiment.

The management seemed fairly confident of receiving the order in February or March.

This unpleasant announcement clouds the near-term outlook and highlights the risk arising from such lapses.

The other factor supporting our buy call was the likely recertification of the affected facilities. According to the company, it has taken remedial actions that are in line with the regulator’s expectations, but the recertification is subject to third-party inspection. While the management is hoping for such third-party certification to fructify between August and October, slippages may result in delays.

The stretched time line may extend the recovery phase and increase uncertainties surrounding revival in the company’s exports. Being a high-margin business, exports are a key precursor for the stock to curtail its losses.

The current price of ₹493 discounts Ipca’s estimated 2016-17 earnings by 16 times; almost equal to its three-year average.

Given the uncertainty surrounding the recertification of its facilities and the negative fallout of the Global Fund decision, it is best to sell this stock at the current level.

The company’s revenue and profit growth averaged 19 and 24 per cent between 2010-11 and 2013-14, respectively, largely driven by export income. The share of export revenue has however, been sliding. While exports constituted 56 per cent in 2014-15, for the nine months ending December 2015-16, the split between domestic sales and exports was almost equal.

Due to the US FDA inspection, there was a 5 per cent drop in revenue and 46 per cent decline in profit in 2014-15.

The reduction in profit is mainly on account of the decline in sales due to regulatory issues in North America, and lower institutional business. Significant currency fluctuations in emerging markets added to its woes.

While operating margin has been stable at about 21 per cent between 2010-11 and 2013-14, it fell to 18 per cent in 2014-15.

For the nine months ending December 2015, standalone results also followed this trend. Revenue is down 11 per cent year-on-year, on the back of a steeper fall in export income. Profits are down a sharp 78 per cent on the back of write-offs of materials and increased costs towards remediation.