Lupin has been in the news lately. Following last week’s blockbuster approval for gSpiriva HandiHaler, there were media reports that Lupin plans to carve out its API unit to unlock value. Amidst the spring of hope, the stock price has gained 35 per cent this fiscal year, with the stock trading at 35/24 times FY24/FY25 earnings. The valuation premium (33 to 60 per cent premium over peers) tentatively factors in the 100 per cent earnings CAGR expected in FY23-25.
But taking a step back amidst the flurry of news, Lupin’s revival is from a highly weakened base. The product approval supports a higher probability of revival. But even after successful execution, the company will be at the lower end of peers based on size and scope of US business, India growth and overall margins. We recommend that investors hold the stock at the current level — where execution risks associated with revival, as well as scope for further improvement, are evenly poised.
API carve-out
The bid to unlock API unit could be directed towards the higher debt on books (2 times net debt to EBIDTA as on March 31, 2023) or to fund other bolt-on acquisitions. Lupin spent ₹1,000 crore on acquisitions in FY23 itself, including two respiratory brands in the US (₹620 crore) to pad up its respiratory portfolio. On eventual carve-out for demerger or sale, the unit’s valuation may be closer to ₹2,200 crore to 2,800 crore or 5-6 per cent of market capitalisation. This is after applying 20-40 per cent discount to Glenmark Life Sciences’ price to sales ratio (Glenmark Pharma too carved out its API business) to account for lower revenue size and lower margins of Lupin.
Lupin’s API unit accounts for 7 per cent of FY23 revenues after reporting flat revenue growth in the last five years to ₹1,109 crore in FY23. The exit growth rate at 46 per cent YoY in Q4FY23 is positive but may likely taper down. The API sector is facing headwinds post Covid, on account of higher inventory in channels, supply chain issues, Chinese competition, and lower value of generic sales in the US. The headwinds may subside in FY24, but revenue acceleration is yet to be consistent.
Betting on US segment
As against US revenues of $1.2 billion in FY17, Lupin reported $632 million in FY23, witnessing the steepest fall amongst peers. US markets hold a prominent place in Lupin’s strategy and gSpiriva should aid in turning the tide in their favour. The product alone is expected to rake in $100 million in FY24, assuming 50 per cent rebate/discount on price and gradually increasing market share. . This is after adjusting for the market share belonging to advanced variant of the innovator.
More importantly, the product should have a longer tail as innovator, innovator authorised generic (eventually) and Lupin will share the market as new entrants are yet to be announced. The current fiscal is also expected to witness launches of several limited-competition products, gDarunavir, gDiazepam gel, gVarenicline, gNascobal and gProlensa, which should boost US revenues to mid-teens growth in FY24. Also, the base business has ‘optimised’ several low-margin oral solids earlier, which should provide for favourable base. The pricing pressure in rest of the base portfolio is also easing to single-digit erosion, providing tailwinds.
The medium term (3-5 years) portfolio will be shaped by R&D investments into inhalation, injectables and complex products the company is currently investing in. After successful launch of biosimilar Enbrel in Europe, its second developed market, biosimilar Pegfilgrastim, is also expected to launch in the US. The pipeline currently holds three nasal sprays in inhalation, four injectables and two more complex products.
Margins
Compared to peer group EBITDA margin range of 22-24 per cent, Lupin reported 11 per cent margin in FY23, which is 800 bps below its FY18 EBITDA margins. This comes after Lupin engaged in a large cost savings programme in the year. Direct costs of product synthesis, supply vendors, freight alternatives, workforce and sales force productivity, optimised R&D budget, and lower proportion from in-licensed sales (lower margin) were targeted. The company derived more than half of targeted ₹550 crore of savings, while the rest is expected to come in FY24. The frail margin improvement from these measures is masked by input cost inflation, US price erosion and lower revenue base, according to the company.
Lupin expects to generate 15 per cent EBITDA margin in FY24 and an exit rate of 18 per cent. Assuming 40 per cent EBITDA margin for gSpiriva sales, this product alone should account for 10-12 per cent of FY24 EBITDA. The rest of cost savings programme and lower quantum of US erosion may be a margin tailwind but has lower visibility.
Even in the year of margin turnaround, headwinds are still expected. Lupin’s India sales have also underperformed (1 per cent YoY growth in FY23) as diabetes (leading segment) faced generic competition along with another leading Cardiovascular product. The impact of diabetes products is expected to creep into FY24 sales growth as well, despite Lupin expecting low double-digit growth in India. The company has also added 1,000 medical representatives to arrest its decline in the domestic market, which will be a drag on margin initially.
Despite a strong US portfolio and improvement in domestic sales, large gap to peer group margins even after improvements, along with its current plant status, are a negative for Lupin. Key plants yet to come out of US FDA observations are Tarapur API plant, Pithampur and Manideep formulations units.
The scope for improvement is large as the decline has been telling in recent years. At 34 times FY24 earnings for 100 per cent EPS CAGR in next two years, investors can hold the stock as risk-return is evenly poised.
