Shilpa Medicare Rating ‘Add’; USFDA warning letter to delay new approvals

Shilpa Medicare (Shilpa) announced that USFDA has issued a warning letter to its Jadcherla unit, its only formulation manufacturing facility. This facility was inspected by the USFDA in Feb’20 and had received fifteen observations, of which four were repeat observations. Management clarified the warning letter would have minimal impact on the existing product supplies though new approvals would be delayed.

Management’s focus is on strengthening the oncology pipeline for regulated markets and foray into biosimilars, transdermals, etc. Further, formulations revenue of ~Rs 2 bn in FY20 from just six products indicates revenue per product of ~$6 mn, better than peers. We believe any success in biosimilars or transdermals may provide a meaningful upside. Maintain Add with a revised target price of Rs 580 (earlier:Rs 638).

Warning letter on Jadcherla unit: Jadcherla is a formulation manufacturing facility for sterile as well as non-sterile products. The company will initiate dialogue with USFDA to discuss the required remedial actions in the next few days in order to resolve the issue at the earliest.

Impact on financials: Total formulations revenue for the company in FY20 was ~21% of total sales, which is being sold in the US and EU. We do not see any risk to the existing sales from this facility despite the warning letter as existing supplies would continue. However, new products may now get delayed until complete resolution. Additionally, the company’s expenditure towards remedial measures would negatively impact margins. We reduce revenue and earnings estimates by 3-5% and 7-10%, respectively, to factor in delay of new product approvals due to warning letter and margin pressure owing to related remediation costs.

Outlook: We remain positive on the company considering the high growth potential of generic oncology business and expect revenue and net profit CAGR of 10.9% and 14.2%, respectively, over FY20-FY23e. Ebitda is expected at CAGR of 15.7% over the same period while margin would improve 330bps. Return ratios would gradually improve with RoE and RoCE reaching 12.7% and 10.9%, respectively, by FY23e. We are positive on the company’s strategy of building high value oncology pipeline for regulated markets and foraying into biosimilars/biologics with the expectation of first launch in FY22e.

Valuations and risks: Maintain Add with a revised target price of Rs 580/share based on 22xSep’22e (earlier: Rs 638/ share). Key downside risks: Regulatory hurdles, delay in new product launches and forex volatility.