Lupin Ltd Q1 FY2023 Concall Summary

Key Takeaways

• US reset masks underlying repair: US sales fell 33% QoQ to \$121 mn as management deliberately slashed trade inventory and exited negative-margin products, a one-time correction that should normalize to \$150–\$160 mn in Q2.
• Margins troughed on the same reset: EBITDA margin dropped to 4.5% because the \$50 mn US revenue hole flowed through against a fixed cost base; gross margin of 55.3% was depressed by shelf-stock adjustments and would be a couple of points higher normalized.
• A large cost-savings program is now underway: Management quantified ₹500–₹750 crores in cumulative savings over the next four to five quarters, spanning a 14% factory workforce reduction, air-freight cuts, and portfolio rationalization.
• The pipeline catalyst is Spiriva, gated by an August goal date: The device manufacturer inspection went well and the company has responded to all agency questions; launch preparations are in full swing for a Q4 FY23 target.
• What to watch next quarter: Whether US sales actually bounce to the promised \$150–\$160 mn range, the pace of margin recovery from the Q1 trough, and any FDA action on the Spiriva ANDA around the August 17 goal date.

US Business Reset

• Trade inventory correction: Management saw excess inventory in the trade channel and sold lower volumes (a couple of weeks' worth of products not sold) to pare it down to normalized levels, creating a one-time \$50 mn QoQ revenue hole. Inventories are not expected to inch back up.
• Product rationalization: The company is exiting or rationalizing oral solid products with low or negative margins, where it lacks vertical integration or a good cost position, or where irrational competitor pricing persists even against vertically integrated players. Some products had been driven to single-digit or negative margins by FY22 price erosion.
• Price erosion: Broad-based price erosion of ~10% continued across the US portfolio this quarter, with some drop on Brovana and a slight decline on albuterol. Management stated erosion has not sequentially enhanced versus the prior quarter.
• Base portfolio floor: The US base portfolio averaged 180 last year; with ~10% price erosion, especially on products with significant additional competitors like Brovana, management believes the base has settled at 150–160, with no further downside expected though pricing is hard to predict.
• Inhalation pivot: Inhalation products were 25% of US revenues last year; the target is to get closer to 35–40% in the years to come as the pipeline delivers. Oral solids will not be vacated entirely, only products with no real value or cost position.

Vinita Gupta: "I mean, we don't easily get out of anything. We like to really be the last person standing in the marketplace, but when the pricing comes down to a level and costs are going up, you have to be rational about it from a margin perspective."

Margin & Cost Structure

• Q1 margin mechanics: The \$50 mn US sales drop flowed through to EBITDA; the gross margin portion was impacted and the fixed cost base brought down the margin. Gross margin of 55.3% was depressed by shelf-stock adjustments and discontinuation of low-margin products; normalized it would be a couple of percentage points higher, similar to Q4, with some price erosion.
• Cost-savings program: Management quantified cumulative savings of ₹500–₹750 crores over the next four to five quarters. Initiatives include a 14% factory workforce reduction (saving ~₹20 crores quarterly from Q2), reducing air-freighting, addressing the manufacturing footprint, reducing failure-to-supply penalties, and dropping negative-margin products. Some parts are completed, others will play out during the year and early next year.
• Air freight normalization: Air-freight mix is currently at ~34%; normalization of inventories is enabling a shift back to ocean freight, with a target to bring air freight down toward 20%–15%.
• Operational inefficiencies addressed: Past inefficiencies included failure-to-supply penalties (addressed significantly), air-freighting costs due to OAI status (being reduced), and recalls. Integrated business planning implemented last year improved end-to-end visibility and alignment, reducing back orders and FTS penalties.
• Core business margin floor: Management stated the core business (without large new US approvals) will get to double-digit EBITDA margin before layering on new products.
• Exit margin target: Management expects to exit Q4 with an 18% margin, aided by initiatives paying dividends, new product introductions, and rupee depreciation, though secular inflation is a moving part. With full impact of Spiriva next year and other products, margins should reach 20% plus.

Ramesh Swaminathan: "It will be very unfair to kind of spell out what will be the outcomes from individual initiatives. That will be very unfair on your part to expect the company to spell it out, but cumulatively in aggregate the total quantum could be in excess of the INR 500 crores. It's actually between INR 500 crores to INR 750 crores."

Pipeline & Regulatory Catalysts

• Spiriva (tiotropium): The device manufacturer was inspected by the FDA; the inspection went well and the company has responded to all agency questions. The goal date remains August 17, 2022. Management does not believe the product is stuck and is targeting a Q4 FY23 launch, with launch preparations in full swing. The company is planning both ways: financially planning for an authorized generic to be in the market, but supply planning ready to take on 100% of the market.
• Somerset facility: The warning letter was cleared within three months of receiving 13 observations, described as a record. The site has been optimized and will manufacture only products that make sense. Diazepam gel (small niche product) approval expected in the next six months; Nascobal nasal spray (first-to-file, exclusive) likely approved June next fiscal year. The facility is expected to be breakeven or cash breakeven on its revenue trajectory.
• GMP remediation progress: Two of five sites that were in trouble have been cleared; management is confident of clearing the remaining three while keeping the rest of the sites compliant. The new product launch engine is expected to kick-start effectively from this year onward, aided by GMP status changes.
• Other pipeline assets: Suprep authorized generic already launched, with potential upside in September if an opportunity to supply arises. Fostair high-strength approval notified, with plans to launch later this year in the UK and Europe early next calendar year. Etanercept revenue crossed \$10 mn. Oncology pipeline: active discussions with companies to monetize, with positive results hoped for in the next couple of quarters.

Vinita Gupta: "Within three months, we went from 13 observations to clearance of the warning letter. So, actually it gives rise to new opportunities for us."

India & Other Markets

• India performance: Branded formulations declined 2.9% YoY, but Q1 FY22 had a positive impact from COVID wave 2 (enoxaparin, respiratory products). Adjusted for those, growth was 5.6%. Headwinds included loss of a cardiac brand, generic competition to in-license diabetes products, slow respiratory growth, and slightly lighter doctor footfall. Lupin gained 10 bps market share and outperformed the market in core chronic therapy areas.
• India outlook: Management expects a return to double-digit growth from Q2 onwards; may be 8–9% in Q2 before reaching double-digit in Q3, but double-digit for the balance nine months overall.
• Emerging markets and Europe: Plans to grow via small bolt-ons, targeting \$400 mn–\$500 mn in revenues in the next four to five years. The company is also under-indexed in Europe with significant potential, especially for complex generics, inhalation, and injectables.

Balance Sheet & Working Capital

• Working capital: Rose to 147 days from 140 days QoQ because of strategic inventory build-up to offset potential raw material price increases, partly offset by a reduction in accounts receivable. Management plans to pare it to 130–140 days, then eventually back toward 100 days over time.
• Debt: Rose principally because of the Anglo French drugs acquisition completed at the beginning of the quarter.
• Employee cost: Rose to ₹778 crores from ₹703 crores QoQ because the prior quarter had some expenditure reclassified to other expenses, plus FY23 increments rolled out in Q1, plus workforce planning at the plant level impacting ~14% of the workforce. Expected to be in the range of 18% to 18.5% of sales on an ongoing basis.
• Other expenses: Fell ~₹160 crores QoQ because the prior quarter included one-time items: Solosec litigation expenses and failure-to-supply elements that did not recur. As a percentage of sales, expected to be lower as sales go up; in absolute numbers, more or less in the same vicinity.

Organizational & Strategic Changes

• Workforce optimization: ~14% of the workforce at the manufacturing plant level was reduced, including delayering, optimizing spans of control, and reducing headcount in plants where volumes declined and new products are not expected. Benefits of ~₹20 crores quarterly expected from Q2 FY23.
• Leadership changes: Changes made in the procurement function, supply chain function, technical operations roles, and quality.
• Portfolio philosophy on oral solids: The company will anchor in products where it is backward-integrated and strategic, to gain additional share if opportunity arises, but will not hold on to products without a great cost position. Backward integration alone is insufficient: operational skill in cost of goods is equally critical.

Nilesh Gupta: "In fact, it's not just backward integration. It's backward integration and operational skill. ... You could be backward integrated. If you don't have skill in cost of goods. So that won't work either."

Guidance & Commitments

Key Metrics