R&D spin-off may help Glenmark Pharma to cut investment risks, reduce debt

But US growth hinges on product approvals and pace of price erosion

Glenmark Pharma plans to spin off its research unit into a separate US-based subsidiary to de-risk its investments, bring down debt, and improve its focus on the base business. The innovation subsidiary, which will house both the conventional as well as the biomolecules, research and development centres, and about 400 employees, is likely to start operations as an independent entity in 2019-20 (FY20). The company may engage strategic or financial investors to fund the research programme.

Saion Mukherjee and Prateek Mandhana of Nomura believe the creation of an innovation subsidiary will limit the gap between money spent on innovation and revenue over time. Currently, the cash flows from the base business are deployed in high-risk innovation programme which, according to them, is a significant drag on shareholder value.

The company spends up to $120 million annually, which is estimated to be over 63 per cent of 2018-19 profit before tax. While prior to 2011-12, the company was able to monetise its molecules, which were in various stages of development, the same has not been the case in the last seven years. The company spent a lot more on research efforts and the revenues from the same were a fraction, which led to pressure on cash flows. If the new unit, which will have its own independent board and chief executive, is able to grow sustainably, it will help monetise the assets in a phased manner for Glenmark Pharma. 

In the near term, the Street will, however, look at the progress of the base business in the US. 

While the US generics business grew 16 per cent year-on-year (YoY) and there is visibility of growth, Surajit Pal of Prabhudas Lilladher believes the company’s guidance of 15 per cent YoY is unlikely, as revenues in the March quarter have to grow at 46 per cent YoY, or 31 per cent, on a sequential basis. 

The company after the December quarter earnings indicated it is guarded on the US sales growth, as price erosion in its core portfolio is around 8 per cent annually. Without one-off gains, operating profit margins would be in the 12-15 per cent range. The company has guided for $120-125 million of quarterly revenues in the US, led by generics of kidney drug Renagel, few complex generics, and plain generics approvals over the next year. 

The bright spot among various geographies is the India business (26 per cent of sales), which saw a growth of 15 per cent YoY in the third quarter. The company’s market share has increased in the respiratory and cardiovascular systems. Led by new product launches, the management expects the India business to grow 10-15 per cent in FY20, compared to the pharmaceutical market’s growth of 10-11 per cent.

Another positive for the company is a reduction in net debt by Rs 60 crore and the management has guided for further reduction in the current quarter. Net debt for the company is estimated to be around Rs 3,430 crore and analysts believe the same will reduce over the next few years on lower capital expenditure and improved operational performance. Net debt-to-operating profit, which is currently at over 2.1 times, is expected to fall to under 1.5 times by 2020-21.

While the stock trades at 15 times its FY20 earnings estimates and potential for growth is strong, investors should await pricing trends, especially in the US market, before taking an exposure to the stock.