Cipla faces downgrade after USFDA warning letter

The recent issuance of a warning letter by the US Food and Drug Administration (USFDA) to Cipla’s Pithampur SEZ unit has heightened concerns about the pharmaceutical company’s future earnings and valuation, according to a report by investment and financial services firm B&K Securities India Pvt. Ltd.  

Cipla’s immediate future, the report stated, hinges on its response to the warning letter, ongoing regulatory hurdles at Pithampur and Goa, and its ability to maintain a strong performance in key markets. This warning comes in the wake of the Goa unit remaining under a warning letter since February 2020. The observations outlined in the warning letter point towards the necessity of comprehensive corrective measures before the USFDA can clear the Pithampur plant for operation.  

Significantly, the potential escalation to an Import Alert (IA) due to data integrity issues, the report said, could lead to substantial consequences, such as a potential cessation of sales in the lucrative US market and potential setbacks in approval timelines for key products in Cipla’s pipeline. This necessitates the hiring of FDA consultants and other remedial measures. An analysis of the worst-case scenario, involving an import alert for both Goa and Pithampur units, indicates a potential reduction of over 20% in earnings in FY25, per the report. 

In response, the report said, Cipla has undergone a downgrade from ‘Hold’ to ‘Sell’, with the target price remaining unchanged at Rs 1,050 apiece. This downgrade is driven by concerns about Cipla’s significant exposure to the US market, constituting 28% of consolidated sales. Any prolonged resolution could impact approvals and future earnings. Factors contributing to these concerns include potential remediation costs, higher R&D expenditure, and additional expenses in the domestic branded market, the report said. 

Despite the recent news of a promoter stake sale in Cipla, leading to a stock surge to five-year highs (around Rs 1,250 per share), persistent concerns about its premium valuations linger. The stock is presently trading at 24x/22x FY24/25E EPS, respectively. 

The report further emphasized the uncertainty surrounding Cipla's ability to navigate these challenges. Crucial milestones include the successful site transfers and the clearance of Goa and Pithampur units by the USFDA. The company's quarterly run-rate target for the US market, coupled with its ongoing endeavors to outperform in the domestic branded formulation market, will be closely monitored, the report said. 

“While the downgrade reflects current challenges, the possibility of a promoter stake sale remains an upside risk, the report said adding that Cipla, with its strong position in the complex generic US market and the India branded formulation market, is expected to focus on resolving these issues to regain investor confidence. 

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