Fitch Ratings has affirmed India-based Glenmark Pharmaceuticals Ltd's Long-Term Issuer Default Rating (IDR) at 'BB' after the announcement of its planned divestment of a 75% stake in its active pharmaceutical ingredient (API) business held under subsidiary Glenmark Life Sciences Limited (GLS).

The Outlook is Stable.

We believe Glenmark will use most of the net proceeds to repay debt. This and Glenmark's prudent approach to growth investments and shareholder returns will help it maintain negative net debt to EBITDA, which is significantly below the positive rating sensitivity level of 1.5x. Nonetheless, Glenmark's revenue scale and EBITDA margins, which are key metrics Fitch uses to measure the company's business profile, are unlikely to improve to levels commensurate with a higher rating.

The planned disposal is unlikely to affect our assessment of Glenmark's cost competitiveness and market position despite some reduction in margins. The Stable Outlook reflects Glenmark's comfortable leverage headroom and our expectation of positive free cash flow before litigation settlement payments.

Key Rating Drivers

Sale to Boost Leverage Headroom: The stake sale, which is likely to be completed by March 2024, will generate nearly INR50 billion in proceeds net of taxes, which exceeds net debt of INR31.9 billion at end-March 2023, excluding GLS. We think Glenmark can sustain a negative net debt position, as it is not considering sizeable growth investments in the next few years. We also do not expect a major rise in shareholder returns. We forecast Glenmark's consolidated net debt to EBITDA, excluding GLS, to remain at around -1.0x, despite litigation settlement payments exceeding USD90 million in FY24-FY25.

Business Profile Intact After Divestment: External sales from GLS contributed 11% of Glenmark's revenue in the financial year ended March 2023 (FY23), but healthy growth in markets such as India and Europe will help to limit the loss of revenue from the disposal. Glenmark's reliance on GLS for API sourcing is limited at 15%-20% of its needs. Glenmark is GLS's largest customer, accounting for close to one-third of its sales. The impact on Glenmark's profitability in the unlikely scenario of discontinued supplies from GLS will be small as it has alternative suppliers on comparable terms.

GLS generates higher margins than Glenmark's formulation business, underscored by its 30% contribution to consolidated EBITDA in FY23. Nonetheless, Glenmark's strategy to cut R&D spending to around 7%-8% of sales and further ramp up higher-margin sales of Ryaltris, its maiden novel drug, after good progress since the launch will limit the margin reduction to around 14% over FY24 and FY25 - pro forma for the disposal - from around 16% in FY23 after proportionally including GLS. The sale is unlikely to hurt Glenmark's position in its key formulation markets and geographic diversification.

Small, Yet Diversified: Glenmark has low revenue and operating EBITDA compared with major global generic drug makers, but this is offset by the company's adequate geographical diversification across pure and branded generic markets, including the US, which accounted for 27% of revenue in FY23, excluding the API business, India (35%) and Europe (16%). Scale and diversification help generic drug makers maintain stable margins. Glenmark also has adequate competitive positions in its core dermatology and respiratory therapy segments.

Regulatory, Litigation Risks: Below-peer production-facility diversification exposes Glenmark to above-average risk from adverse regulatory actions that could hurt US sales and product approvals. The US Food and Drug Administration took adverse action at three plants in 2022. Glenmark is a defendant in other cases after it agreed to settle suits involving generic Zetia for USD87.5 million and a US drug-price fixing case for USD30 million recently. We treat this as an event risk, as there is poor visibility over liability. Pricing pressure could rise from changes to laws governing drug price negotiations in the US.

Solid Long-Term Domestic Prospects: The Indian government's focus on boosting mass healthcare access supports pharmaceutical demand. Glenmark's formulation business ranks 14th in India, with a revenue market share of 2.1% in June 2023, according to IQVIA MAT. Stronger shares in dermatology (7.4%), respiratory (5.7%) and cardiovascular (5.2%) underpin Glenmark's position in the fragmented and physician-driven market. India's robust long-term growth prospects limit the impact on profitability from continued pricing pressure in the US generic pharmaceutical market.

Risks in Novel Drugs: Glenmark faces high inherent risks around novel drug development due to its small scale and limited record. This is despite the approval of Ryaltris in the US in early 2022. R&D spending weighs on profitability and free cash generation, although Glenmark expects further cuts after reducing it to 9.5% of sales in FY23, from 14.7% in FY19. We expect Glenmark to take a collaborative approach to R&D spending, in line with its strategy.

The company has signed multiple partnerships for its R&D assets and plans to sell a stake in Ichnos Sciences Inc., a subsidiary holding novel drug assets. Nonetheless, a more aggressive approach may pressure credit metrics and financial flexibility, outweighing the benefits of lower dependence on the highly competitive generic drug business. Glenmark aims to launch or monetise its R&D drugs in advanced stages of development, which could provide significant earnings. However, we do not consider this in our rating case due to the uncertainty and potential delays in the approval process.

Derivation Summary

Glenmark has smaller scale and diversification than large generic pharmaceutical companies, such as Viatris Inc. (BBB/Stable) and Teva Pharmaceutical Industries Limited (BB-/Stable). The larger peers also have deeper launch pipelines, with a focus on more complex products. This mitigates price-erosion risk, especially in the US. Glenmark is rated three notches below Viatris due to its weaker business profile and profitability, which are partly counterbalanced by Viatris' higher leverage. Glenmark is rated a notch above Teva, as Teva's stronger business profile is offset by higher leverage amid continued pricing pressure on generic drugs in the US and litigation.

Glenmark is rated two notches below Hikma Pharmaceuticals PLC (BBB-/Positive), underscoring Hikma's larger scale and robust market positioning, particularly in the US injectables market. Hikma also has a stronger financial profile, which is characterised by higher profitability and cash generation.

Glenmark is rated at the same level as Grunenthal Pharma GmbH & Co. Kommanditgesellschaft (BB/Stable), which has a similar scale and operational scope. Glenmark has greater product and geographic diversification, but this is counterbalanced by Grunenthal's stronger market position in its core segments, underscored by its higher profitability and cash generation.

Ache Laboratorios Farmaceuticos S.A.'s (BB+/Stable) smaller scale and lower geographical diversification are offset by its strong competitive position in Brazil and a record of low financial leverage. Ache's Foreign-Currency IDR is capped by Brazil's Country Ceiling of 'BB+'.

Key Assumptions

Fitch's Key Assumptions Within our Rating Case for the Issuer:

Revenue, excluding GLS, to increase by mid-single digits annually over FY24-FY25;

EBITDA margin, excluding GLS, to remain between 14% and 15% over FY24-FY25 (FY23: 13.3%);

Capex, excluding GLS, to average around 5% over FY24-FY25;

Stable annual dividend payouts at below 10% of net income.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Sustained increase in scale to at least USD2 billion in sales with EBITDA margin of at least 17%, excluding the API business, and;

Sustained positive free cash flow generation; and

Financial leverage, measured by consolidated net debt/EBITDA, excluding GLS, sustained at below 1.5x.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

A weaker competitive position or adverse regulatory action by the US Food and Drug Administration;

Deterioration in financial leverage to above 3.0x.

Liquidity and Debt Structure

Comfortable Liquidity: Glenmark had readily available cash, after excluding GLS, of INR11.6 billion at end-March 2023. This comfortably covered INR5.0 billion of short-term debt maturing in FY24, including INR3.5 billion in working-capital debt that we expect Glenmark to roll over in the normal course of business.

Total debt maturities over FY25 and FY26 are manageable, at INR6.6 billion. Reduced capex and interest payments after the stake sale will enable positive free cash generation over FY24 and FY25. This will help meet a substantial portion of drug litigation and antitrust settlement payments over FY24 and FY25. Completion of the GLS stake sale and use of proceeds for debt repayment will further boost Glenmark's liquidity and financial flexibility.

Issuer Profile

Glenmark is an India-based pharmaceutical company focused on branded and generic formulation and novel drug development businesses.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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