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Lockdown increases off-take over near term '
However, administrative hurdles on rise over medium term
We interacted with management of Alkem Lab (ALKEM) to understand the impact of COVID-19 on the business in its focus geographies. Key takeaways:
* The evolving situation due to the COVID-19 outbreak is likely to have a mixed impact on the domestic formulation (DF) growth outlook over the medium term.
* With healthcare being priority, the existing inventories and the normalized operations at manufacturing facilities can cater to near-term requirement with a few hiccups from the supply chain side.
* While resumption in supplies of RM from China is expected to provide respite on the gross margin front, we cut our FY21/22 EPS estimate by 5.6%/5.3% and lower the P/E multiple to 21x (prior: 22x) to factor in (i) gradual slowdown in MR effort on account of lockdown and (ii) recently increased RM prices.
* Accordingly, we reduce our TP to INR2,700 (prior: INR2,950). We remain positive on ALKEM on the back of its industry outperformance track record in DF and better traction with minimal regulatory risk in US generics. Maintain Buy.
DF – a mixed bag
ALKEM has delivered 14.7% YoY growth in DF business (67% of sales) over 9MFY20. With the situation on account COVID-19 intensifying, there has been higher off-take of chronic set of medicines (15% of DF). Further, with rising cases of cough/cold and respiratory, there is increased requirement of antibiotics in case of ALKEM. At the same time, recent lockdowns across various states in India has led to (i) postponement of elective surgeries, affecting anti-infective segment growth to some extent, (ii) adoption of ‘work from home’ model, restricting the movement of MRs to visit doctors, (iii) impact on transportation to some extent as labors intend to travel to their hometown and (iv) intermediate non-operation of warehouses, which may have some impact on secondary sales.
US business (26% of sales) – momentum intact
ALKEM has received robust approvals for 70 ANDAs since 2013. Specifically, it received 19 approvals in FY20. Accordingly, the company has delivered 13% YoY growth in 9MFY20. It remains confident to file 12-15 ANDAs on an annual basis. With regulatory compliance in place, the approval and subsequent launch momentum is expected to sustain over the next 2-3 years. While ALKEM supplies antibiotics to the US market, the increased off-take of this drug is expected to have marginal impact as it forms small share in the US generics business. ALKEM has a natural hedge in terms of export/import and thus expected to have a minimal impact of INR depreciation on the US generics.
With the situation in China easing to some extent with reduced impact of COVID-19, manufacturing of KSM (key starting materials) and intermediates has resumed and moving toward normalcy. Though the direct dependency of ALKEM on China is ~5%, there has been a rise in RM for the company in India as well due to the COVID-19 issue. Shipment of goods manufactured by China is in the transit mode and hence RM price softening is yet to be seen.
Valuation and view
We cut our FY21/22 EPS estimate by 5.6%/5.3% and lower the P/E multiple to 21x (prior: 22x) to factor in gradual slowdown in MR effort on account of lockdown and recently increased RM prices. Accordingly, we revise the price target to INR2,700 (prior: INR2,950). ALKEM is one of the companies with higher exposure (two thirds of the business) to DF, which is a strong industry outperformer. It has lower exposure to US generics (~25%), which is driven by new launches. We thus we maintain our Buy stance on the stock.
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