Q1 Preview: Down, but not out
* As widely expected, Q1 is likely to be a weak quarter for the sector, with flat revenues and a ~12% yoy decline in EBITDA, owing to lockdowns across the world. Currency tailwinds and lower opex will mitigate the impact to some extent. We expect margins to fall ~260bps yoy. On a qoq basis, we expect revenue/EBITDA to decline by 4%/5%, with a ~20bps fall in margins.
* Post a strong Q4 led by pre-buying, we expect India sales to fall in Q1. IQVIA data shows that the industry has seen a decline of 12%/8% in April/May. In our coverage list, we expect Ipca (positive growth in April/May and HCQS supplies to government) and Cipla (low base) to post positive growth, while the rest should record a yoy decline.
* US approvals have been strong in Q1, but Rx levels have seen a sharp decline vs. pre-Covid levels. We expect all companies in our coverage to report a qoq decline in the US, with Lupin (Tamiflu seasonality, impact on metformin sales due to impurities), Sun Pharma (decline in specialty portfolio and Taro sales due to derma concentration) and Aurobindo (lower injectable sales) recording the highest qoq fall.
* On an average, INR has depreciated by around 4% qoq against US$ and ~5% qoq against EUR. Indian generics are net beneficiaries of INR depreciation against US$/EUR, which will reflect in higher realizations. Further, with little activity on marketing/travelling, we expect opex to come off as well. This will be partially negated by the sharp depreciation in emerging market currencies against INR (BRL, RUB for e.g.) as sourcing is largely from India and costs are INR denominated.
* Our checks suggest that API prices have also been increased in Q1, due to higher local sourcing and price hikes in a few products from China. This will impact gross margins to some extent, though some of it is likely to be passed on.
* We expect a relatively strong quarter for Ipca and Granules led by deferred sales from Q4 and operating leverage. On the other hand, ARBP, SUNP, GNP and LPC should post a relatively weaker quarter led by declines in the US sales. Divis can see some impact from a possible fall in the CCS business, due to possible disruption in R&D activities amongst innovators.
* We expect the sector to continue to relatively outperform in the near term given the defensive earnings characteristics, but after a sharp run-up, we remain selective as valuations leave little room for execution misses. We prefer Aurobindo and Cipla in the large caps and Ipca and Granules in the mid and small cap space.
* More than the earnings, we believe investors will keenly watch out for management commentaries on the pace of recovery, especially in India, as Street estimates still range between 5% and 7% for FY21. Key risks: DOJ penalties on price fixing, lower than expected growth in India and API disruption/price increases
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