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Seasonality drives revenue, price cut hits margin

Alkem Laboratories’ (Alkem) Q4FY23 India growth of 17% YoY was driven mainly by better demand for flu-related products while traction in its chronic portfolio too was healthy. However, mandated price cuts in India dented gross margins by 170bps. Discontinuation of St. Louis plant will aid cost savings of Rs700mn- 800mn (60-70bps margin benefit) and help bring about a nominal 200bps improvement in overall FY24 EBITDA margin. Alkem’s India business growth is anticipated to be in double digits and decline in the US will likely be arrested next year, though margins may remain range-bound at 15-16%. Alkem trades at a pricey 27x / 24x FY24E / FY25E earnings due to higher sales contribution from India. Reiterate ADD with a revised target price of Rs3,750/share (earlier: Rs3,650).

* Business review: Revenues in Q4FY23 grew 16.9% YoY (-4.5% QoQ). Domestic business grew by a strong 17% YoY to Rs20bn driven by better traction in anti- infectives, gastrointestinal and pain management therapies. Chronic segment also witnessed healthy double-digit growth (>20%). Trade generics grew on the high base of last year. Ahead, India growth will likely be driven by rise in volumes. US revenues declined 22.3% QoQ (up 9.2% YoY) on a seasonally elevated base. Reduction in price erosion to single digits and ~15 launches will aid gradual recovery in the US. Other international market sales surged 33.3% YoY to Rs2.7bn.

* Margins recede with RM price pressures and price cuts: Gross margins declined 170bps YoY to 56.7% (down 220bps QoQ) due to price cuts on NLEM portfolio and higher raw material costs. Raw material costs are still elevated viz-a-viz pre-covid levels, but are expected to taper down over the medium term. EBITDA margin declined 140bps YoY (-750bps QoQ) to 12.2% with fall in gross margin and resumption of certain marketing expenses. In Q4FY23, the company recorded an impairment charge of Rs1.03bn pertaining to discontinuation of St. Loius plant. Normalising raw material prices, cost savings from St. Louis plant closure and certain optimisation programmes are expected to elevate EBITDA margin to ~16% over the next two years. Adjusted-PAT was up 38.7% YoY (-65.1% QoQ).

* Outlook: We expect Alkem to register 8% revenue and 15.7% EBITDA CAGRs over FY23-FY25E. Consistent growth, coupled with limited capex requirement, would help high FCF generation of ~Rs48.5bn over FY23-FY25E. We remain positive on the stock considering the higher proportion of India sales with a consistent track record of outperformance and potential for operating leverage.

* Valuations and risks: We largely maintain our revenue estimates and raise our EPS estimates by ~5-6% for FY23-FY25E to factor-in cost savings from St. Louis plant closure. Reiterate ADD with a revised target price of Rs3,750/share based on 27x FY25E earnings (earlier: Rs3,650/share based on 28x FY25E earnings). Key downside risks: Regulatory hurdles, addition of products in NLEM, and delay in product approvals in the US.

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