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Submissive quarter

Aarti Drugs’s Q1FY23 performance was marred by geopolitical uncertainties, sharp downward currency movement and sustained inflationary environment. Overall revenue came at Rs6.2bn up by 7% YoY, mainly driven by higher realizations in Antibiotics, Anti-protozoals and Specialty Chemicals, Intermediates & Others. Inflated material cost and weighed power and fuel costs, coupled with sharp depreciation in the currency resulted EBITDA margin contraction by 295bps YoY and 160bps QoQ at 10.8%. PAT for the quarter came in at Rs348mn declined by 28.7% YoY and 37% QoQ. Commercialization of majority CAPEX in FY23, new launches & revenue recovery will boost earnings ahead by 22% CAGR over FY22-24E. We recommend ADD rating with a revised TP of Rs460 (14x FY24E EPS).

Improving gross margins

Q1 the gross margin was flat on YoY and QoQ to 31%. The company continues to face RM pressure, high freight and coal prices, this was partially off-set by price increases. The management guided 80%+ raw materials have tapered down and have negotiated agreement with rest of the vendors. Management expects that the gross margins would improves from late Q4/Q1FY23 due to lag in realization. EBITDA margin achieve 15%+ as contribution from higher margin products increases and stability in the raw material prices sustain. The recent crude price increase has not impacted the input cost adversely.

Strong API and specialty

APIs contributed 91% of sales, Rs5.8bn up 22% YoY. Driven by 12% volume growth backed by demand from both acute and chronic products. The specialty segment, at 10% of sales, growing 62% QoQ. The total API business (API + specialty) had 59:41 split between domestic and export markets. API segment has a robust pipeline of products to fuel future growth. The formulations business contributed ~9% of sales at Rs549mn, declining 22% YoY and 28% QoQ. Under formulations, 30% revenue came from exports. The management expects formulation performance to improve from coming quarters

Capex of 7bn expected to add better asset turn

The upcoming Capex of Rs 7bn expected to expand Anti-diabetic product meaningfully to a larger scale. Specialty Chemical brown and green field would mean better volumes with higher margins. Expansion into more chronic therapies would help diversify from the acute-driven portfolio. This planned CAPEX is expected to be commercialized in FY23.

Valuation and risks

Growth in the API is expected to refelect from H2FY23 onwards. aided by price hikes (in Q1), a gradual uptick in volumes (from Q2), good traction in antidiabetes drugs (gliptins) and launches (derma from Tarapur). This would be further boosted by launches of oncology products. Management expects the operating performance to improve to 15- 16% in 2-3 quarters. The company enjoys strong market share in top-15 products domestically and globally. We recommend ADD, with a revised target price of Rs460. At the CMP of Rs513, ADL is trading at 15.4x FY23E EPS of Rs26.3 and 12.3x FY23E EPS of Rs32.9

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