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*We met with the management of Ajanta Pharma (AJP) recently to understand its business outlook in further details.

* AJP has enhanced its efforts to improve profitability over the next 2-3 years.

* Superior execution in the branded generics segment across domestic formulation (DF), Asia and Africa would result in industry outperformance. This will be further supported by relief on the cost front, which would pave the way for at least 200bp margin expansion over FY23-25E.

* However, the US generics growth prospects might moderate due to slowdown in the pace of approvals over the near term.

* We expect 15% earnings CAGR over FY23-25 v/s 4% YoY earnings decline in FY23.

* We continue to value AJP at 22x 12M forward earnings to arrive at our TP of INR1,410. AJP had multiple headwinds such as higher raw material costs and operating deleverage over the past 12-15M, leading to historically lower margins in 9MFY23. However, with efforts in place to overcome these hurdles, there is scope of better margins from FY24 onwards. Maintain BUY.

* Inferior execution in branded generics market of India/Asia/Africa, untoward regulatory outcome at Dahej, Paithan site and adverse currency headwinds are the key risk to our rating/estimates.

Margin recovery – key for earnings growth

* Over 9MFY23, the various factors that hit AJP were: a) inventory write-off (1% of 9MFY23 sales), b) adverse currency (EUR-INR) movement that impacted 0.5% of 9MFY23 sales and c) a spike in raw material prices (0.7% of 9MFY23 sales).

* Historically, AJP had taken inventory write-off to such extent only twice so far and it has been one-time in nature. The INR depreciation is expected to reverse the impact of currency movement from 1QFY24. Further, there is scope of passing some increase in raw material cost in the branded generics segment, thereby improving its overall gross margin going forward.

* Further, the freight cost (which was ~6x from pre-Covid to post-Covid phase) has fallen considerably, providing comfort on the cost front as well.

DF – new launches/better MR productivity to drive industry outperformance

* AJP has delivered consistent 20%+ YoY growth in revenue over the past two years on 9M basis.

* In ophthalmology and cardiology, AJP has been gaining market share over the past five years. Particularly, in cardiology, there has been a shift towards trade generics at the industry level, thus moderating the growth prospects of this therapy. Despite this, AJP has been able to outperform in this therapy.

* The benefit from restructuring exercise is now reflected in dermatology therapy (strong 24% YoY growth v/s +4% for IPM over 12M ending Dec’22).

* In addition, AJP has reduced the field force by 200 to 2,800 and still managed to deliver robust growth in the DF segment, thereby driving sales and profitability. We expect 16% sales CAGR in DF to INR15.6b over FY23-25.

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