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Domestic Formulation/non-US segment drives earnings growth

Posts market beating growth in Acute/Chronic therapies in the DF segment

* ALKEM delivered an in line 2QFY22 earnings, led by a strong showing in the Domestic Formulations (DF) segment, but excluding the international US segment. Like its peers, ALKEM also exhibited subdued performance in the US segment, impacted by high single-digit price erosion in the base business.

* We lower our FY22E/FY23E earnings estimate by 3% each to factor in: a) increased raw material/Logistics costs, b) ongoing pricing pressure in the US Generics portfolio, and c) operational cost normalizing to pre-COVID levels in the Domestic Formulation segment. We value ALKEM at 24x 12-month forward earnings to arrive at our TP of INR4,150. We remain positive given its: a) superior execution in Acute and Chronic therapies in DF, b) leadership position in Trade Generics, and c) new introductions, including Biosimilars. We reiterate our Buy rating.

Superior product mix benefit outweighed by lower operating leverage

* Revenue grew 19% YoY to INR28b (est. INR27.5b) in 2QFY22.

* The domestic business grew 26% YoY to INR19.6b (71% of sales). International sales, excluding the US, grew 28% YoY to INR2b (7% of sales), while US sales fell 2.6% YoY to INR6.1b (22% of sales).

* Gross margin rose ~170bp YoY to 62.2% due to a higher share of the India business.

* EBITDA margin contracted by ~310bp YoY to 22.3% (est. 22.4%) due to higher other expenses/staff cost (+530bp/+40bp as a percentage of sales), but was partially offset by lower R&D costs (-90bp as a percentage of sales).

* EBITDA increased by 4% YoY to INR6.2b (est. INR6.2b).

* The income tax rate stood at 4% in 2QFY22 v/s 12.1% in 2QFY21. As a result, adjusted PAT grew at a higher rate of 15% YoY to INR5.4b (est. INR4.9b).

* Sales/EBITDA/PAT grew 27%/10%/16% YoY to INR55b/INR12b/INR10b in 1HFY22.

Highlights from the management commentary

* The management is targeting an EBITDA margin of 20-21% in FY22.

* It has guided at a 12-15% YoY growth in DF in 2H, and flat YoY sales in the US in FY22.

* The tax rate is expected to be 10-11% (from its earlier guidance of 13-15%) as 60-65% of India sales are catered to by its Sikkim facility, which enjoys a tax benefit till FY26.

* ALKEM has an estimated market share of 20-25% in g-Duexis, which the management expects to maintain.

* Price erosion is in the high single-digits in the US. There was also an adverse impact on sales due to market share losses in some products.

* The company launched eight of the 10 approvals received in 1H, and expects to launch 3-4 products in 2HFY22.

Valuation and view

* We lower our FY22E/FY23E earnings estimate by 3% each to account for the medium term weakness in the US business, increased OPEX with normalization of promotional activities in DF, and cost pressures led by supply disruptions from China.

* On a high base of FY21 (40% YoY growth), we expect 10% earnings CAGR over FY21-23E, led by 18%/7% sales CAGR in the DF/US segment on account of launches, market share gain in existing products across key markets, and better MR productivity in the DF segment.

* We value ALKEM at 24x 12-month forward earnings to arrive at our TP of INR4,150. We maintain our Buy rating.

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