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Channel destocking, higher RM costs impact margins Efforts underway to develop/file complex products

* Aurobindo Pharma (ARBP)’s 2QFY22 results came in below our estimates, weighed by decline in ARV/API sales and an increase in raw material (RM) costs, which impacted profitability. Compared with the steady-to-declining US sales of peers for the quarter, ARBP’s US sales grew 7% YoY (ex-Natrol) on higher volumes.

* We cut our EPS estimate for ARBP for FY22/FY23 by 9%/6%, factoring in: a) a slowdown in injectables offtake on account of COVID, b) lower ARV/API sales due to channel destocking, c) higher solvent prices, and d) increased R&D spending on complex products and biosimilar trials.

* We value ARBP at 13x 12M forward earnings and arrive at TP of INR800. Near-term headwinds are expected in the business, led by higher RM costs and higher inventory in the channel at the industry level. Nonetheless, we remain positive on ARBP on the back of a) a complex product pipeline buildup (respiratory products / injectables / biosimilars), b) a wide product portfolio, supported by backward integration, and c) improving margins in the EU business. Additionally, current valuations largely factor in the nearterm pressure on the business. We maintain a Buy rating.

Lower ARV sales, high costs drag down quarter performance

* 2QFY22 sales were down 8.4% YoY to INR59.4b (our estimate: INR59.2b).

* Ex-Natrol, Formulation sales (down 1.5% YoY to INR51.6b) and API (down 5.8% YoY to INR7.8b) contributed to the overall decline.

* Within Formulation, ARV revenue declined 71.2% YoY to INR1.5b (2.4% of sales) and Growth Markets sales declined 13.5% YoY to INR3.9b (6.5% of sales). On the other hand, Europe Formulation sales grew 9.7% YoY to INR16.6b (28% of sales) and US Formulation revenues (ex-Natrol) grew 7% YoY to INR29.7b (50% of sales).

* The gross margin (GM) is down 340bp YoY to 57.8% due to cost pressures on some key raw materials.

* The EBITDA margin contracted 210bp to 20% (our estimate: 22%), largely due to a lower gross margin. The impact was partially offset by lower other expenses (down 200bp as a percentage of sales). R&D/Employee expenses inched up (+40bp each YoY as a percentage of sales).

* EBITDA was down 17.2% YoY to INR11.9b (our estimates: INR13b).

* Adjusted for forex gains of INR19m, PAT declined at a lower rate v/s EBITDA (13.2% YoY) to INR6.9b (our est: INR8b), due to lower tax rate in 2QFY22.

* 1HFY22 rev/EBITDA/PAT declined 6.2%/12.9%/10.3% to INR116b/INR24b/INR14b.

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