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Pricing pressure drags profitability

Product approvals key to benefit from the acquisition

* ARBP delivered a miss on 1QFY22 earnings, led by increases in pricing pressure in the US Generics segment and reduced offtake of ARV medicines. It has recently allocated ~USD160m for forward integrating/enhancing product offerings in the Veterinary space and adding ANDAs in the US Generics segment.

* We reduce our FY22E/FY23E EPS estimate by 5%/6% to factor in higher competition in US Generics and lower other income to account for the usage of capital for acquisitions. We value ARBP at 14x its 12-month forward earnings to arrive at our TP of INR900. ARBP is working on building a complex product pipeline. However, timely approval remains critical for a better growth outlook over the next 2-3 years. We maintain our Buy rating.

Lower US/ARV sales led to a YoY earnings decline

* Sales declined by 4% YoY to INR57b in 1QFY22 (est. INR62.2b). The decline was largely led by lower Formulation sales (down 5% YoY to INR49b) and divestment of the Natrol business.

* US Formulation sales declined by 1.5% YoY to INR26.8b (USD364m; 47% of sales). ARV sales fell 30% YoY to INR3b in 1QFY22 (5% of sales).

* EU Formulation sales grew 19.7% YoY to INR15.8b (28% of sales). Sales in growth markets grew 13.7% YoY to INR3.3b (6% of sales). API sales grew 4.1% YoY to IN8.12b (14% of sales)

* Gross margin contracted by 90bp YoY to 58.5% due to the product mix.

* EBITDA margin contracted by 100bp to 21.2% (est. 21.3%) due to lower gross margin. Lower other expense (-200bp as a percentage of sales) was offset by increase in R&D expenses (+200bp as a percentage of sales).

* EBITDA fell 8% YoY to INR12.1b (est. INR13.2b).

* Adjusting for the forex gain of INR286m, PAT declined by 7% YoY to INR7.5b (est. INR8.2b) due to lower EBITDA margin, partially offset by a lower tax rate in 1QFY22.

Highlights from the management commentary

* ARBP acquired nine marketed OTC brands and six ANDAs for USD104m. It expects a potential annual revenue of USD30m from these six ANDAs.

* It has entered into an agreement to acquire 51% stake in Cronus Pharma for INR4.2b, through primary infusion. These funds would be utilized to repay debt (INR1.7b) and as filing fees/to conduct exhibit batches. The capital employed in Cronus till date stands ~USD50m

* It has received Form 483, with seven procedural observations, post the recently concluded USFDA inspection at Unit 1.

* There was a high single-digit price erosion in the US in 1QFY22, which was higher than usual. Price erosion is mainly due to higher inventories in the channel and subsequent dumping.

Valuation and view

* We lower our FY22E/FY23E EPS estimate by 5%/6% to factor in intense competition in US Generics, lower other income, and lesser ARV sales.

* We expect 8% earnings CAGR over FY21-23E, led by launches in key markets (US/EU) and from the acquired Veterinary business, better profitability in Europe, lower financial leverage, and controlled costs.

* We value ARBP at 14x its 12-month forward earnings to arrive at our TP of INR900. ARBP’s efforts are underway a) to enhance product offerings comprising Oncology, Hormones, Depot Injections, Inhalers, Biosimilars, Topicals, and Patches, and b) improving margin in the EU business. We maintain our Buy rating.

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