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Work-in-progress to address challenges in the CDMO segment

Favorable demand and healthy launches to drive the Hospital Generics business

* As a demerged entity, PIRPHARM reported its first quarter of detailed financials. The receipts from government grants have been included in other income and excluded from EBITDA and hence it is not comparable with our EBITDA estimate. Including other income, EBITDA stood at INR2.2b (est. INR2.3b). The moderate YoY growth in sales and increased OPEX affected profitability on a YoY basis.

* We have recalibrated our FY23/FY24 earnings estimate based on: a) its detailed financials, b) prolonged period of pandemic-induced challenges in the Contract Development and Manufacturing Organization (CDMO) business, and c) improved traction in the Complex Hospital Generics (CHG) and the India Consumer Products (ICP) segment. Using the SoTP methodology, we value PIRPHARM’s CDMO/CHG/ICH business at 17x/12x/ 18x FY24E EV/EBITDA. We value its 49% stake in the Allergan JV at 18x FY24E P/E and arrive at an overall TP of INR185.

* While there are near-term headwinds in its CDMO business, the outlook remains interesting, given the pipeline of molecules in Phase III clinical trials, which can provide a commercial opportunity, subject to a successful regulatory approval. The revival in the CHG segment continues, with reduced COVID-related restriction. We maintain our Buy rating.

Sales in line; margin yet to pick up

* Revenue grew 9% YoY and 16% QoQ to INR17b in 2QFY23.

* CDMO sales rose 6% YoY to INR9.4b, led by price rises in certain products, cost optimization, and other measures. CHG sales grew 12% YoY to INR5.6b on strong Inhalation Anesthesia (IA) sales in the US market, with continued volume growth driving market share gains. ICH sales increased by 18% YoY to INR2.3b, led by new products and SKUs and continued traction in power brands like Lacto Calamine, Littles, Polycrol, Tetmosol and I-range.

* Gross margin fell 20bp YoY, but grew 20bp QoQ, to 61.4% in 2QFY23.

* EBITDA margin contracted by 220bp, but expanded by 900bp QoQ, to 10% in 2QFY23. EBITDA fell 12% YoY to INR1.7b.

* PIRPHARM delivered an adjusted loss of INR300m v/s a PAT of INR273m YoY. ? In 1HFY23, it delivered a revenue/EBITDA growth of 11%/3% YoY.

Highlights from the management commentary

* The management expects an improvement in EBITDA margin in 2HFY23 v/s 1H. Historically, the second half of the fiscal has always been much stronger than the first half.

* The USFDA recently concluded the GMP inspection of its Michigan facility with zero observations.

* CDMO is a fixed cost leverage business. The management expects an improvement in margin due to higher operating leverage, with a mid-teen revenue growth in 2HFY23.

* Overall margin fell YoY in 2QFY23, due to: a) reinvestment of profit in sales promotion in ICH, b) investment in overseas facilities, and c) inflation led input cost.

Key takeaways from management commentary

* PIRPHARM plans to double CDMO revenue in next 5 years. 60% of CDMO business is API and 40% is formulation. It has diversified mix of big pharma and generics. Revenue from top 10 clients is 40% in the CDMO segment. Peptide, high quality injectables continue to attract customers. In CDMO business, PIRPHARM is witnessing attrition and is taking measures to control it.

* Intrathecal portfolio in the US continued to command leading market share for PIRPHARM. Extensive pipeline of new products consisting of 37 SKUs at various stages of development. Market size of these SKUs is USD7b.

* PIRPHARM launched 3 products during H1FY23 including a Pre-Filled Syringe (PFS) in Germany. 8 SKUs expected to be launched in various targeted markets in Q3FY23 based on tender calendar.

* PIRPHARM expects growth in API generic business as it continues to file DMFs with help of Hemmo Pharma. It also expects API services to grow well.

* Majority of other income includes FX gain/loss and government grants.

* PIRPHARM announced growth CAPEX of $157mn to be completed over the next 18-24 months for Brownfield expansion including Michigan API facility, UK facility for ADCs, Aurora. CDMO has grown at 12% CAGR in past four years.

* CHG - Strong sales with continued volume growth driving market share gains Inhalation Anesthesia (IA) in the US market. In Inhalation Anesthesia, PIRPHARM has less competition and expects high growth as it is gaining more supply chain.

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