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Price erosion in the US and higher OPEX impacts earning

US outlook an area of worry; downgrade the stock to Neutral

* ARBP delivered a 2QYF23 earnings miss, led by lower-than-expected US and ARV sales. Sales from Europe (EU) were stable YoY in CC terms, with a pickup in API sales.

* We cut our FY23/FY24 earnings estimate by 18%/13% to factor in: a) reduced demand for Injectables, led by shelf stock adjustment, b) considerable price erosion in the base portfolio in the US segment, c) adverse currency impact in the EU business, and d) increased R&D spends. We value ARBP at 11x 12M forward earnings to arrive at our TP of INR500.

* We downgrade our rating on the stock to Neutral, given: a) the headwinds in the US Generics segment, b) the rising concerns related to the arrest of Mr. P. Sarath Chandra Reddy (a Whole-Time Director), c) the reduced operating leverage, and d) the limited upside from current levels.

Lowest quarterly EBITDA margin in the past five years

* Sales declined by 3% YoY to INR57b (est. INR64b) in 2QFY23.

* Overall Formulation sales declined by 8% YoY to INR48b. Revenue from US Formulations fell 11% YoY to INR26b (down 18% in CC terms to USD331m; 46% of total sales). Revenue from ARV increased by 13% YoY to INR1.6b (3% of total sales). Sales from Growth Markets grew 17% YoY to INR4.5b (8% of total sales). Formulation sales from Europe grew 32% YoY to INR15b (26% of total sales). API sales grew 17% YoY to INR9.7b (17% of total sales).

* Gross margin (GM) contracted by 260bp YoY to 55.3% due to steep competition in the US.

* EBITDA margin contracted by 540bp to 14.6% (est. 16.6%). As a percentage of sales, higher other /employee expense (400bp/70bp YoY) was offset by lower R&D costs (200bp YoY) in 2QFY23.

* EBITDA fell 30% YoY to INR8.4b (est. INR10.6b).

* Adjusting for a forex loss of INR461m, PAT declined by 36% YoY to INR4.5b (est. INR6.4b).

* Revenue grew 3% YoY, while EBITDA/PAT fell 22%/28% in 1HFY23.

Highlights from the management commentary

* Given the price erosion, reduced demand, and shelf stock adjustment, its Injectables sales guidance of USD650m may get delayed by a fiscal.

* After the arrest of Mr. Sharat by the Enforcement Directorate, his responsibilities (procurement, logistics, and IT) have been re-allocated to other Whole-Time Directors.

* The commercial benefit in the Biosimilar segment can kick-start from 3Q or 4QFY24.

* ARBP is launching 20 products annually. Going forward, the management expects 20 filings per year in the Injectable space.

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