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Growth visibility remains strong

We remain positive on pharmaceutical sector considering high possibility of growth revival in India formulations on low base of FY21, stable pricing in US generics and sustenance of cost control initiatives seen during FY21 due to pandemic, albeit partially over long term. Hence, FY22E EBITDA margin would likely be lower than FY21 with resumption of some S,G&A expenses (travelling, marketing etc.) but would still be higher than FY20 levels. We believe underperformance of the sector in last few months has factored in this concern. We have assumed increase in S,G&A expenses for FY22E over FY20 levels and any incremental savings will provide an upside. We prefer companies with strong India business, complex generics pipeline for US and improving return ratios.

* India growth to revive in FY22E, US to steadily improve: IPM reported a muted growth of 1.9% in MAT Feb’21 (as per AIOCD-AWACS) due to lockdown impact. We believe ~10% growth is sustainable over medium-term with driven by 4-5% volume, 3-4 price and 2-3% new products growth, and FY22E may witness higher growth on a low base. US sales has stabilised over past few quarters as price erosion has come down and new launches continue. We expect US sales to gradually improve hereon for companies led by new approvals and complex/limited competition products. Resumption of USFDA inspections would help companies in resolving existing issues but could be a concern for other plants, if found non-compliant.

* Savings in S,G&A expenses partially sustainable: The companies witnessed significant cost savings in India & other branded generic businesses during the pandemic as travelling and promotional costs were restricted. These costs are gradually increasing as witnessed during Q3FY21 and we expect normalisation in FY22E. We expect a hybrid model (digital+physical) to be the norm in the future which will help in sustaining some of the cost benefits. We have assumed S,G&A to be higher in FY22E over FY20 and any incremental savings would provide upside.

* Our view: We maintain positive stance on the sector. Considering the recent stock price movement, we have upgraded Divi’s, Pfizer and Jubilant Pharmova to BUY from Add.

* Key risks: Adverse outcome of USFDA inspections, currency volatility, and inclusion of more products under NLEM in India.

* Top picks:

       * Cipla (BUY): Focus on India & branded generic segments along with profitability improvement and high growth visibility.

       * Alkem Labs (BUY): Solid India business, improving margin trajectory, consistent track record of growth outperformance and attractive valuations.

       * Abbott India (BUY): Strong growth across therapies and marquee products to continue, generate strong cashflows pushing return ratios even higher

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