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Outlook 2022: Volatile near term; need to be selective

Post volatile CY20 and CY21, we expect CY22 to be predictable and steady with low COVID-19 cases coupled with high vaccination; however, Omicron variant could turn out to be disruptive. We remain positive on the sector as 1) India business is expected to grow in double digit, 2) continuous cost-control measures would likely support margins and 3) US business could report incremental growth led by new complex launches, subdued base and normalising price erosion. USFDA inspections have selectively resumed and we expect the inspection pace to pick up with easing travel restrictions. Pharma companies under our coverage saw significant re-rating in CY20 but remained largely stable in CY21. Considering the uncertainties, it is prudent to be selective, and we thus recommend companies with strong India business and/or pipeline of complex generics and innovative drugs in the US. Natco, Alkem and JB Chemical are our top picks.

* Outlook for CY22: Though uncertainty remains in the near term amid cost inflation and steep US price erosion, we believe these factors are likely to normalise in CY22. Hence, we are positive on the sector and expect revenue growth to improve in the coming year. We expect ~10-11% of domestic growth excluding any benefit from COVID-19 related drugs. In the US, companies with strong compliance record and complex/specialty pipeline are poised to grow with steady improvement in profitability. USFDA inspection have selectively resumed and we expect the inspection pace to pick up with easing travel restrictions. Progress on complex/specialty products in the US would be closely monitored as this would be the key driver for the sector. API and CRAMS businesses would continue to grow with India gradually becoming a preferred manufacturing destination.

* Key sector trends in CY21: Key notable trends in pharma were: 1) USFDA begun inspections with declining COVID-19 cases, 2) robust growth in India business led by COVID-19 related drugs opportunity, low base and recovery in acute segment, 3) healthy traction in API and CRAMS business, 4) cost headwinds with rising raw material and logistics prices and 5) steep price erosion in US impacting profitability. Indian plants received five warning letters in CY20 and nil in CY21 vs 15 in CY19 as the number of inspections was limited this year.

* COVID-19: Omicron variant is highly contagious and may force restrictive measures once again, potentially affecting growth. However, learnings from the first and second wave of COVID-19 should cushion some of the negative impact, in our view.

* Key expectations in CY22:

* Indian branded pharma market to grow at ~10-11% on a normalised base with additional benefit from COVID-19 related drugs opportunities.

* High number of USFDA inspections as several plants are due for re-inspection.

* US channel inventory would normalise suggesting reduction in base price erosion.

* Launch of complex/specialty in US to reflect in strong growth for select companies.

* Cost headwinds may be partially offset by cost-savings measures from companies.

* Our view: We continue to prefer stocks with higher India sales, complex/specialty US pipleine, and clean FDA status. We also introduce FY24 estimates for all covered companies. Considering the recent stock volatility, we downgrade Torrent Pharma (HOLD from Add), Biocon (HOLD from Add) and GSK Pharma (REDUCE from Hold), while we upgrade Cadila (ADD from Hold), Divi’s (HOLD from Reduce), Glenmark (BUY from Add), Jubilant Pharmova (BUY form Add) and Strides (ADD from Hold).

Top picks: Natco, Alkem Labs and JB Chemicals.

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

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