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Q3 Preview: A modest quarter in the offing

* We expect a modest Q3FY22 for pharma names due to: 1) absence of high-value launches and continued price erosion in the US, 2) absence of Covid contribution in the domestic business and 3) higher input costs. On an aggregate basis, we expect yoy revenue growth of ~4%, while EBITDA and PAT are expected to decline by 1% and 4%, respectively. Revenue growth should be largely driven by yoy growth in the domestic formulations business, which benefited from the acute segment’s recovery and the low base from last year. We expect EBITDA margin compression of ~110bps yoy due to continued normalization of marketing and promotional activities in branded markets. On a QoQ basis, we expect revenues, EBITDA and PAT to decline by 2%, 6% and 12%, respectively, due to the absence of Covid-related tailwinds.

* Marginal US business growth: Our coverage universe’s US revenues are expected to grow by 2% sequentially. This would be largely driven by the ramp-up of products launched in Q2, as launch activity remained subdued in Q3. Most companies have launched 3-5 products in the US market in Q3, with almost no high-value launches. For Sun Pharma, we expect the continued ramp-up of specialty to drive US revenue growth, which would be partially offset by price erosion in the generics business. While the Flu season seems to be picking up in the US, its contribution will only be visible in Q4 due to the timing.

* Resilient domestic formulations business: We expect a normalized quarter for the domestic formulations business, with aggregate yoy growth of ~10% for our coverage companies. Secondary sales data from IMS for the months of Oct and Nov suggests yoy growth of 10% for our coverage (two-year CAGR also at 10%). YoY growth in IPM is driven by the recovery in acute segments, while the chronic segment remains stable.

* Opex to normalize: We expect other expenses to increase by ~6% yoy but to remain flat qoq. The year-over-year increase is due to the normalization of sales and promotional activities in the branded business. As a proportion of revenue, other expenses should inch up by ~60bps qoq and 40bps yoy. For our coverage universe, we expect employee expenses to remain largely stable sequentially. However, R&D cost as a percentage of revenue is expected to increase by ~60bps.

* EBITDA margin to compress yoy and qoq: We expect EBITDA margin of our coverage companies to compress by ~100bps yoy and qoq due to raw material price increases, normalization of operating expenses and R&D, partially offset by modest INR depreciation against the USD.

* Remain selective: We prefer stocks with long-term structural visibility, such as Gland (differentiated B2B model with flywheel effect), Cipla (high proportion of branded business and strong respiratory franchise), and Dr. Reddy’s (strong execution and healthy pipeline of limited-competition products).

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