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Q3FY21 Preview: Good quarter as tailwinds continue

We expect a good Q3 for the pharma names under our coverage, with YoY revenue, EBITDA and earnings growth of 9%, 21% and 33%, respectively. This will be driven by 1) good growth in the US, 2) recovery in branded markets, 3) continued cost savings and 4) low base for companies such as Lupin. EBITDA margin is expected to expand by ~220bps YoY for our coverage despite the pressure from Merchandise Exports from India Scheme (MEIS) discontinuation. Sequentially, we expect flat revenues, while EBITDA and PAT are expected to decline 6% and 12%, respectively. In our view, Cipla (Buy) and Dr Reddy’s (Buy) have the potential to beat our and consensus estimates. On the other hand, the slow start to the Flu season in the US could make it difficult for Lupin to achieve its low-double digit growth guidance for H2.

* US revenue ($ terms) to grow 6% YoY and 5% QoQ: Growth in the US will be driven by: 1) new product approvals/launches; 2) benign pricing environment due to ongoing Covid19-related uncertainty; and 3) continued ramp-up in limited competition and specialty products. QoQ, we expect a recovery in Sun Pharma’s specialty business and ramp-up in limited competition product market share for Cipla and Lupin. Dr Reddy’s, Aurobindo and Cadila are expected to benefit from product shortages and new product launches.

* India business to grow at high-single digit to mid-teens rate for our coverage: Secondary sales data from AIOCD and IMS suggest healthy recovery in Indian Pharma Market (IPM) growth in Q3. AIOCD data suggests that IPM grew at 6 in Q3 vs. 1% growth in Q2. Similarly, IMS data for October and November suggest IPM growth of 7% vs. 4% growth in Q2. Companies with good Covid-19 portfolio such as Cipla, Dr Reddy’s and Cadila are expected to beat the IPM growth in Q3. Ipca is also expected to outperform the market due to its leading brand position.

* Cost savings to continue but expenses to inch up sequentially: Cost savings due to hampered field-force activity in the branded market will be the major driver of YoY EBITDA margin improvement. However, with the easing of Covid-19-related restrictions, marketing and selling expenses are expected to move up. For our coverage companies, we expect other expenses to go down by 130bps YoY but increase 90bps QoQ.

* MEIS discontinuation to negatively impact margins: For our coverage, we estimate the termination of the MEIS scheme will have 50-100bps negative impact on EBITDA margins sequentially. While the RoDTEP scheme is expected to replace MEIS from January 1, 2020, there is not much clarity around it as of now.

* Our top picks are Dr Reddy’s and Cipla: Dr Reddy’s and Cipla could surprise positively given their strong momentum in the US and Covid-19 portfolio in India. The slow start to the US flu season could make it difficult for Lupin to meet H2FY21 guidance.

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