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Normalized growth to dampen earnings flare up; downgrade to Reduce

We assess the potential triggers ahead for margin expansion and sustainability of acquisition-led high growth phase of last 1 year. A large part of growth catch-up in acquired brands is complete as Sporlac, Azmarda scale up towards Rs850mn-1bn brands each. Moreover, contract manufacturing (CMO) which has more than doubled over past 3 years would have included tailwinds for medicated lozenges in the pandemic; since gestation period is long for new product introduction and onboarding new customers (renewed traction only after Q4 FY24), reckon CMO segment might consolidate or struggle in FY24 which would also dampen the incremental EBIDTA growth from CMO. Additionally, margin expansion lever appears weaker after completion of growth catch up especially as input costs have not declined significantly since Q4 FY23. We note FY24/25 earnings growth is already factored at 30% cagr leaving little room for disappointment; downgrade to Reduce as likely tepid Q1, lack of earnings surprises preclude any PE rerating.

Domestic growth – catch up in acquired brands largely over

Over last one year JB Chem has executed well in pulling up the growth of acquired brands notably Azmarda (acquired in Apr’22) and Sanzyme (acquired in Feb’22). Probiotic brand Sporlac has done most of the heavy lifting in matching the category growth of ~15% and reckon after the catch up, the competitive positioning would preclude any major above category growth. Our understanding is Sporlac is being marketed to pediatricians as a pro-biotic brand along with prescriptions of Azithromycin (and other anti-biotics), but this would be a slower build rather than being a case of low hanging fruit.

Margin ramp up visibility beyond 27-28% ex-ESOP is low

Key base business segments – domestic and contract manufacturing have shown particularly good growth and we reckon contract manufacturing (CMO) would have a solid profitability profile only lagging that of domestic business. CMO has enjoyed tailwinds in last 2 years as medicated lozenges demand took off, as also alluded by other global players like Reckitt. We note that CMO business requires long gestation as product development and new customer addition both are time consuming. While management had indicated a large order win in Q4, it does not appear to move the needle on growth and would replace the excess demand at best of last few years. With domestic catch up largely over and CMO more in a consolidation phase, margin triggers dwindle out in the near term.

Input cost decline not meaningful in recent months

Input cost decline across acute and chronic therapies has been limited as key starting material prices are still not correcting in any meaningful way. For JB Chem, Metronidazole API along with other acute input costs have not declined materially in April and May leading to lack of any visible rebound in gross margin. Moreover, slower topline growth would also lead to lower operating leverage benefits.

Potentially tepid Q1, elevated valuation weigh on near term performance; downgrade to Reduce from Add

After a stellar 12 months driven by acquisition led growth, reckon the low hanging fruit of domestic outperformance might narrow as follow up acquisition like Razel may not provide the same boost. Further, Q1 FY24 is likely to be tepid as Rantac and Metrogyl have seen delayed off take due to slower monsoon pick up. Valuation at ~26x FY25 EPS trades above most of the domestic pharma names even as we build in 30% EPS cagr over FY23-25. With limited scope for margin surprise, normalized domestic growth and elevated valuation, downgrade to Reduce from Add with unchanged TP Rs2,450, based on 27x FY25 EPS. Our targe PE is second only to that for Torrent even as 28- 30% growth in FY24 is already factored in ours and consensus expectations

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