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Focusing on profitable growth across segments

We met with the ALKEM management to gain a deeper understanding of the business outlook:

* With an established presence in the Domestic Formulation (DF) segment and exports, ALKEM is boosting its growth prospects in the bio-CDMO and med-tech segments. The overall investment in the bio-CDMO segment is expected to be ~INR14b.

* ALKEM’s revamped strategy for the DF segment is yielding improved results with potential for higher growth in the chronic space and reduction in MR attrition.

* Considering a) the extended benefit of lower API prices, b) improved productivity, and c) investments in other initiatives (CDMO/Med-tech), we value ALKEM at 27x 12M forward earnings to arrive at a TP of INR6,030.

* Having said that, we believe the current valuation adequately reflects a 13% earnings CAGR for FY24-FY26E. Maintain Neutral.

New initiatives (CDMO/med-tech) into investment mode

* After establishing R&D/manufacturing capabilities for biosimilars in India, ALKEM seeks to set up a manufacturing plant in the US to provide CDMO services.

* The investment will be ~INR4b-INR4.5b and the plant is expected to be operational by 4QFY25.

* Besides, ALKEM has invested INR10b to date in Enzene.

* The company has implemented appropriate measures to cater to innovator customers for biologics as well as biosimilars.

* Its biologics segment records annual sales of around INR2.6b (largely domestic) and has recently achieved EBITDA break-even. Semaglutide is expected to be the focus product for ALKEM. ? Its med-tech venture is expected to be asset-light with less than INR2b investment over the medium term.

* The products are in-licensed and manufacturing is outsourced in the medtech segment. The overall annual Opex is expected to be INR350mINR400m.

* Given ALKEM’s surgery-related portfolio in the anti-infective space, the investment in this segment is expected to enhance the overall hospital offerings.

Strategic reset yielding improved results in the DF segment

* The DF segment has implemented a new strategy that includes a) changes in the MR incentive scheme, b) focus on top 50-100 brands, c) day-1 launches in the chronic space, and d) digital intervention to improve the efficiency of MRs and enhance service offerings.

* Notably, the attrition rate has reduced by 5% post the implementation of the revised strategy.

* The gross margin of chronic/acute portfolio is typically 72-80%/55%-65%. While investment continues to remain higher in the chronic space, the profitability is not dilutive in the DF segment.

* The trade generics segment has experienced a slowdown at the industry level, leading to relatively lower growth prospects.

Reassessing the US generics segment with a greater focus on profitability

* The portfolio selection strategy has been revised with enhanced focus on product-specific economics. The near-term growth may be impacted due to increased efforts toward margin improvement.

Other key highlights

* ALKEM expects 100bp margin expansion in the base business. This would be offset by higher Opex toward new initiatives. As a result, ALKEM is likely to reiterate its significant EBITDA margin of 18% for FY25.

* The company has experienced an increase in Pen-G prices in the recent past.

Valuation and view

* ALKEM has recorded 18% CAGR earnings over FY18-FY24 and is further expected to deliver healthy growth of 13% over FY24-FY26, led by the 260bp margin expansion. Although ALKEM has a strong presence in the DF and exports markets, it is further investing in biosimilar/CDMO/Med-tech segments. Additionally, it is exploring inorganic opportunities with surplus cash of INR38.5b.

* We value ALKEM at 27x 12M forward earnings to arrive at a price target of INR6,030. We maintain a neutral stance on the stock due to limited upside potential from current levels.

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SEBI Registration number is INH000000412