At bl.portfolio we had recommended in April 2022 that investors buy Ajanta Pharma based on recovery in branded portfolio and lower valuations (18.6 times one-year forward earnings). Since then the stock has returned 25 per cent (adjusted for stock split) ,while at the same time valuations have got more expensive at 25 times forward earnings as well.

At the time of our call last year, we had expected margin stability given that higher raw material costs were likely to be offset by pricing power in the company’s branded business. But the EBITDA margins witnessed a sharp decline to 20 per cent in FY23. A small base in the US business was expected to gain from pipeline of launches last year but failed to materialise for the company and now Ajanta expects to temper down the capital allocation to US business.

The markets have thus taken it in stride, given the hit appears largely one time in nature. A turnaround in both areas (margins and US business) is to be expected and should be positive for the company and is reflected in the higher valuations the company is trading at now. The company continues to remain on a good footing in branded business. While we remain positive on the stock, considering the execution risks and current valuations already factoring in the turnaround , we now recommend an ‘accumulate on dips’.

Branded business and generics

Ajanta’s branded business operates from India, Asia and Africa. The company reported 20 per cent YoY growth in India in the last two years, which is double the IPM (Indian Pharmaceutical Market) growth rate, aided by price, new products and even volume growth. With IPM growth of 10 per cent YoY expected for the next decade, Ajanta is likely to deliver a higher run rate.

The company operates with strong focus on limited therapy spread in Cardiac, Diabetes, Ophthalmology and Pain therapies. New launches, especially in the former two, pricing growth backed by established brands and volume growth from higher field force should aid Ajanta Pharma. Trade generics accounting for 10-12 per cent of India revenues focused on chronic segments is also a high growing area. Ajanta Pharma has 12 per cent of India business under NLEM (National List of Essential Medicines) pricing restrictions, which should be a consistent but minor headwind for growth, periodically.

African branded business de-grew 4 per cent in FY23, but on a high base in FY22 which grew 43 per cent in FY22, aided by Covid sales. The business, centred on Francophone Africa (West), was impacted by rupee depreciation against the euro. With stability in the currency and market potential (mid-teens market growth expected in the region), Ajanta’s established presence and new product focus should turn around growth rates for the region.

Asian markets have reported consistent growth of 14 and 17 per cent YoY in the last two fiscals for Ajanta Pharma, which has the Philippines and the Middle East as key markets. The company enhanced its field force by 50 per cent in India, and Asia & Africa regions in FY23, which was necessitated by the launch of 30 new products in these regions cumulatively. Margin implications from the recent additions will be positive in the next two years as field force utilisation gets scaled up..

Ajanta Pharma, with a smaller base in US generics, has felt the impact of price erosion in the US at a higher level compared to peers in 1HFY23 before a strong flu season aided FY23 growth of 18 per cent in the US.

The lack of new product launches in the market, up until recently as it was awaiting plant inspection, has also hurt the revenue potential. The company expects to launch a limited competition product in Q1FY24 along with plans for 4-5 launches in FY24, which should sustain the base performance. The price erosion is also expected to soften to high single digits for the industry as a whole in FY24, which should be beneficial to Ajanta Pharma as well. But with sub-optimal returns on capital from US business as product launches were delayed and price potential eroded, the company expects to temper the capital allocation to the segment.

Margins and valuation

Ajanta Pharma EBITDA margins declined to 20 per cent in FY23 from 28 per cent the previous year. Gross margins decline of 400 bps accounted for most of the dip. This was impacted primarily by input material costs and price erosion in US markets. Freight and logistics costs were also on the higher end for the company, compared to recent years, as air freight and cold chain logistics prices inflated in FY23. Forex losses from African trade added to the margin decline last year.

The company expects to scale back to 25 per cent margin range in FY24. Input material costs have started softening by Q4FY23 and should continue to provide relief by 200 bps, according to the company. US price erosion softening is also expected to aid margins by next year. The field force addition has added structural costs in FY23, but higher utilisation should be a margin tailwind next year

The company is trading at 10 per cent premium to last 10-year average one-year forward earnings at 25 times FY24 earnings. While scope for margin recovery and continued growth in branded business are positives, they may be factored into the valuations currently. Hence we recommend accumulating on dips

Margin recovery expected
Strong branded business with capital allocation focus
Valuation at premium to historical average