How R&D spends make Alembic Pharmaceuticals a good buy

In the current market turmoil amid the Covid-19 pandemic, pharma stocks have put up a decent show. While the Indian bellwether index, the S&P BSE Sensex, plummeted 23 per cent year-to-date, the S&P BSE Healthcare index gained as much as 13 per cent.

While unavailability of labourers and interrupted supply of raw materials are causes for concern, experts believe that the Indian pharma sector has been relatively resilient to disruption caused by Covid-19, and is poised to gain from favourable currency tailwinds and stable outlook for India and US businesses.

Many pharma stocks have in fact rallied, thanks to their attractive valuation and improving growth outlook. Alembic Pharmaceuticals is one such pharma stock that has gained 36 per cent, year-to-date.

While the company witnessed subdued earnings growth, led by multiple headwinds in the key US market and its domestic portfolio, its aggressive capex and R&D over the last two-three years appear to be paying off.

Alembic has been able to build manufacturing capabilities for the US market in the high-value portfolio and change the business strategy for the domestic market. This has helped the company’s performance across business segments in the recent quarters.

In the fourth quarter of FY2019-20, the company’s consolidated revenue grew by 30 per cent (year-on-year) to ₹1,207 crore and net profit was up by 81 per cent at ₹225 crore. The company’s operating margin stood at 28 per cent during the period.

At ₹769, the Alembic stock trades at about 14 times its trailing 12-month earnings, which is around 46 per cent discount to its three-year average of 21 times.

It is cheaper than similar-sized peers such as Ipca Laboratories, Natco Pharma and Ajanta Pharma, which are trading at 20-26 times.

The stock has rallied significantly in the recent period. However, its medium- to long-term growth prospects remain attractive on the back of R&D investments in speciality areas such as oncology, injectables and derma, along with new facilities and JVs.

Investors with a three- to five-year time horizon can consider buying the stock.

As a century-old drug firm, Alembic Pharma has been renowned for its legacy brands such as Azithral, Althrocin and Wikoryl in the anti-infective, and cough and cold segments. Its export and domestic business mix as of FY20 was 63: 37. Its consolidated net sales and net profit have grown at a CAGR of 10 per cent and 20 per cent, respectively, over the past five years.

Strong prospects in US

The US market has been the key growth driver for Alembic Pharma, contributing about 48 per cent to revenues (as of fourth quarter of FY20).

Many generic filings with the USFDA have been met with considerable success in the past — Abilify (CNS), Exforge (CVS), Celebrex (Pain) and Micardis (CVS). However, its US business has contracted over the last few years due to price erosion in base business, channel consolidation and increased competition.

The company started a major investment cycle in 2017 to build manufacturing capabilities for the US market in high-value portfolios such as oncology, oral solids and injectables, peptides, ophthalmology and dermatology. It also enhanced its supply chain and strengthened regulatory compliance.

The management expects such investments to drive earnings growth significantly from FY21 onwards. The firm’s R&D spend has been highest among peers (14 per cent of sales), strengthening its position in various speciality segments. Currently, it has more than 235 products in the research pipeline, which will scale up filings in the speciality therapeutic areas from FY21 onwards.

As of March, 2020, the company has filed a total of 183 ANDAs (abbreviated new drug application) with the USFDA, received 119 approvals, and launched 76 ANDAs. None of Alembic Pharma’s manufacturing facilities faces regulatory action currently.

Domestic recovery

With its acute (disease)-heavy portfolio, Alembic’s domestic business (28 per cent of Q4FY20 revenue) registered a lower growth than the industry during 2016-19 due to demonetisation, GST, NLEM (National List of Essential Medicines) expansion and higher raw material prices. The company has been constantly adding speciality products in the domestic space, making up 58 per cent of the domestic portfolio.

Starting March 2019, the company took some strategic decisions in its domestic business by rationalising existing distributors (de-risk customer concentration) and reducing discounts to stockists, mainly in chronic areas. Though this has impacted its domestic business in the first three quarters of FY20, it has started to yield results from the latest March quarter.

Alembic has managed to grow its market share in cardiac, gynaecology and diabetes — which indicates improving sales-force productivity and good brand presence in the domestic segment. About 14 per cent of the company’s product portfolio is under NLEM (including Azithromycin).

The company’s overall API (active pharmaceutical ingredients) segment contributes 13 per cent to the total sales (as of Q4FY20). Alembic’s net borrowings stood at ₹1,666 crore (as of Q4FY20); net debt equity stood at 0.52.