Initial signs of moderation in API cost pressures: IIFL Capital Services

1 Nov 2022 , 10:53 AM

IIFL’s ‘API/KSM Pricing Index’, based on 16 key imported products, shows that API costs have moderated ~4.5% sequentially in Q3CY22

Analysts at IIFL Capital Services had highlighted in their March 2022 report that they have created an API/KSM Pricing Index, based on imported prices for 16 key APIs/KSMs across antibiotics, anti-infectives, neurology, cardiac, diabetes and VMN segments. India’s import dependence on China for these 16 key APIs/KSMs varies between ~60-100% and 9 of these APIs/KSMs are also part of India’s proposed API PLI scheme. They have calculated weighted import price for this ‘API/KSM Pricing Index’ from Q1CY19-Q3CY22 (weighting based on CY21 value imports for these 16 products).

Their analysis shows that weighted import price for these 16 APIs/KSMs has declined ~4.5% sequentially in Q3CY22, the first quarter showing a sequential decline in API import prices versus a consistent ~3-8% sequential increase in API prices over the past 6 quarters (since Q1CY21). Although import prices for these 16 key APIs/KSMs declined ~4.5% sequentially in Q3CY22, the weighted import prices are still ~10/20/32% above the levels seen in Q3CY21/Q3CY20/Q1CY20 respectively. Sustenance of recent moderation in API cost pressures will be critical for providing margin tailwinds to pharma companies in CY23, given that most of the high-priced API inventory would also have been largely consumed by the end of CY22.
 
Of the 16 key APIs/KSMs that analysts at IIFL Capital Services track, 11 products saw an import price decline of 2-17% QoQ in Q3CY22

Few key APIs/KSMs witnessing sequential price decline in Q3CY22 include:

• Clavulanic acid/Clavulanate Potassium (antibiotic; 2.4% sequential import price decline; Alkem is the key player),
• PAP/Para-Amino-Phenol (KSM for Paracetamol; 14% sequential import price decline; Granules is the key player),
• DCDA (intermediate for diabetes product Metformin; 4.3% sequential import price decline; Granules, Aarti and Ipca are the key players),
• Azithromycin (antibiotic; 9.5% sequential import price decline; Alembic, Cipla, Jubilant and Alkem are the key players)
• Artemisinin (antimalarial; 7.3% sequential import price decline; Ipca is the key player),
• CDA (intermediate for Gabapentin; 17% sequential import price decline; Solara and Divi’s are the key players)

While weighted import prices for the above 6 APIs/KSMs have declined ~8% sequentially in Q3CY22, import prices for these 6 products are still ~10/52/68% above the levels seen in Q3CY21/Q3CY20/Q1CY20 respectively.

Few APIs/KSMs (Pen-G and Amoxicillin) have continued to see sequential price increases in Q3CY22 as well

While import prices of few antibiotic APIs/KSMs, such as 7ACA (Aurobindo is one of the key players), Erythromycin (Alembic) and Metronidazole (JB Pharma, Aarti), have remained largely flat sequentially in Q3CY22 (after having increased ~20-30% since Q3CY20 levels), other products such as Penicillin-G and Amoxicillin have continued to see price increases this quarter as well with Pen-G/Amoxicillin import prices being up ~2.5/30% sequentially in Q3CY22. Pen-G is a KSM for several antibiotics and most pharma players will be dependent on imports of Pen-G. Import price of Pen-G in India has further shot up from USD19-20/kg in CY21 (and USD7-8/kg during pre-COVID times) to USD33-34/kg over the past 6 months.

Recent moderation in API costs (if it persists) will materially benefit acute-heavy players such as Alkem, Alembic, Ipca; relatively sanguine margin outlook for Cipla, Sun, JB, Torrent

High raw-material inflation (both in terms of API/solvent costs), elevated freight expenses, normalization in costs (incl. marketing spends) and decline in COVID-product sales have impacted margins of Indian pharma players over the past 12 months, including Q1FY23 during which EBITDA margins of 18 pharma stocks under IIFL Capital Services’ coverage universe declined on an average by ~450-500 basis points year-on-year (for Q2FY23 as well, analysts at IIFL Capital Services expect ~250-300 basis points year-on-year decline in EBITDA margins for pharma companies under their coverage). Alkem, Alembic and Ipca were the worst impacted on margins during Q1FY23 owing to their acute-heavy portfolios, while Cipla, Sun, JB Pharma and Torrent were the least impacted.

Analysts at IIFL Capital Services believe recent moderation in API cost pressures (if it persists) will materially benefit acute-heavy players such as Alkem, Alembic, Ipca, Zydus and Dr. Reddy’s. However, if the API cost pressures sustain, they see highest downside risks to their FY23 margin estimates for Alkem, Alembic and Ipca as these 3 companies need to deliver EBITDA margin improvement of ~250-700 basis points versus Q1FY23 levels to achieve their FY23 margin estimates.
 
Dr. Reddy’s, Lupin and Biocon also need to deliver ~400-800 basis points improvement in EBITDA margins during Q2-Q4FY23 to meet IIFL Capital Services’ FY23 margin estimates, and that will be contingent on scale-up in the key US products (such as Revlimid for Dr. Reddy’s, Suprep/Spiriva for Lupin, Glargine/Bevacizumab/Aspart for Biocon), where there could be disappointments either owing to USFDA product approval delays or slower commercial execution.

Comparatively, analysts at IIFL Capital Services see the lowest risk to their FY23 margin estimates for Cipla, Sun, JB Pharma and Torrent, which remain their top-picks in the sector. For these companies, impact of US price erosion on margins has been limited (owing to Sun’s Specialty and Cipla’s respiratory portfolio), while sustained strong growth in India formulations business (JB Pharma and Torrent) aided by price hikes will provide margin tailwinds in H2FY23.