Lower API costs should start benefiting now, to lend comfort on FY23-25 margin expansion

19 Apr 2023 , 10:39 AM

Overall API import costs have declined by 15%, with prices of several key APIs (PAP, DCDA, Azithromycin, 7ACA, Artemisinin, CDA) having corrected 20-30% from peaks. However, import prices for certain antibiotic APIs (Pen-G, Clavulanate and Erythromycin) remain sticky at elevated levels. Given that Pharma companies usually stock API/KSM inventories for 3-4 months, the correction seen in API import costs from Q3CY22 has still not reflected in the earnings performance of companies. Lower API costs and hence GM improvement should start reflecting now in Q4FY23 numbers, in order to lend comfort to IIFL Capital Services’ assumption of ~200 basis points EBITDA margin expansion for the Pharma sector (and ~330-420 basis points margin expansion for Ipca, Alkem, Alembic) over FY23-25, barring which the sector could again see earnings downgrades. Sun, JB Pharma, Alkem & Torrent are the top picks of analysts at IIFL Capital Services in Pharma, as they continue to see relatively lower risk of margins/earnings downgrades for these companies.

IIFL’s ‘API/KSM Import Pricing Index’ shows that API import costs have moderated ~2% QoQ in Q1CY23 and ~15% from Q2CY22 peaks

In their reports published in March 2022 and October 2022, analysts at IIFL Capital Services had highlighted that they have created an API/KSM Import 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%. Analysts at IIFL Capital Services have calculated the weighted import price for this ‘API/KSM Import Pricing Index’ from Q1CY19-Q1CY23 (weighting based on CY21 value imports for these 16 APIs/KSMs).

Their analysis shows that API import costs (weighted average) for these 16 key APIs/KSMs have marginally declined by 2% QoQ in Q1CY23, after having corrected 8% QoQ and 6% QoQ in Q4CY22 and Q3CY22 respectively. Q1CY23 is the third consecutive quarter showing sequential decline in API import prices versus a consistent ~3-9% QoQ increase in API import prices over the prior six quarters (Q1CY21-Q2CY22).

From the peaks seen in Q2CY22, overall API import prices have declined by 15%, while prices of several key APIs have corrected 20-30% from the peaks. Analysts at IIFL Capital Services note that API import costs have now retraced to the levels last seen in mid-CY21 and are only ~10% above the pre-COVID levels.

 

Prices of key APIs (PAP, DCDA, Azithromycin, 7ACA, Artemisinin, CDA) have corrected ~20-30% from peaks

• PAP/Para-Amino-Phenol – KSM for Paracetamol; import price decline of 2% QoQ in Q1CY23 and 30% from peaks; Granules is the key importing player.
• DCDA – Intermediate for diabetes product Metformin; import price flat QoQ in Q1 and decline of 20% from peaks; Granules, Aarti and Ipca are the key importing players.
• Azithromycin – Antibiotic; import price increase of 8% QoQ in Q1, but decline of 20% from peaks; Alembic, Cipla, Jubilant and Alkem are the key importing players.
• 7ACA – Antibiotic; import price decline of 15% QoQ in Q1 and 25% from peaks; Aurobindo and Orchid are the key importing players.
• Artemisinin – Anti-malarial product; import price flat QoQ in Q1 and decline of 20% from peaks; Ipca is the key importing player.
• CDA – Intermediate for Gabapentin; import price decline of 6% QoQ in Q1 and 27% from peaks; Solara and Divi’s are the key importing players.

Pricing for antibiotic APIs (Pen-G, Clavulanate and Erythromycin) remains sticky at elevated levels

Pen-G and Clavulanate are the two largest antibiotic APIs/KSMs being imported into India. While Pen-G is a KSM for several antibiotics and most Pharma companies rely on imports of Pen-G, Alkem is the key importing player for Clavulanate (for Alkem’s antibiotic Clavam). Import prices for Pen-G stay at elevated levels of USD33-34 per kg versus USD12-13 per kg during the pre-COVID period. Similarly, import prices for Erythromycin have been continuing at USD75 per kg versus pre-COVID levels of USD60 per kg. Sustenance of elevated API/KSM prices for antibiotics will be negative for players who are dominant in the Anti-infectives segment — particularly Alkem and Cipla from IIFL Capital Services’ Pharma coverage universe.

Lower API costs should reflect in 4QFY23 nos, to lend comfort on anticipated margin expansion over FY23-25

Analysts at IIFL Capital Services note that the overall API import costs have now retraced to the levels last seen in mid CY21 and are only ~10% above the pre-COVID levels. Given that Pharma companies usually stock API/KSM inventories for 3-4 months, the correction seen in API import costs from Q3CY22 has still not reflected in the earnings performance of companies. However, most of the high priced API/KSM inventory would now have been largely consumed by companies by the end of CY22.

Aggregate EBITDA margins for IIFL Capital Services’ Pharma coverage (18 stocks) have declined from ~23% in FY22 to ~21.5% in FY23 (estimated), owing to API/RM inflation and higher freight/logistic costs. With the recent moderation in API/RM costs, IIFL Capital Services’ estimates factor in ~200 basis points EBITDA margin expansion for the Pharma sector over FY23-25 to ~23.5%. Lower API costs and hence GM improvement, should start reflecting now in Q4FY23 numbers, in order to lend comfort to IIFL Capital Services’ assumption of ~200 basis points EBITDA margin expansion for the Pharma sector (and 330-420 basis points margin expansion for Ipca, Alkem and Alembic) over FY23-25 — barring which the sector could again see earnings downgrades.

Analysts at IIFL Capital Services expect aggregate EBITDA growth for their Pharma coverage universe (18 stocks) to be ~17% CAGR over FY23-25, driven by ~12% revenue CAGR and ~200 basis points margin expansion. Management commentary on margin outlook during Q4FY23 results will be keenly watched, since ~30% of the Pharma sector’s earnings growth over the next 2-year period rests on margin normalization.

Sun, JB Pharma, Alkem and Torrent are IIFL Capital Services’ top picks in the Pharma sector, as there seems to be relatively lower risk of margins/earnings downgrades for these companies. For these four companies, impact of US price erosion and API cost escalation on margins, has been limited (barring Alkem). Also, sustained strong growth in India Formulations business aided by price hikes will provide margin tailwinds in FY24.