Only a marginal reduction in API cost pressures: IIFL Capital Services

18 Aug 2022 , 10:36 AM

IIFL’s ‘API/KSM Pricing Index, based on 16 key imported products, shows that API costs have moderated only ~2-2.5% in July 2022 versus Q2 CY2022 levels

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 the antibiotics, anti-infectives, neurology, cardiac, diabetes and VMN segments. India’s import dependence on China for these 16 APIs/KSMs varies between ~60-100% and 9 of these APIs/KSMs are also part of India’s proposed API PLI scheme. Analysts at IIFL Capital Services have calculated weighted price for this ‘API/KSM Pricing Index’, based on CY 2021 value imports for these 16 products, from Q1 CY 2019 to July 2022. Their analysis shows that weighted import price for these 16 APIs/KSMs has declined by only 2-2.5% in July 2022 versus Q2 CY 2022 levels, but prices are still up 13/38% versus Q3 CY 2021/Q1 CY 2020 levels.
 
Prices of several key antibiotic APIs/KSMs (such as Pen-G, 7ACA, Clavulanic, Amoxicillin, Metronidazole) still remain at elevated levels

While many of the Indian pharma companies have indicated that API cost pressures have started moderating and its benefit will start reflecting in margins from H2FY23 given that 70-80% of the high-priced API inventory has already been consumed, the imports data is still not showing any meaningful reduction in costs of many antibiotic APIs/KSMs. For e.g. import prices of Pen-G (a KSM for several antibiotics) in India has further shot up from USD19-20/kg in CY 2021 (and USD7-8/kg during pre-COVID times) to USD33-34/kg over the past 4-5 months. Similarly, prices of other antibiotic APIs/KSMs such as 7ACA, Clavulanic, Amoxicillin and Metronidazole have sustained at elevated levels and in-fact have increased ~1-2.5% in July 2022 versus Q2 CY 2022 levels. This might continue to present cost and margin headwinds for players with sizeable acute portfolios such as Alkem, Ipca, Alembic, Zydus, Dr. Reddy’s and Cipla.

Few APIs/KSMs (such as Erythromycin, Azithromycin, PAP, Artemisinin, CDA, DCDA) have seen a moderate 3-10% price correction in July 2022

This follows price increases of ~50-150% since pre-COVID. While import prices of Erythromycin and Azithromycin had increased ~35-50% since pre-COVID levels, both these APIs have seen 3-8% price correction in July 2022 versus Q2 CY 2022 levels. Additionally, prices for PAP (Para-aminophenol; KSM for Paracetamol), Artemisinin (antimalarial), CDA (intermediate for Gabapentin) and DCDA (intermediate for Metformin) have moderated 3-10% in July 2022. However, the price correction appears moderate given the large ~50-150% price increases which many of these products have seen over the past 18-24 months. Analysts at IIFL Capital Services believe this marginal correction in API prices is unlikely to provide any material margin benefit to Indian pharma companies and these players remain largely dependent on passing on these cost increases to customers through price hikes.

Downside risks to IIFL Capital Services’ FY23 margin estimates for Alkem, Alembic & Ipca; relatively sanguine margin outlook for Cipla, Sun, JB Pharma and Torrent

High raw-material inflation (both in terms of API/solvent costs), elevated freight expenses, and normalization in costs (incl. marketing spends) & COVID-product sales have impacted margins of Indian pharma players over the past 12 months, including Q1FY23 during which EBITDA margins of 17 pharma stocks under IIFL Capital Services’ coverage universe declined on an average by ~450-500bps YoY. Alkem, Alembic and Ipca were the worst impacted on margins during Q1FY23, while Cipla, Sun, JB Pharma and Torrent were the least impacted.

While players such as Alkem have indicated that they have already consumed 80-85% of the high-priced API inventory during Q1FY23 and moderating RM inflation & benefit of India price hikes will provide margin tailwinds in H2FY23, IIFL Capital Services’ API import pricing data shows that the moderation in API cost pressures has been very marginal and might not provide any material benefit to Indian pharma companies in the near term. If these cost pressures sustain, then analysts at IIFL Capital Services see highest risks to their FY23 margin estimates for Alkem, Alembic & Ipca as these 3 companies need to deliver EBITDA margin improvement of ~250-700bps versus Q1FY23 levels to achieve IIFL Capital Services’ FY23 margin estimates. Dr. Reddy’s, Lupin and Biocon also need to deliver ~400-800bps improvement in EBITDA margins during Q2-Q4FY23 to meet IIFL Capital Services’ FY23 margin estimates and that will be contingent on scale-up in key US products (such as Revlimid for Dr. Reddy’s, Suprep/Spiriva for Lupin, Glargine/Bevacizumab/Aspart for Biocon) where there could be disappointments.

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, the impact of US price erosion on margins has been limited (owing to Sun’s Specialty & Cipla’s respiratory portfolio), while sustained strong growth in the India franchise (JB and Torrent) aided by price hikes will provide margin tailwinds in H2FY23.