Recent significant decline in API cost pressures to aid margins in FY24: IIFL Capital Services

23 Jan 2023 , 07:47 AM

Key takeaways include:

• API costs (weighted average) have declined consistently for the past 2 quarters
• API import costs have declined ~12.0% QoQ in Q4CY22 and ~4.5% QoQ in Q3CY22
• From the peaks seen in Q2CY22, prices of several APIs (such as PAP, DCDA, Azithromycin, 7ACA, Artemisinin) have corrected ~20-25% and lower API import prices have sustained in December 2022 as well despite COVID-related supply chain disruptions from China
• Pricing for certain antibiotic APIs (such as Pen-G, Clavulanate and Erythromycin) have largely been sticky at peak levels.
• Although potential supply chain disruptions in China from the fresh COVID outbreak need to be watched out, recent moderation in API cost pressures (if it persists) will materially benefit acute-heavy players (Alkem, Ipca and Alembic) in FY24 whose margins have been the worst impacted owing to API/RM inflation 
• Sun, JB Pharma and Torrent are the top picks of analysts of IIFL Capital Services

 

API/KSM Import Pricing Index of IIFL Capital Services shows that API costs have moderated ~12% QoQ in Q4CY22 and ~16% from Q2CY22 peaks

In their reports released 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 weighted import price for this ‘API/KSM Import Pricing Index’ from Q1CY19-Q4CY22 (weighting based on CY21 value imports for these 16 products).

Their analysis shows that weighted import price for these 16 APIs/KSMs has declined ~12.0% QoQ in Q4CY22, after having moderated ~4.5% QoQ in Q3CY22 as well. Q4 is the second successive quarter showing sequential decline in API import prices versus a consistent ~3-8% QoQ increase in API prices over the prior 6 quarters (Q1CY21-Q2CY22). From the peak levels in Q2CY22, API import costs are down ~16% and have reverted to the levels last seen in H1CY21.

Lower API import prices have sustained in December 2022 as well despite COVID-related supply chain disruptions from China. Sustenance of recent moderation in API cost pressures will be critical for providing margin tailwinds to Indian pharma companies in FY24, given that most of the high-priced API inventory would also have been largely consumed by the end of CY22.

Prices of several APIs (such as PAP, DCDA, Azithromycin, 7ACA, Artemisinin) have corrected ~20-25% from the peaks

• PAP/Para-Amino-Phenol (KSM for Paracetamol; import price decline of 16% QoQ in Q4 and 28% from peaks; Granules is the key importing player)

 

• DCDA (intermediate for diabetes product Metformin; import price decline of 16% QoQ in Q4 and 20% from peaks; Granules, Aarti and Ipca are the key players)

 

• Azithromycin (antibiotic; import price decline of 17% QoQ in Q4 and 25% from peaks; Alembic, Cipla, Jubilant and Alkem are the key players)

 

• 7ACA (antibiotic; import price decline of 11% QoQ in Q4 and 11% from peaks; Aurobindo is one of the key players)

 

• Artemisinin (antimalarial; import price decline of 23% QoQ in Q4 and 29% from peaks; Ipca is the key player)

 

• CDA (intermediate for Gabapentin; import price decline of 6% QoQ in Q4 and 22% from peaks; Solara and Divi’s are the key players)

The weighted import prices for the above 6 APIs/KSMs have declined ~15% QoQ in Q4CY22 and ~23% from the peaks seen in Q2CY22.

 

Pricing for certain antibiotic APIs (such as Pen-G, Clavulanate and Erythromycin) have largely been sticky at peak levels

Pen-G and Clavulanate are the two largest antibiotic APIs being imported into India. While Pen-G is a KSM for several antibiotics and most pharma players will be dependent on imports of Pen-G, Alkem is the key importing player for Clavulanate (for Alkem’s antibiotic Clavam). Import pricing for Pen-G, Clavulanate and Erythromycin (Alembic is the key player) continues to sustain at peak levels and these 3 APIs/KSMs have seen only marginal price decline of ~0-3% QoQ in Q4CY22.

 

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

High raw-material inflation (both in terms of API/solvent costs), elevated freight expenses, normalization in costs (incl. marketing/promotional spends for India) and decline in COVID-product sales have impacted margins of Indian pharma players over the past 12 months, including H1FY23 during which EBITDA margins of 18 pharma stocks under the coverage universe of IIFL Capital Services have declined on an average by ~400-450bps YoY. Alkem, Ipca and Alembic have been the worst impacted on margins during H1FY23 owing to their acute-heavy portfolios; while Sun, Cipla, JB Pharma and Torrent were the least impacted.

Although potential supply chain disruptions in China led by fresh COVID outbreak need to be watched out, recent moderation in API cost pressures (if it persists) will materially benefit acute-heavy players (Alkem, Ipca and Alembic) in FY24 whose margins have been the worst impacted owing to API/RM inflation.

In FY24/25 estimates of IIFL Capital Services, analysts have already factored-in ~300-500 bps margin improvement over H1FY23 levels for Ipca and Alkem. However, with export business challenges and the possibility of API costs remaining elevated, they see margins and earnings downgrade risks for Ipca and Alkem. Despite assuming significant margin normalization for Ipca and Alkem, they find their valuations expensive at ~22x and ~18x FY25 PE respectively. Hence, they continue to maintain their Add ratings on Ipca and Alkem.

Comparatively, they see the lowest risk to their margins and earnings estimates for Sun, JB Pharma and Torrent, which remain their top picks in the pharma sector. For these companies, impact of US price erosion and API cost escalation on margins has been limited, while sustained strong growth in India formulations business aided by price hikes will provide margin tailwinds in FY24.