Summary: Alembic Pharma (APLLTD) is a leading players in anti-infectives in Indian market and expanding in US formulation market. APLLTD has total investment plan of approx. ~$200mn+ to scale up US business. With series of drug launches in US market, the company is expected to see good growth momentum over next 3 years. We believe buying APLLTD at reasonable valuation can earn very good returns.
About the Industry
Global pharmaceutical industry is expected to be at a size of $1.5 trillion by 2023. Such a large industry includes variety of players in different regions specialised in different things. Broad categories include innovative drugs, generic drugs, speciality drugs and API (Active Pharmaceutical Ingredients).
The developed markets like US are hubs for specialised drugs because of innovation. But to increase affordability for all class of patients, US encourages generic drugs. The competition is global with the players from different countries. Recent past has been challenging for the generic industry with USFDA clampdown and increase in competition. However, the risks have subsided and the outlook has become positive once again.
On the domestic front, the pharmaceutical market is growing at steady pace of 10-12% with growth in affordability and diagnosis. While there are large sized pharma companies which enjoy large distribution and scale benefits, the small size pharma companies enjoy a benefit of high margins by catering to niche segment.
About the Company
Alembic Pharma (APLLTD) traces its roots way back to 1907 and focused largely on India’s domestic formulations market. Over time it expanded into branded generics and expanded globally.
Vadodara based promoters Chirayu Amin and family owns 73% of the company through various holding companies including Alembic Ltd. Mr. Chirayu Amin’s two sons, Mr Pranav Amin and Shaunak Amin are managing directors of the company. Mr. Pranav is a graduate in industrial management and MBA from US and handles international operations while Shaunak takes care of Sales & Marketing, also a graduate from US.
Growth Track Record
In 2011, APLLTD was de-merged from Alembic Ltd to provide more thrust to formulations and insulate this business from the vagaries of commoditised APIs. The company has acquired US based Orit Laboratories LLC.
APLLTDhas grown its sales in last 9 years from Rs. 1,200 Cr to Rs. 4,600 Cr in 2020 at a CAGR of 16%. FY17 & FY18 have been challenging years in terms of growth due to disruption from demonetization and GST roll out, but the decline has been arrested in FY19.
Earnings CAGR for the same period is similar at around 16% CAGR. APLLTD has enjoyed high ROEs and drawn reasonable debt mostly for capacity expansion for US market opportunity.
APLLTD has around 38% of total sales coming from domestic formulation market. While it has diversified product basket; APLLTD is a market leader anti-infective drugs in India. It has been quite active in this space over the years and retained reputation in few molecules. It owns a few legacy brands like Azithral, Althrocin and Wikoryl in the anti-infective and cough & cold segments. Domestic portfolio has 68% chronic and 32% acute. Chronic products tend to have sticky revenues and higher margin.
Over time, APLLTD expanded geographically to take advantage of low cost manufacturing with plants based out in India. International sales contributes more than 60% now and expected to grow higher as US is likely to see more growth versus other regions from new drugs filings by the company. Currently US contributes 72% of international sales while other countries contribute the rest.
Future Prospects
APLLTD operates across three segments in the pharmaceutical industry- API, Branded drugs and International generics. Branded and generics are part of formulation segment and contributes to bulk of the business while API forms the rest of 20%.
Domestic: APLLTD domestic branded portfolio is gradually shifting to the speciality business segment, which now accounts for more than 50% of domestic branded formulations. The management plans to run down small products where the company has low market share. For now, we find that domestic performance has started picking up just last quarter. It is to be seen whether their new strategy to improve sales delivers.
APLLTD’s focus in India has been on select therapies, with a bigger spotlight on maintaining brand positioning. APLLTD has five brands among the top 300 pharmaceutical brands in India, and its top 10 brands contribute 75-80% of domestic revenues, growing at over 12% in the last few years. However such concentration comes with its own risks of aggressive competition. Most pharma companies including MNC pharma and mid-sized Indian companies, tend to have product concentration as a company can scale up business only by developing relationship with doctors in a particular therapy area. Also, domain expertise can’t be built across therapies easily. This focus on handful of therapies leads to product concentration.
International: In the last couple of years, APLLTD has seen better timelines for the US market by building high-value capabilities. It is planning to introduce few products in speciality segment however, its contingent on USFDA approvals.
APLLTD states that their US strategy will focus on (a) profit per product rather than chasing volume market share, (b) spotting market opportunities (previously seen in products such as Abilify and Sartans), and (c) efficient supply chain management. We find that late mover’s advantage may have helped APLLTD to conclude these guiding principles when it comes to expanding US business. Other players that expanded in US early did lose growth momentum due to heavy competition. If this strategy is implemented well, we can see healthy monetisation of the ~Rs 16bn investment and giving us growth visibility over the next 2-3 years.
In past, APLLTD did maximise three key short-term opportunitiescaused by market disruptions – Aripiprazole in FY16 (supply issues at competitors), Theophylline in FY17 (exit by Teva), and the Sartan class in FY19 (impurity issues at competitors). This was possible due to in-house API approvals and capability.
At present, APLLTD has 235+ products in the research pipeline (from 45 in FY16) and expects to scale up filings in US for some of the newer product categories, such as ophthalmology, general injectable, peptides and oncology injectable from H2FY20. The company believes that while the number of new drug filings could stay at 18- 20 annually, the quality of filings/end market size would improve in coming years. This is evident by R&D as a percentage of sales that has increased from 6% in FY16 to 12% in FY19-20.
Positives
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Increased R&D expenditure and capacity addition augurs well for future growth
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Above average profitability indicates profitable growth till now, we expect it to continue
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Diversified business across geographies and therapy areas.
Risks
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Delays/rejections in filings for the US market can reduce return on investment in new capacities and R&D.
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Concentration in select products in domestic market can bring down domestic market growth rate.
Valuation
In pharmaceuticals, various companies have different composition of geographies, formulations and APIs.
India business is more profitable i.e. ROE% and enjoys high valuation. We already recommended Lupin and Cipla whose valuation is largely driven by domestic business. Complex generic is second best category with good margins and reasonable ROE.
Parameters of individual segment. Every company will have different mix of these segments
APLLTDis scaling up its business in Generics and Complex generics in global markets. The company is investing into new plants and will be filings series of complex generics.
At current price, APLLTD trades at 22x 1 year forward P/E ratio. We believe with expected growth rate of 15% CAGR over next 3 years, it may trade at expensive valuation. We would like to add to company near Rs. 750/share. However, you can add small portion today and add more at lower prices during market volatility.
We recommend investing upto 3% of portfolio in APLLTD and ensure you do not exceed 20% of portfolio in Pharmaceutical sector.
When a sector gets a tailwind, larger and bluechip companies tend to rally first. For those who missed them can look at other mid-size companies which may not have the best products line up but good growth and improving prospects. These might be riskier than bluechips but compensate for that risk with more upside due to cheaper valuation or better growth rate. Allocation must be limited to such companies.
