The Daman inspection outcome remains a concern. We factor in lower US sales to factor in delayed approvals and, accordingly, reduce EPS estimates for FY19F and FY20F by 13% and 9%, respectively. We reset our 12-month price target at Rs 2,089/sh (down from Rs 2,298/sh) based on 22.5x FY20F EPS (methodology unchanged). Our target price implies 17% potential upside from current levels. Hence, we upgrade to Buy.
The domestic formulation business is a significant contributor to earnings and valuations. Alkem’s domestic business contributes 87-93% of Ebitda over FY18-20F. Alkem has sustained growth ahead of the broader market over the past four years despite higher dependence of acute segments and impact of price control. On a lower base of FY18F, we expect Alkem to record 14% CAGR over FY18-20F. Assuming 4x FY19F sales, the domestic business contributes 88% to our target price, in our assessment.
Since the Daman inspection, Alkem stock has lost Rs 400 mn in market cap, 2x its current US sales. We think the stock correction factors in delay in approvals and high possibility of a warning letter. In case of a warning letter, we expect 7% cut in earnings in FY20F. We don’t expect escalation into an import alert, which can adversely impact FY20F earnings by 18%.
Valuations
Alkem is trading at 23.6x FY19F and 19.2x FY20F EPS estimates. The valuations are at 4%/10% premium to peers. We expect premium valuation for Alkem due to significant high contribution from India business and scope for Ebitda margins to expand beyond FY20F. As capex intensity reduces, free cash flow is likely to rise. The stock trades at FY20F FCF yield of 4%.
Concerns remain on the Daman formulation site
ALKEM stock has corrected 11% (vs. Sensex +4.3%) since the issuance of Form 483 at the Daman formulation site on 27 March 2018. We expect uncertainty around the inspection outcome may remain over the next 3-6 months. As per the new procedure followed by USFDA, the agency strives to communicate the inspection classification – OAI (Official Action Indicated), VAI (Voluntary Action Indicated) or NAI (No Action Indicated) – to the facility owner within 90 days. In the case of OAI, enforcement action in the form of a warning letter or an import alert is expected to be initiated within six months of inspection.
India business should sustain growth ahead of broader market
Over FY14-18F, Alkem recorded CAGR of 11.8% vs. industry growth of 10.6%, as per AIOCD data. Strong execution has a key role to play in outperformance vs. the broader market. We expect this to be sustained for the following reasons:
We expect the management to continue focus on execution. We don’t expect ceiling price revision or expansion of price control list in any material way till FY22F.
Scope to expand market presence, particularly in chronic therapy areas.
Geographic expansion is a possibility. Alkem has stronger presence in East India and is consistently trying to expand presence in other geographies.
Expansion in OTC segment and pursuing in-licensing deals.
Source: financialexpress.com