Pharmaceuticals - Double-digit growth sustained - Edelweiss

Q2FY13 was a robust quarter for pharma sector with all round performance (domestic: 18%, US: 60%, ROW: 28% and EU: 22% YoY) and continued gains from higher currency realisations (19% YoY depreciation). EBITDA surge of 40% was triggered by improvement in core margin on strong operating leverage (EBITDA margin up 200bps YoY) and favorable currency. Despite higher tax out go (23.4% versus 20.0% in Q1FY13), PAT surged 39% YoY and primarily reflected core operational performance (recurring PAT growth of 33%). Within CRAMs, volume expansion and currency benefited growth. Within our coverage universe while Dr. Reddy's (DRRD), Cipla, Glenmark (GNP) and Aurobindo (ARBP) reported robust performance, Cadila (CDH) and Ranbaxy (RBXY) disappointed.

Robust all round growth

The pharma universe continued to outperform with 28% revenue surge, driven by 18% growth in domestic, robust traction in US (60%) and notably higher traction in ROW/EU. While recurring business grew 25%, one-off contribution from Actos, Doxil and Lexapro belied expectations. Domestic growth of 18% was strong, but could taper in H2FY13 as low base effect recedes (higher base of H2FY12 at 18% versus 12% in H1FY12).

Strong operating leverage, favourable currency pep up margin

Our universe's EBIDTA margin catapulted 200bps YoY and 77bps QoQ riding favourable currency and strong operating leverage. While DRRD, Cipla and ARBP posted highest EBIDTA margin improvement, CDH, Torrent, RBXY and GNP depicted QoQ contraction. Spurt in R&D costs (8% of sales versus 6% in Q1FY13) had negative impact on margins of Glenmark and Cadila, while disruption in Brazil eroded margins of Torrent.

DRRD, ARBP and Cipla key outperformers

Despite lower currency realisations (hedges at INR49), DRRD was an outlier with strong swing in margin (430bps QoQ) led by sharp growth in US. Similarly, ARBP's margin improved sharply (500bps QoQ), again led by scale up from launches in US. Cipla benefited from better product mix, currency and continued Lexapro sales.

Valuations: Strong growth visibility over H2FY13

Given strong H2FY13 earnings growth visibility led by: (a) continued benefit from currency realisation (which remains stable at INR53 (Oct-Nov 2012) versus INR54 in Q2FY13); and (b) increase in number of launches (including FTFs) in US, the valuation is likely to sustain at the current level. However, we see limited upside due to pricing policy overhang. Moreover, pace of growth is likely to decelerate in FY14 owing to fewer drugs going off patent. Hence, we saw a couple of M&A activities including DRRD's acquisition of Octoplus and SUNP's acquisition of DUSA, to augment the US product pipeline. Our top picks are Lupin and CDH among large caps, and GNP and IPCA among mid caps.

Source : Equity Bulls

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