BofA Reinstates Coverage On Gland Pharma, Glenmark Lifesciences With A 'Buy'; 'Neutral' On Divi's Labs

BofA Securities has reinstated coverage on Indian active pharmaceutical companies and contract drugmakers citing lower pricing risk and growing opportunity.

It has a 'buy' rating on Gland Pharma Ltd. and Glenmark Lifesciences Ltd. and a 'neutral' call on Divi's Laboratories Ltd., the brokerage said in its report released on March 23.

While most large Indian pharma companies may not fall in the "defensive play category" of good returns on low risk, the report said two categories have seen significant rerating over the last five years:

• Indian active pharmaceutical ingredients/contract development and manufacturing companies.

• Domestic market-focused pharma companies.

According to the report, the Indian API/CDMO companies have gained favour since they face a lower downside risk to the U.S. generic downcycle. By comparison, the growth outlook for most generic-focused Indian pharma companies is sensitive to factors like price erosion, new approvals, competition in key products and U.S. regulatory scrutiny.

The dependence on China for bulk drugs and increasing share of Asia in CDMO offers an opportunity for Indian companies, the report said.

Source diversification driven by “China-plus-one” strategy and the government’s production-linked incentive scheme for bulk drugs creates a large domestic market for API players, it said.

This growth opportunity is also reflected by the planned capital allocation by API/CDMO companies to support higher volumes in existing portfolios, portfolio expansion, and backward integration for critical products.

However, the effort to de-risk the supply chain has to be supported by scale and cost competitiveness to ensure sustainability, even if China capacity were to come back, it said.

Key highlights of BofA Securities report of select pharma stocks:

The report said while Divi's Labs trades in line with global peers, Gland Pharma is at a discount given its generic focus. Glenmark Lifesciences offers a favourable risk-reward at the current price.

"We are below the street on Ebidta margins for Divi's and Gland Pharma," the brokerage said.

• Reinstated 'buy' with a target price of Rs 3,800 apiece, implying a potential upside of 19%.

• Pure-play generic injectable manufacturer with its B2B model differentiating the company from Indian pharma peers.

• Model allows it to capture increasing focus by generic peers on U.S. injectables as well as the rest of world’s institutional business.

• While the U.S. is a core market for the company (55% of sales), the model limits the impact from price erosion and dependence on new launches, therefore providing better earnings visibility.

• Gland Pharma is among the largest injectable manufacturers globally, which allows the company to leverage its portfolio to build scale through new partnerships and geographical expansion.

• The company is investing for growth beyond FY24 through complex pipeline investments, China expansion, and biosimilar CMO.

• These could drive inflection in earnings momentum which are not fully captured in estimates.

• The volume growth augmented by new launches should help drive 20+% earnings per share growth over FY23-24, and sustain premium valuation vs large cap pharma.

Upside To Estimate

• Faster scale-up of its complex pipeline after approval, given the large customer base.

• Monetisation of the China pipeline to gain momentum by end FY24.

• Best positioned to capture the biosimilar CDMO opportunity leveraging on its manufacturing capabilities.

Key Risks

• While the geopolitical risk cannot be ignored given Fosun Pharma’s holding, the brokerage sees limited impact on operating performance or capital allocation in case of adverse events.

• Reinstated 'buy', with a target price of Rs 665 apiece, implying a potential upside of 47%.

• The company is a pure-play API manufacturer with a nascent CDMO business, listed in June 2021.

• It focuses on high-value APIs reflected in its superior margins and returns vs mid-sized peers.

• While the company has a short trading history, the growth outlook for the company is reaffirmed by:

  -Significant investment in capacity expansion (~30% addition in FY23).

  -Cost improvement initiatives.

  -Focus on complex molecule pipeline.

• These factors should reflect in earnings growth from second half of FY23, driving 18% EPS compound annual growth rate over FY23-24 factoring cost headwinds.

• Long-term growth potential is strengthened by its greenfield capex, expected to be commissioned by FY25 to augment growth in APIs and high-margin CDMO business.

Downside Risk Ro Estimate:

• Delay in completion of capex.

• Higher pricing pressure in large molecules, moderating margins meaningfully below current levels.

• Increase in cost pressure.

Key Risks

• Short trading history and related party dependence (40% of sales).

• However, the brokerage said these are factored in its valuation (12.5 times its FY23 estimated earnings versus 14-15 times for mid-sized players).

• Reinstated 'neutral' with a target price of Rs 4,550 apiece, implying a potential upside of 2%.

• The company has a strong execution track record from its core business.

• Its model focused on APIs (mix of CDMO on innovation and mature generic supplies) insulates its earnings from U.S. generic headwinds.

• While this could support premium valuations, the risk to earnings in a normalised post-Covid business environment is not factored into consensus estimates (BofA ~12% lower).

• The solid margin performance in FY21-22 due to higher Covid-19 related demand and Molnupiravir will normalise over the next few quarters leading to lower margins, particularly in an elevated cost environment.

• While some contribution from Covid-19 drug development by big pharma is expected to continue, the opportunity size could be lower than recent quarters.

• The company is trading at 47x (FY23 EPS), which is at a meaningful premium to its five-year average.

• Inflection from current multiples will be tough without catalysts indicating a step-up in growth/margins.

• Medium-term growth outlook could be supported by:

  -Its process development skills, specialised chemistry capabilities, large capacities and backward integration.

  -Disruption in China supply chain and source diversification by global players.

  -Capacity expansion.