Near-term overhang for Alkem Laboratories' fast growing US business

Any adverse outcome of the FDA's observations will impact the company's overall growth

The Alkem Laboratories stock has shed about 9 per cent over the last few trading sessions after it received 13 observations from the US Food and Drug Administration (FDA) for its Daman formulations plant. The facility contributes about 30 per cent to the company's US revenues and accounts for 25-30 pending abbreviated new drug applications (ANDAs) out of a total pipeline of 60 ANDAs. The US contributes about 21 per cent of the company’s overall revenues. 

Analysts at Nomura say that observations are a concern and highlight that the system is not adequately equipped/staffed to carry out tests in a timely manner. Also, the observation raises concerns about data protection and reliability to some extent. 

The overhang from this is likely to stay in the near term given the timeline of three months within which the US FDA has to communicate its course of action. With a strong ANDA pipeline and plans to grow the US revenues at 20 per cent annually over the FY17-19 period, any adverse action will have a bearing on the company’s US and international revenue growth. From a low base and on the back of organic and inorganic initiatives, the international (largely US) business revenue with a presence in niche segments of dermatology, oncology and nasal spray has ramped up significantly growing at 37 per cent annually over the FY13-17 period. 

While the company is the sixth largest domestic formulations player with a market share of 3.4 per cent and has been outperforming overall pharma market over the last few years, its overall profit margins are lower than peers. Analysts at Axis Securities believe that higher share of acute business which has lower gross margins, US business which is neutral at the operating profit level, third party distribution business in the US and higher investment in the field force are reasons for the lower margins. However, they add that profitability should improve on the back of operating leverage, a higher share of the chronic portfolio and increasing share of own products in the US market. 

Given that over 70 per cent of revenues come from India, the near-term earnings growth will be driven by its domestic formulation business. The company posted 12.2 per cent growth in February led by anti-diabetic therapy which grew by 15.9 per cent, new product introductions and volume growth. Its growth was better than the overall pharma market growth which came in at 7.1 per cent. Though sales of the chronic portfolio are much smaller than the acute segment, it is growing at a faster pace and should help improve its market share and margins. 

At the current price the stock is trading at 21 times its FY19 estimates and investors should await clarity on the US FDA observations as well as March quarter numbers before taking an exposure to the stock.