Hospitals could face some challenges in near term as occupancies could remain low on account of lockdown. However, this sector should emerge much stronger post pandemic with better cost structure and margin profile.

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Following tailwinds will help sustain the current earnings momentum and maintain pharma sector valuation over next few years-:

1) Improved pricing environment in the U.S.

2) Better visibility on pipeline and launches

3) Higher demand for APIs (Active Pharmaceutical Ingredient)

4) Upside from Covid-19 related drugs (Remdesivir, Favipiravir )

Citi’s view on Dr. Reddy’s Labs, Apollo Hospital and Laurus Labs

1) Citi raised target price on Dr.Reddy to Rs 6060 (17% upside potential)

2) Citi raised target price on Apollo Hospital to Rs 2740

3) Citi downgrades Laurus Labs to Sell from Buy rating with target price of Rs 260  

Citi raised target on Dr. Reddy’s Labs due to better earnings visibility and to factor in Revlimid value

Strong pipeline and momentum in Covid-19 drugs should keep their earnings momentum strong. Dr. Reddy’s is the only Indian company among the large sector peers with all the facilities compliant with U.S.FDA.

The company will benefit -:

1)      They have strong U.S. pipeline with multiple complex generics and an increased approval flow

2)      Tailwinds from Covid-19

3)      Strong momentum in non-U.S. markets

Dr. Reddy’s launch momentum has picked up in the U.S. market. Company had launched 25 products in FY20 and another 25 to 30 new launches are expected in FY21. Company’s strategy of growing non-U.S. segments by leveraging its U.S. pipeline and R&D strength is paying off extremely well.  

Citi raised its target on Apollo Hospital 

Citi expects better margins from healthcare services and good upside from Apollo 24/7. Also, Citi expects potentially strong EBITDA growth from pharmacies and likely ROCE improvement. Post pandemic Citi expects hospital business to come out with a much better margin profile driven by improved cost structure. Company is expected to sustain a significant part of cost savings that it has initiated during this period. Businesses in Pharmacies have appeared to be more resilient during Covid-19 with 27%/44% growth in revenue / EBITDA over the past six months. Company is targeting 100 mn subscribers from Apollo 24/7 revenues of over $500 mn in the next 5 years from this vertical. Citi assumes there would be gradual recovery in hospital occupancies in near term.

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Citi downgrades Laurus Labs

Citi believes current valuations are more than factoring in the potential step up in the revenues and margins. Also, inherent risk of an abnormally high exposure to ARVs (antiretrovirals) where the growth would likely peak out with lower margins seems to be underestimated. Current pricing is unlikely to sustain and hence margins will come down eventually, pulling down overall margins of the company. Citi says margins will decline by 400 bps over FY21-23E.

(Authored by Rahul Kamdar)