Pharma || Hospitals || Diagnostics : Industry perspective

Q&A: Questions & Answers
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Indian Pharma has done very well in the last few years but as the industry matures it becomes important to have an overview of the entire industry. Overall industry view will help us understand the investments in terms of R&D and capex at the same time will help us see how the opportunity is evolving for the sector as a whole.
It will also help us broadly identify how the competitive intensity emerging in the sector.

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Some data points:
a) Overall opportunity is not increasing significantly. The amount of drug patent expiry (147 $bn) in next 5 yrs is less than what it was in the last 5 years(214 $ bn).
b) Significant investment happening in R&D and capex.
The entire R&D spend (of which USFDA filings are a major contributor) in last two years (15700 cr approx) is almost the same as the R&D expense for the previous 5 years together (16200 cr approx).
The Cash flow from investment as per Screner.in in last 2 yrs is -25000 cr vs -19500 cr for previous 5 yrs (some of it might have gone for acquisitions as well) but still there is huge capacity coming up.
c) The amount spent in R&D and Capex building would clearly result in lesser exclusivity and higher first day competition on launch.
d) The above set includes data from only few indian companies and does not include some major US generics companies like Teva, Mylan etc.
e) Many of the investments of the above companies going to onco
f) The regulatory(FDA) risks are increasing significantly
g) There is considerable pressure in US to reduce healthcare costs. There is high possibility they go german/european way of going by tenders. Even the Indian generics industry is undergoing considerable drug price control.
h) Many of the Indian companies are not investing in the biologics currently.

Views invited.

Links:

Don’t have capex data for fy17 as annual reports are out.

Disclosure; invested in shilpa,alembic,divi

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Pharma companies not exporting their Medicine to USA? Pls do share names of such companies. No Need to worry about US FDA. As Pharma Sector is undervalued at this moment.

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RJ veiw on Pharma from the above interview:

Q: You said pharmaceutical also perhaps at the bottom at this point in time. What gives you the confidence that we are going to see a revival there?

A: There are three factors why the bearishness. One is the genericization which Government of India is claiming which I think is a night-keeper’s dream. You can do genericization if you have a control on the quality of the manufacturer.

Q: So, you do not agree with the move towards to moving to generics?

A: It is impractical. I do not say agree or disagree, I say it is impractical; it is un-implementable because you do not know the quality of who is making where, what.

Q: What about greater price control?

A: Greater price control, they are having price control --50 percent of the materials are already under price control. Second thing is the problem of erosion and enhanced competition and consolidation in America. That is coming to a climax. And third is your rupee. I personally feel rupee will also go back to 66-67 per dollar levels. So, I do not say they have bottomed. They might have bottomed, but they might be in the process and I can be wrong.

Q: But, what about the Food and Drug Administration (FDA) related issues that most Indian companies seem to be burdened by?

A: I think it will be a legacy issue because more than a technical issue, it was a cultural issue. But now Indian companies have realised that you have got to be very careful.

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Thanks Anant for starting this thread. There are few observations for US and domestic markets from my end as well:

  • Increased competition leading to severe price erosion: As discussed with some industry sources, they indicate that lot many players get Day 1 or FTF launches post exclusivity/expiry and some of the companies (including one which files for almost all the products possible :slight_smile: ) erode price to 98 - 99% during the first few days of launch itself. Earlier, even if there were 5 - 6 players, the price erosion used to be gradual and companies used to make decent money during the first few months. This has led to shrinking of margins for the US market which used to be pretty decent earlier. The margins have shrunk to almost as much as some companies generate in the Indian markets.

  • Increased bargaining power of the customers: The consolidation of large pharmacy retail chains in US has led to increase in their bargaining power. Earlier, even if there were not many big bang launches for any company during a year, its base business used to remain steady. These customers now come to the generic companies every year to renegotiate the contracts and ask for price cuts. This has led to the erosion in base business as well.

  • If everyone spends more on R&D and work on complex therapies (oncology, dermatology etc), will these segment remain attractive?: Thats the question which has been lingering in my mind since last few weeks. If most of the large and mid sized pharma companies are increasing their R&D spend and incurring huge capex for entering into new segments like oncology, dermatology etc, will these segments remain as attractive as they seem to be now? However, as per the same industry source, the opportunity in oncology generic during 2022 - 2023 is huge and lot of companies will be able to make good money during that period.

  • Domestic market is also facing lot of challenges: Last two years have been tough for many pharma companies in domestic markets as well. There have been lot of uncertainties from government policies. DPPO and NPPA has led to pricing caps on the drugs being sold in the market. Furthermore, the ban on FDC during last year came as a shocker for many companies manufacturing them. They were not even given a single day to clear off their inventory at company or stockist levels. GST again can be big challenge in the near term with stockists refusing to keep inventory till July. Furthermore, the announcement of ‘generic medicines’ also sent shivers to these companies. It might seem impractical to implement such policies in India, however, companies manufacturing branded products do get scared out of it.

Furthermore, most of these companies are trading at rich to moderate valuations (I agree that their earning are depressed because of higher R&D cost, however, I am not sure how much value to attach to R&D!) and see US as the next growth driver for them. How they do going forward is something that only time will tell!

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Strategically what would make sense given the outlook is some amount of consolidation through M&A. But while it is happening in the international space, there is no sign of it among the Indian players. Sun pharma is probably the only one with size to be able to buy outright paying cash. But even a few mergers among the mid size players would lead to rationalization of redundant R&D spends and also reduction in the competitive intensity leading to rapid price erosion. But I guess the main roadblock is that most of these businesses are family owned and the promoters might to reluctant to give up control especially considering the companies are still quite profitable and remunerative to the promoters in a lot of ways.
The IT companies, even the professionally managed ones missed a trick by hoarding their cash when they should have acquiring new capabilities. Let’s see how the pharma guys handle these challenges.

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As far as i have researched there are three reasons why market turned bearish on Pharma companies -

1) Price Erosion -
Margin / Competition on new generic launches - Unlike before in today’s world drug companies are ready with generics as soon as patents expires. hence they making less margin on new launches today compared to years before.
Less Drug Patents Expiring - As mentioned by others the overall patents expiring are less in next 5 years compared to last 5 years.

2) U.S Food and Drug Administration (FDA) - Very well knows problem but this should be intermediary & hopefully short term. As it seems fixable & it will only make companies better.
One of the prime reason FDA pushing hard on Indian companies is they want them because significant portion of Budget of U.S government goes into Healthcare & Indian companies play a huge role in bringing generics into the U.S markets which helps bringing drug prices down.

3) Rupee & Regulatory - Nobody can guess whats going to happen to exchange rate and RJ comment on regulatory issue is very logical.

Bullish case scenario -

Best time to buy is when there is lots of uncertainty - Provided
1st) Business is good and you believe it will keep growing.
2nd) Management are able and has shown the ability to handle the bad tides in past.

I think the Pharma business is a quality business and it will continue to grow because of two primary factors - 1) Demographics - World population is getting older and older specially developed counters. No brainier old people consume more medicines.
2) World population will continue to grow - i was reading we will reach $9-10 billion by 2050, i don’t know but that trend with average age of people going up should be a natural tail wind of Pharma companies.

How about Management ?

I was looking are share prices of Sun Pharma , Glenmark & Dr Reddy etc all of them have fallen almost 45-50 % from their peak.
Wow this makes me always wonder was markets over bullish before or are they over bearish now ?
Why markets behaving like the end of the world for Indian Pharma Companies ?

I think there should not be any doubt about the Management of these companies. They are more competent than any other industry in India today (Specially compared to chemical industry which everybody is buying like its was hidden gold).

Its hard to value these businesses today as there are lots of uncertainty but certainly its not the end of life for these businesses like in Tech disruption ended life of Yahoo , Kodak (may be Infy TCS join soon) etc.
There is no disruption here and if there is its going to be slow because of very nature of this business as anything new (Related to DNA , Stem cell all these biologic’s stuff - https://www.youtube.com/watch?v=T0-4ArvrHUo) going to take lots of time to be adapted completely because you have to prove first over mouse then over human that there no side effect for 25 -30 years to completely replace today’s medicine .

I think markets are always wrong on the Up side (two years back in pharma companies) & on the down side today.
Whenever great businesses fall 50% historically it has been the great opportunity to buy.

I hold none of these pharma companies & never bought them as i never understood their business but since there is no value elsewhere in market today i have just starting learning about them.

Research report on Glenmark by HDFCSEC
http://www.hdfcsec.com/Research/ResearchDetails.aspx?report_id=3022594

http://www.hdfcsec.com/Research/ResearchDetails.aspx?report_id=3022379

Thanks,
Dhruva

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This is a good discussion on the opportunities (or lack thereof) available to Indian pharma companies and their ability to capture them etc. As investors we have to balance the trade off between rewards of investing and risks that come with it. I want to add some discussion to the risk side of equation.

Over the last two decades pharma companies have delivered consistently good results. Investors generally pay a high price for consistency as uncertainty creates volatility which is considered risky. Pharma not only gave consistent results like an FMCG company but those results were also good like a growth company. Combine those two together and you had a sector that was selling for 30+ PE ratio.

Both these factors are slowing changing. Increased FDA oversight is causing higher incidences of 483s along with the associated stock price volatility and cost of remedial measures. Larger companies also need more and more blockbuster drugs just to post double digit growth numbers. They will have to increase their R&D spend just to maintain revenue targets. Not all of these R&D will pay off. that itself will add to volatility. Larger companies have higher R&D budget so they will squeeze smaller ones.

The point I am trying to make here is that rewards have gone down while risks in the pharma sector has gone up and current valuations have not yet fully priced in these risks. Until the valuations reach a level where rewards are in line with risks, the sector could continue its secular decline.

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However much we may dislike - “Generics growth is slowing across markets”. From the horse’s mouth.

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Source: http://corporates.bseindia.com/xml-data/corpfiling/AttachLive/e6292965-9f06-4161-b6db-371379cc37cb.pdf

Mr Market is telling us something…

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Source: Bajaar

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Japan with highest life expectancy, high income and ageing population has an expected growth rate of 7%. Other developd nations should be below that.
I think the opportunity has shifted to emerging markets from developed markets and from formulations to API (where margins and opportunity size are low).

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You mean to say from API to formulations? or…

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sorry to come in between if that could be the case the companies who have large API facilities could benefit,

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No. I mean from formulations to API. There is a lot of competition in the formulations space as there is more opportunity there. Also anyone in formulations will not get into API as customers for APIs will be competitors in formulations. Although Divi’s into API and they have a strongest margins in the industry (before the recent issues), I think overall opportunity size is small in API.
It’s because of the increased competition in formulations, I think there is opportunity in API and even bulk drug if you are the lowest cost manufacturer.

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One side street is worried about generic- generic movement by Gov over branded generic but they are bullish on other sectors due to GTS as they say unorganized to organized going to happen.

Well if GST going to promote organized players (branded generics) over (generics generics ) then why pharma companies catering to only India markets are down ? I see huge correction in MNCs listed pharma subsidiaries in India. Which i think is over done.

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https://www.outlookbusiness.com/the-big-story/lead-story/under-the-weather-part-1-3574

https://www.outlookbusiness.com/the-big-story/lead-story/under-the-weather-part-2-3606

Decent read in Outlook Business on challenges faced by Pharma companies in domestic market.

MNCs have more dependence on brands compared to domestic players -

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Branding leads to higher realisations and it might be under pressure after generics order.

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Cadila Healthcare Ltd. has become India’s second most valuable pharmaceutical company surpassing Lupin Ltd.
Cadila rose 10 percent on Wednesday, adding nearly Rs 5,000 crore to its market capitalisation. The surge in June has been driven by product approvals by the U.S. drug regulator.

Source: Bloomberg

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US FDA plans to ease market entry of generic drugs:

Easier US generic drug access can be a double-edged sword:

I believe the U.S health care budget will continue to go up and if you compare the size of Indian drug companies with that of U.S the push towards generics by FDA could help Indian companies gain market share from the U.S counter parts. Well there will be price erosion but there will be more approvals too as we have been seeing lately.

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I agree to many points of @Dhruva1705

At any point of time, the market has good news and bad news. When the market is booming, the media has a tendency to highlight positive factor, completely ignoring negative factors. However, when the overall market is bad, media has a tendency to highlight severe or extreme scenarios about the overall market. Believe it or not media influence largely on the short term investment sentiments after all majority of the investor/MF managers read the same newspaper and watch the same channel.

Someone has said, “Man is not a rational animal but rationalising animal”. One could question if their doomsday reports about pharma sector are rational stories (probably are) or the media is rationalising the correction in stock prices for the major pharma stock and bring in stories to support the case.

Thinking about question – “How much market know about the stock or sector?”, and I would argue that market often gets it wrong when it comes to knowing. For example, due to demonization, there was a fear in the market that there will be many of default for the loan against property, which resulted in prices correcting considerably for some bank exposed to this sector. Fast forward 6 months, there is not much talk about it. In fact, some of the same beaten down stocks have appreciated more than 50% (or doubled e.f DCB Bank).

Coming back to Pharma, I think is an open secret that a lot of stocks are down 40/50 %, their PE has contracted much and coming considerably. Based on the commentary from Sun Pharma, they are looking for de-growth. However, I am not sure if it structural in nature for the industry or it is Sun Pharma specific.

In my view, some of the pharma stock coming down and offering a good valuation. I am not sure if they go down further, probably yes, but based on their current prices, a lot of negatives is priced in.

Many of pharma companies (Dr Reddy, Sun Pharma, Divis Laboratories) have good competitive advantage, in term of R&D and processes. In the short term, US FDA has shattered their high growth aspiration, but the same US FDA could become their competitive position. It is not easy to get approval from US FDA, so the company who has approved plant could still command higher prices for their product and it is not easy to get new plant US FDA approved. Even though the US buyer market is consolidating, if there are fewer suppliers in the market, it is not a one-way street for the supplier.

Note- I have a small position in some of the stock I have mentioned above.

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India Pharma and FDA woes.

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The development comes as a double-edged sword for Indian drug makers. In the short to medium term the approval rate will gather pace, however in the longer term generic makers will have to face significant pricing pressure due to increased competition.