Dr Reddy’s — up 19% this month. Lupin up 17%, Sun Pharma up 18%, Cipla up 16%, Cadila up 13%, Aurobindo up 9%. The list goes on.
Most pharmaceutical stocks, barring a few like Biocon, after underperforming for the past two years, have now rebounded.
But investors wonder if the rally will sustain. Is it supported by fundamentals? And have factors changed materially on the ground?
The following is a summary of some of the key issues that dragged pharma stocks down and where we stand currently.
US Pricing Pressure
Price pressure in the US, one of the key markets for the India pharmaceutical sector, has averaged 10-12% in the past two years.
The reasons are supply chain consolidation and expedited approvals from the US.
For example, in 2017, US Food and Drug Administration (USFDA) approved a record 1,027 drugs.
This rapid pace of approvals saved Americans $8.8 billion in drug costs that year. So by the looks of it, it seems the steps to increase competition will continue in 2018.
The USFDA actually announced more steps to increase generic competition, including measures such as resolving regulatory, scientific issues and expediting review processes.
But industry, it seems, is taking its own steps to adjust to this new normal.
A prominent example is Teva, the largest generic drug manufacturer in the world, said in May 2018, that it's exiting 80% of its generic portfolio in the US.
Reason: the US is becoming a ‘semi-commoditised’ market and competing on prices would impact its own profitability.
This concept of ‘product discontinuation’ or ‘rationalisation’ (where competition in products reduces as companies exit in order to conserve profits) is one such reason why generic prices might be stablising.
Jubliant Life, when questioned by billionaire investor, Rakesh Jhunjhunwala, in its Q4 call, highlighted this concept.
The company expects better volumes and prices due to rationalisation by large players in some products.
Lupin, in fact, said it rationalised its portfolio in the US and is constantly monitoring the practice.
Pricing pressure is expected to average 5-6% this year with some products being susceptible to more, according to analysts.
The expected levelling or bottoming out, has been corroborated by most managements in their Q4 calls.
For example, Cipla said price pressure is settling and it expects lesser price pressure than last year and Aurobindo said, it experienced price pressure limited to only 1% quarter on quarter (QoQ) and the direction is changing.
While there will be some companies that will probably see more price pressure than others due to the portfolio of products, the larger direction it seems is that price pressure might not be as severe as the last two years.
Analysts are looking at companies that have the most scope beyond generics.
Lupin is a shining example as the company recently launched the drug Solosec to treat bacterial vaginosis in women in the US.
The market is worth more than $700 million and falls under the branded category segment for the company (which means the company can market it with the branded name Solosec).
Lupin is confident of making more than $200 million from this branded product in the US.
Ditto with Sun Pharmaceutical. The company has three speciality drug launches — Ilumya (psoriasis), Seceria (for dry eyes) and Yonsa (prostrate cancer) — lined up for FY19-FY20.
In fact, Sun Pharmaceutical mentioned that its research and development (R&D) expenditure at 8-9% of sales is expected to increase in FY19, due to the allocation on its speciality portfolio.
The street doesn’t mind that, because the longer-term story for a pharmaceutical company is a portfolio of either speciality or complex products, where competition is lower and margins are higher, protecting it from headwinds such as price pressure.
Biocon too falls in this category as it outperformed peers due to its biosimilar portfolio, a success other companies are still trying to emulate in the US.
A few near to medium term opportunities to watch out for would be the limited competition that anti-opiod drug Suboxone of Dr. Reddy's faces, though it's currently mired in litigation.
Aurobindo’s antibiotic Ertapenem that could make the company up to $60 million in profits in one year and potentially Glenmark’s atopic dermatitis New Chemical Entity — GBR 830 — which could eventually be an outlicensing opportunity for the company.
There have been few compliance issues Indian companies have faced in 2018.
In fact, there have been more prominent examples of resolutions this year.
The most recent and significant example has been Sun Pharmaceutical's Halol facility.
The USFDA issued an Establishment Inspection Report (EIR) after its latest February 2018 inspection. The company indicated the three-year-old Warning Letter Issues have been solved.
Likewise, Alembic’s Panelav formulation facility secured a resolution. It was issued three observations by the USFDA in March 2018.
The street feared escalation of those observations, but the company received approvals and an EIR for the facility in June.
Other examples included Aurobindo’s Unit 4 injectable plant receiving a Voluntary Action Indicated (reinspection not required if remediation is okay) from the USFDA after being issued nine observations in February 2018.
In another cases, Divi’s Labs Unit 1, Dr Reddy’s API SEZ plant and Cadila’s Ahmedabad unit, which were all inspected with zero observations.
However, issues remain. Cases in point: Alkem’s 13 observations to its Daman unit, re-inspection of Lupin’s Goa and Pithampur 2 units and remediation of Dr Reddy’s Srikakulam API and Duvvada facilities.
In one of its recent notes on pharma, brokerage CLSA indicated that Indian pharma growth in May was 10.9% year-on-year.
The sector has bounced back to normalcy after disruption caused by the Goods and Services Tax (GST).
CLSA expects the recovery in India to support earnings growth revival for pharma in FY19.
The note largely reflected the commentary of companies post Q4.
Lupin, which gets over 25% sales from India, has seen an 11% compound annual growth rate (CAGR) over the past four years.
The company believes India along with Mexico and South Africa would be at the ‘high end of the spectrum’ in emerging markets, with India poised to grow around 15%.
Cipla, whose revenue growth in India was adjusted of 21% in Q4 due to GST, has set a billion dollar consolidated revenue target for the domestic market in FY19.
Other companies echoed similar thoughts.
Glenmark said, except the US, growth in other geographies should be 10-15%.
Alembic gave a guidance for higher than industry growth and Alkem, whose revenue adjusted for GST grew in double digits, is expecting mid-teen growth in FY19.
But there are risks.
The biggest is price control. There is fear that the government could take steps such as linking annual price increases in medicines to the Wholesale Price Index (WPI) inflation index or even create a separate pharma index for it.
Such a step could be a double whammy for pharma companies — lower prices in the US and potentially in India will curtail the ability of companies to invest in R&D and spur future growth.
Lastly, valuations. Due to the recent run-up, many stocks, barring a few such as Aurobindo (another article is needed for that one) have reached close to their historical valuations of 21-24x of one-year forward price to earnings.
The other view point, which fund managers are making, is comparing these pharma stocks to fast-moving consumer goods (FMCG) valuations.
Both are a play on the domestic consumer story but pharma valuations are half of the 35-45x FMCG companies enjoy.
So maybe for many reasons stated above, pharma is seeing a renewed interest and maybe they will catch up to their 52-week highs but a sustained rally will depend on delivering on earnings. That, only time will tell.
Ekta Batra is an anchor and associate editor, research at CNBCTV18. She has been tracking pharma and healthcare for almost a decade.