Green shoots in Indian pharma sector: US generics, specialty drugs drive recovery, says HDFC Securities

Pharmaceutical companies, which witnessed tumultuous times in the past two years owing to the pandemic and geopolitical unrest, are witnessing fresh signs of recovery, according to a report by HDFC Securities.

The report pointed to green shoots in the US business and an overall stabilisation in costs. Such positive indicators have seen the BSE Healthcare Index outperform the Sensex by nearly 25% in the past year.

A significant growth driver is the US generics market with the report predicting steady growth momentum due to moderating price erosion, lesser competition, and new product launches. The loss of exclusivity (LOE) presents a sizeable opportunity of over $100 billion for generic companies over the next five years. "Increasing focus on the specialty business will create differentiated pipelines targeting chronic and niche therapies," stated the report.

Sun Pharma and Zydus Lifesciences have already capitalized on this, with Sun Pharma's specialty products Ilumya, Winlevi, and Cequa leading the way. Other big players in the market, such as Aristo Pharmaceuticals, Dr. Reddy's Laboratories, and Laurus Labs, are following suit with specialty franchises, the report said.

The HDFC Securities report initiated a 'BUY' coverage with Sun Pharmaceuticals for steady growth underpinned by specialty upscaling and Zydus with a clear visibility of US growth. "We believe domestic formulations can expect steady growth led by volume recovery, price growth, and new launches," it said. Leading companies here are predicted to outperform the Indian Pharmaceutical Market (IPM).

The report further indicated an improving profitability scenario that will strengthen balance sheets for the leading companies in the sector who are reportedly looking for mergers and acquisitions of specialty assets to fill portfolio gaps.

However, their assessment also expressed caution concerning the scope for further rerating given the outperformance of the BSE Healthcare Index versus the Sensex.

Despite concerns regarding recent cost spikes, improved profitability is anticipated as input costs begin to moderate, leading to stronger balance sheets for leading companies like Sun Pharmaceutical Industries Ltd. and Zydus Cadila. This has promoted a climate conducive to merging and acquisition activities, effectively filling portfolio gaps with specialty assets.

However, while the generic pharmaceutical industry remains positive about US growth prospects, the HDFC report remained cautious about valuations with restricted opportunities for further rerating due to the outperformance of the BSE Healthcare index over the Sensex. It, therefore, urged investors to embrace structural and near-term opportunities carefully.

For Sun Pharmaceutical Industries Ltd., this leads to a predicted growth led by a scale-up in specialty, and Zydus Cadila, with a forecasted visibility of US growth/R&D allocation for niche pipeline. Meanwhile, the Aurobindo Pharma Ltd. is predicted to experience margin improvement and growth in the US market, motivating an ADD rating. However, HDFC Securities suggested a REDUCE stance for Lupin Limited and Dr. Reddy's Laboratories Ltd. due to factored-in key triggers and growth/margin constraints in the core business.