More Pain

Pharma stocks continue to underperform as policy uncertainty adds to the toll taken by USFDA and market challenges.

The Big Pharma of India is passing through turbulence after hitting the jackpot with generic drugs and ingredient making. On November 7, 2017, Mumbai-headquartered Lupin informed the stock exchanges that two of its manufacturing units in Goa and Indore had received a warning letter from the US Food and Drug Administration (USFDA) and consequently, its shares went into a free fall. The stock hit a 52-week low, losing a market capitalisation of `7,871.8 crore in just one day. It was a steep slide from its peak at Rs 94,856 crore just two years ago when the scrip traded at around `2,000. But even before that announcement, there was a deluge of analyst reports that highlighted the firm's weak financial numbers.

On October 30, for instance, Credit Suisse analyst Anubhav Aggarwal said in his report (up on the Lupin website), "We factor the weakness of US sales and cut FY18/19E EPS by 4 per cent/7 per cent. We reiterate that Lupin has high risk and FY20 profit is likely to be flat as (1) 10 per cent of FY19 profit is from Ranexa exclusivity; (2) Aurobindo and Nostrum will enter the Fortamet market by FY20; (3) Sun should have entered Glumetza by FY20; (4) we expect more competition in Levothyroxine as well. Therefore, the stock is already trading at 20.5x FY20E EPS."

Lupin is witnessing falling sales in the US, its key market that accounts for more than $1 billion or over 40 per cent of the company's total sales). Lupin is the second most valuable company after Sun Pharma, in the BT 500 Pharma and Healthcare sectoral ranking; overall, it ranks 42nd, a sharp fall from the 27th spot last year.

But Lupin is not alone when it comes to shrinking sales or sluggish performance on bourses. Most companies are now trading at less than 50 per cent of their peak share prices two years ago. Sun Pharma used to trade at around `1,100 at the time while Lupin was at around `2,000. Earning forecasts made at the time for the current period have also been trimmed by 50 per cent. All this is bad news for the country's $32 billion pharma market, two-thirds of which is controlled by the top 20 which account for nearly 75 per cent of the US exports.

"From a US perspective, there have been pricing pressures, and some of the companies are facing regulatory challenges. On the domestic front, several policy changes and the uncertainties around them seem to have an impact on stock prices. Markets tend to look at the future; therefore, uncertainty is bad," says Pankaj R. Patel, Chairman of Zydus Cadila and President of the Federation of Indian Chambers of Commerce and Industry. "There is nothing wrong with the sector structurally. What is happening is triggered by a combination of several factors."

All Is Not Well

A deadly cocktail of three adverse factors is responsible for the gloomy picture. First, the USFDA hurdles. Leading companies - the likes of Sun Pharma, Lupin and Dr. Reddy's - have all been hounded by it. Second, channel consolidation in the US. Today, only four large wholesalers and chains source generic drugs, compared to about a dozen three years ago. It means they have tremendous bargaining power that puts more pressure on pricing. The net effect, coupled with fierce competition among manufacturers, produces another piece of data that is troubling most players operating in the US. A company's base portfolio (the main drugs it launched, say, a year ago) is getting eroded by 10-12 per cent every year. But the firms facing regulatory challenges are unable to cushion it with new product launches as they have trouble getting marketing approval in the US.

Back home, companies are also facing rapid tinkering with regulations, and the draft pharmaceutical policy is not making things easier. The proposal underlines a constant move towards price control and focusses on generic drugs without much being effectively done about quality control or allaying fears on the potential entry of spurious drugs. Even though the draft talks about inspections, companies are far from convinced on the checks, given the manpower and infrastructure challenges that the regulators have to deal with. (More on that later).

Failure on the research front is another crucial factor. Instead of chasing basic drug discovery, many companies are now putting their resources behind more predictable innovations on existing generics in a bid to gain market share with products that have limited competition.

For most firms, about 80 per cent of the total profit comes from the US and India. So, a closer look at the giants will further reveal if they have really landed in deep water. Sun Pharma, India's largest drug maker by market cap, had seen its share price tumble more than 50 per cent in two years from its all-time high in April 2015. Founder Dilip Shanghvi, once the richest man in India, saw his net worth take a big hit. Worse still, the company is still dealing with a warning letter from the USFDA over violation of manufacturing norms in its major plant at Halol in Gujarat. Sun is developing a pipeline for speciality products, but to what extent a pure play generics company can transition to a complex ecosystem is yet to be seen.

Cipla, with around 40 per cent of its total sales coming from India, is facing two major challenges. One, navigating the policy uncertainties at home, including the possibility that more drugs will come under price control. It should also scale up its business in the US, which accounts for about 17 per cent of its total sales. The company must build predictability on high-margin product launches to stay ahead in that market.

As for Dr. Reddy's, only one of its three plants faced with the warning letter has been cleared. But its key injectibles unit at Duvvada, Visakhapatnam, is yet to close a USFDA inspection. It invests more into R&D than most of its peers, but faces the challenge of monetising the pipeline of complex generics and biosimilars products where it will be seeking approval.

Home Turf Woes

Interestingly, companies largely dependent on the US market are not the only ones to suffer. At home, there are growing concerns over the draft pharma policy mentioned earlier. First, making bioavailability and bioequivalence tests mandatory for all manufacturing permissions given by the regulators can raise costs and hinder small firms. Second, phasing out loan licensing may not see the desired outcome. Currently, a manufacturer develops one pharmacopeial drug in multiple brand names and supplies the same to other firms so that these can be sold at a price chosen by them. In fact, many companies have multiple brands for the same molecule and sell them at different prices across different markets. Scrapping the practice will upset their economics and especially hurt niche and smaller players dependent on just one or two molecules.

Take the case of Mankind Pharma (not yet listed), which believes in taking on the competition with its low-priced products. The strategy has borne fruit and nearly 90 per cent of its sales comes from the domestic market. According to Founder and Chairman R.C. Juneja, Mankind has moved up some five-six notches in the domestic pecking order, but now the draft policy poses challenges and contradictions. "Uncertainties around pricing and the move towards prescription of generic drugs will only harm the industry and lead to an influx of poor quality and spurious drugs into the market," says Juneja.

D.G. Shah, Secretary General at Indian Pharmaceutical Alliance, concurs. "Differing voices from different authorities give mixed signals to the industry, which is unable to plan for growth at the moment. What the industry needs is stability and clarity on policies for the next two years, at least."