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Mar 14, 2012, 05.34 PM IST | Source: Moneycontrol.com

Earnings growth may continue in pharma stocks: ICRA

ICRA has come out with its report on Indian pharmaceutical sector. According to the research firm, earnings growth will continue, benefitting from healthy growth in the domestic formulations business and steady growth expected in the U.S/Europe generics space on back of patent expiries.

ICRA has come out with its report on Indian pharmaceutical sector. According to the research firm, earnings growth will continue, benefitting from healthy growth in the domestic formulations business and steady growth expected in the U.S/Europe generics space on back of patent expiries.

After a period of sustained growth, the domestic formulations market began to decelerate since the beginning of Q3 FY11 largely prompted by intense competition, especially in the acute segments. The growth rates slipped quite sharply in H1FY12 on back of high base effect of the previous year and spill over of pricing pressure even to the chronic segments to some extent. The competitive pressure in the domestic formulations market has been rising steadily for some time now. While on one hand, this has been prompted by significant increase in investments by domestic players in marketing efforts through expansion in field force, on the other, MNC have also renewed their focus on India. Some of the smaller players have also contributed to the competitive intensity by offering huge discounts/incentives to the distribution network and doctors. However, while competitive pressures are unlikely to abate, the growth momentum appears to be back on track with last few months reporting a fairly strong growth across therapy segments. We believe, that the structural demand drivers would continue to support growth in the long-run despite short-term headwinds.

The Domestic formulations market, valued at ~Rs. 48,200 crore has grown steadily at CAGR of 14-15% over the past five years. The strong growth has been driven by a confluence of factors including – a) rising household income levels leading to higher expenditure on healthcare, b) increasing prevalence of lifestyle related diseases, c) improving healthcare infrastructure/delivery systems and 4) rising penetration in smaller towns and rural areas. As a result, majority of the growth in the Indian market has been driven by expansion in volumes and new product introductions as against prices increases.

The MNC pharma companies which have so far lagged the domestic market growth are now becoming increasingly aggressive in the Indian market as part of their focus on emerging markets. In the past, most of MNCs players had maintained a subdued profile in India owing to limitation on launch of patented products, limited marketing and distribution bandwidth and relatively small scale offered by the Indian market. However, with the implementation of the product patent regime and strong growth prospects, the landscape for MNCs pharmaceutical companies is gradually changing. Series of major acquisitions, steady growth in new product introductions (especially in the branded segment with steep pricing difference to global prices) and expansion in field force clearly indicates at their renewed interest in the Indian market.

The emerging markets represent the fastest growing segment of the Global pharmaceutical industry. As per industry estimates, the total spending on healthcare in these markets is likely to grow from US$151 billion to $285-315 billion by 2015 with most markets expected to grow at double digit. Apart from the developed markets, the Indian Pharma companies have also been eyeing growth opportunities in some of the other fast-growing emerging markets. Among them, in Russia, South Africa and some of the countries in Latin America (Brazil, Mexico) and South-East Asia, Indian companies have strengthened considerable presence. These emerging markets with some of them being branded generics offer strong growth prospects for Indian players given the high out of pocket expenditure on healthcare in these markets (unlike developed markets) and relatively easier regulatory pathways. During the initial phase, most of the Indian players preferred acquisitions/in-organic investments to enter into these markets are now enhancing their presence through ramp up in product portfolio and therapy segments. In addition to direct presence, Indian companies have also been partnering with MNCs in emerging markets. Such alliances benefit from the R&D and manufacturing capabilities of the Indian partners and the extensive marketing & distribution footprint of the MNCs in those markets. For instance, GSK has a tie-up with Dr. Reddy’s whereas Pfizer has tied-up with a number of Indian companies to launch a range of branded generics in emerging markets (besides generics in US)

Our outlook on the Indian Pharmaceutical Industry remains favourable, reflecting our view that earnings growth will continue, benefitting from healthy growth in the domestic formulations business and steady growth expected in the U.S/Europe generics space on back of patent expiries. In the U.S, companies with a robust and selective product pipeline, presence in niche/complex segments and diversified therapies would continue to exhibit a relatively strong earnings profile. There would also be significant one-time upsides for companies, stemming largely from Para IV/FTF opportunities in US. In the European markets, while companies may face pressure on profitability, volume growth would continue as healthcare reforms initiated by Governments would push growth in generics. Emerging markets, with growing spend on healthcare and strong branded generic market offers profitable growth opportunities for generic business. Besides emerging markets, the gradually evolving generics opportunity in Japan, the second-largest market in the world (after United States) also offers generic players the opportunity to pursue long-term investments. On the CRAMS front, Indian players are focusing on providing services across the value chain spanning from development stage to commercial scale production. Relatively lower exposure to small biotech companies has been a risk mitigant during the downturn for these entities. With several drugs going off-patent and big pharma increasing exposure to cost efficient sourcing locations, opportunities remain favourable for CRAMS players to provide developmental services and subsequently graduate to commercial scale production.

Key challenges facing the industry are potential implementation of the new pricing policy in India, increasing competitive pressure in the chronic segments, aggressive approach such as authorized generics by innovators in the US and healthcare reforms in European markets are some of the factors that could impede profitability for pharma companies. ICRA currently has ~80 entities with long-term ratings (excluding ‘SO’ ratings) in the pharmaceutical sector. About 10% of these entities are rated in the ‘AA’ category - these entities have strong and profitable domestic branded formulations business, which has been a stable source of cash flows over the years. Around 41% of the entities are rated in the non-investment graded. Most of these entities are relatively small entities, often in API business and suffer from high product or client concentration.

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