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5 reasons why pharma stocks could still come under pressure

The recent set of results highlights the ills of the sector. Pharmaceutical companies are having a tough time with the US authorities pulling them up regularly for irregularities at one end, while on the other hand the companies are taking a hit on the revenue front at the international and domestic front.

May 25, 2017 / 04:34 PM IST

The so-called defensive pharmaceutical sector is on the way to the ventilator. The sector is trading at a 3-year low and has lost over 10 percent in value over the last one year. Compared to this the BSE Sensex has risen by nearly 18 percent.

The recent set of results highlights the ills of the sector. Pharmaceutical companies are having a tough time with the US authorities pulling them up regularly for irregularities at one end, while on the other hand the companies are taking a hit on the revenue front at the international and domestic front.

The only solace is that the troubles are not restricted to Indian companies but are also impacting generic companies across the world.

The onslaught in the market has resulted in many pharmaceutical stocks trading at multi-year lows with price-to-earnings approaching the lowest quartile in most companies in the sector.

Though the valuation might look compelling, the outlook for the companies is not. We look at five reasons why the fall in pharmaceutical stocks is far from over.

Muted revenue and profit growth: For most pharmaceutical companies the best seems to be behind them. With almost all companies that are exporting to US facing regulatory hurdles, export growth is likely to come down. Six of the top eight Indian pharmaceutical companies derive more than 40 percent of their revenue from the USA. Not only is exports getting restricted, increasing competition is ensuring that the margins will be under pressure.

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Increasing approvals: Though US FDA (Food and Drugs Administration) seems to be working overtime in India with its inspection team pulling up pharmaceutical companies, it has increased its pace of approval in US, too. A Credit Suisse report on the pharma sector points out that US FDA is increasing approvals of ANDA (Abbreviated New Drug Application) by 50 percent over the next two years from 650 to 1,000 a year. FDA already has a huge backlog of around 4,000 drugs to clear plus around 900 new applications that come in every year. Increased approvals mean increased competition which, in turn, mean lower prices.

Channel consolidation: Indian pharmaceutical generic companies tap the US markets through various supply chains. That the channel was consolidating has been known for the last two years. In an analyst call on the second quarter of 2014, Abhijit Mukherjee, COO of Dr Reddy’s Laboratories had said that channel consolidation had caused brutal price erosion. The same continues till date. Credit Suisse reports that further consolidation has now resulted in large buyers who account for 90 percent of all generic purchases coming down from four to three. Lower number of buyers and increasing number of suppliers tilt the balance of negotiations in the hands of the buyers. Though consolidation might not affect volume, it might hit margins. Ramesh Swaminathan, CFO, Lupin in the analyst call on Wednesday said that there is further consolidation in the channel end in US, so there is going to be pricing pressure for sure.

Increasing competition through new entrants: Indian pharmaceutical companies used to be the main players to get approvals from US FDA. But the market is now getting crowded. Nearly, a third of approvals have been given to players from outside traditional markets, says the Credit Suisse report. Companies from Turkey, New Zealand, Taiwan and even Bangladesh have now got clearance to sell products in USA. A new entrant generally attacks the market with lower prices which, in turn, can impact the overall market.

There are better stocks in the market: Indian markets are in the midst of a bull run. Even though private sector numbers are muted there is a visibility of growth. The same cannot be said for pharmaceutical stocks. Money will chase companies which have high growth and clear visibility. Pharmaceutical companies are a victim of headwinds in global market, especially their biggest market. Unless companies in other sectors become overpriced and pharmaceutical stocks reach compelling valuations, we can see investors steering clear of pharma companies.
first published: May 25, 2017 04:34 pm

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