ICRA Note on Indian Pharmaceuticals Industry

Growth revives as US market shows signs of recovery; Growth in India remains strong

( The revenue growth for Indian pharmaceutical industry recovered in Q1 FY2016 after two quarters of moderation aided by some signs of recovery in US revenues, skewed by few major launches (including gAbilify) and continuation of strong growth in domestic pharmaceutical market

( Aggregate revenues of 21 leading players in our sample grew by 13.2% during the Q1 FY 2016 vis-à-vis the prior year after modest growth of 7.8% during H2 FY2015. The aggregate profitability indicators (of our sample set) also improved to 25.7% (vis-à-vis 24.5% in Q1 FY2015) after moderation in Q4 FY2015 benefitting from limited competition opportunities (gAbilify in Q1 FY2016 and gNexium in Q4 FY2015) in US for few companies and certain one time gains by other companies. The base business margins continue to face pressure due to rising investments in R&D, forex losses in emerging markets and higher regulatory compliance costs. With most of the leading entities now generating a sizeable proportion of their revenues from international markets, especially U.S., most of them were affected by slowing growth in US during last fiscal though same has shown signs of recovery in current fiscal. Further the adverse impact of weakening macro-economic environment along with currency depreciation in some of the key emerging markets and evolving healthcare reforms in Europe did have impact on the industry’s aggregate performance.

( Within our sample, while few companies witnessed improvement in EBITDA margins on back of limited competition opportunities, improved operating efficiencies and continued growth in relatively high margin domestic formulation business, others saw contraction on account of a) increasing competitive pressures in some of the segments in the U.S. generics space, b) lack of approvals in the U.S though number of approvals has increased recently and c) steadily rising R&D costs owing to increasing focus on complex therapy areas. For some companies, subdued earnings were also caused by continued regulatory disruptions and associated remediation costs along with currency headwinds in markets like Russia and Latin America. Consolidation of acquired businesses and one-time gains/losses also had impact on margins.

( We believe that while some headwinds persists, the outlook on the profitability indicators continues to be stable on back of sizeable generics opportunities in the US, increasing focus towards complex and niche therapy segments and favorable growth prospects in both the domestic market as well as emerging markets.
United States: Growth skewed by gAbilify launch; Confluence of factors influencing base business

Companies (within our sample set) witnessed recovery in the growth from the U.S. market as reflected by a growth of 12% in Q1 FY2016 as against 3.6% growth during H2 FY2015 (15.7% during FY 2015). The growth was driven by the launch of generic version of Abilify from Torrent along with stabilizing base effect. Excluding gAbilify, base business growth for our sample was modest (estimated at less than 5%) explained by factors like lack of other major launches, price erosion and continued effect of regulatory overhang for certain companies.

( Nonetheless, we believe Indian companies would continue to experience steady growth in the US over the mediumterm on back a) sizeable generic opportunity (drugs with brand value of US$ 25-30 billion are expected to face generic competition) over the next 2-3 years and b) strong product pipeline of pending ANDAs with high increasing proportion of complex generics that compares favorably with generic majors such as Teva and Mylan. The recent acquisition by companies such as Lupin and Cipla are likely to further support scaling-up of business.

India: Continued Growth momentum on back of price hikes, low-base and overall pick-up in demand

After experiencing moderation in the growth momentum in FY 2014 on back of price cuts and trade related disruptions, the growth in the domestic pharmaceutical industry bounced back with the industry registering a growth of 12.9% on MAT basis (as on March 2015) and 14.3% as on June 2015. Much of this recovery has been led by price hikes implemented by companies (in line with change in WPI) in their National List of Essential Medicines (NLEM) portfolio, stabilization of supply related issues, and increased market penetration. In addition, the lifestyle oriented therapy segments have continued to grow steadily, which along with increased focus by companies towards introducing new products and enhancing field force productivity has also contributed to the growth momentum.

The domestic formulations business of companies within our sample set also registered a growth of 17.7% during Q1 FY2016 after 16.2% growth during FY 2015.
With steady demand being witnessed across therapy segments, regular new launches and price hikes taken by companies in line with Drug Price Control Order (DPCO) guidelines, we expect growth momentum to sustain in the near-to-medium term.
The regulatory risk of additional therapy segments being brought under control remain a concern with NPPA proposing to bring at least 100 more drugs under control by making corrections to DPCO 2013.

Emerging markets: Macro environment and currency headwinds remains a near-term challenge

While growth prospects remain strong in most of the emerging markets, the operating environment has turned relatively less benign over the past couple of years. This can be attributed to a confluence of factors including frequently evolving regulatory landscape, increasing competition (from both local as well foreign players) and more recently weakening macro environment and currency depreciation across some of the oil dependent economies.

Accordingly, the growth in the emerging markets portfolio (for our sample) slowed down from 24% in FY 2013 to 16% in FY 2014 and further to 2% in FY 2015 with Q1 FY2016 registering de-growth of -4.4% for our sample set. Given some recovery shown by most affected currencies recently and continued investment of domestic pharma companies in emerging market, the growth is expected to recover in medium term.

The local currency growth, though, remains healthy across markets like Russsia, Brazil and Venezuela indicating increasing market share of Indian pharma companies. In addition, companies are increasing presence in markets like Mexico and South East Asia though contribution still remain marginal at present. We believe acquisitions remain the key route for Indian companies to scale-up presence in EMs as organic route has proven to be fairly time consuming given the branded generic nature of many markets. We expect companies to remain fairly active in the M&A space and look for in- organic route to fill gaps in their portfolio.

Europe: Growth opportunities marred by pricing pressure and changing market dynamics

The operating environment in Europe also remained challenging as implementation of healthcare reforms and resultant prices cuts continue to impact performance of drug manufacturers with Indian companies looking at rationalizing their portfolio and marketing approach. For our sample set, Q1 FY2016 growth at 8.1% was helped by low base effect after growth of 3-4% in FY 2015. The local currency growth was relatively better driven by new launches and growth in base business though rupee growth was impacted on account of ~15% depreciation in Euro in the past twelve months.

Given the challenging environment in Europe, companies have been altering their business plans with focus shifting in favor of segments or markets that offer higher profitability, making their operations leaner and even exiting certain segments.

Some of the companies have also been looking at expanding their branded generic business and entering into relatively niche/complex segments. Overall, Indian companies have a relatively small scale of operations in Europe with the continent’s overall contribution at 5-7% in FY 2015. Among large players, only Wockhardt and Torrent have more than 20% of their FY 2015 sales coming from Europe.

Increasing focus on complex generics & bio similars to necessitate higher investments in R&D

Over the past few years, pharma companies have increased their R&D budgets significantly in view of their growing focus both on regulated markets and complex molecules/therapy segments. In FY 2015, most of the leading pharma players spent anywhere between Rs. 5-17 billion on R&D, which represented an increase both in absolute term as well as in proportion to net revenues (8-12% of sales).

We expect this trend to continue as most of the leading companies are in the midst of expanding presence in complex therapy segment such as injectables, inhalers, dermatology, controlled-release substances and even biosimilars. Many of these segments entail higher R&D costs during the development stage owing to product complexities and need for clinical trials.

While R&D spending would continue to vary across companies, we expect significant rise in R&D budgets, especially for companies that are developing biosimilars (for regulated markets) or have portfolio of NCEs under development. As these entities get closer to conducting clinical trials, they are likely to pursue JVs/Alliances with the objective to share investments and securing technological capabilities.

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