Special Article : Pharma Sector; Large Addressable Market, But Few Concerns Remain

In recent times, margins are under pressure due to pricing demands in the U.S., forcing companies to cut expenses. Delays in approval of new drugs by the USFDA is another issue that pharma companies are facing. There is an increasing opportunity in China as new rules reduce the entry barrier. The domestic market has the potential to boost growth, as India is increasing spending on health care.

The revenue of top 10 Indian pharmaceutical companies was Rs. 1.3T for FY 2018, of which more than 40% was derived from the U.S. market. The major categories of business include generic medicines, marketing of branded generic medicines, marketing of innovator medicines, and the manufacture and supply of active pharmaceutical ingredients (APIs).

Margins Under Pressure due to Pricing Pressure

The margins are under pressure as the pricing pressure has intensified in the U.S. This could prove to be a headwind for pharma companies in the near future. For Sun Pharma, Dr Reddy’s, and Lupin, the operating profit margins were the lowest during FY 2017 and FY 2018 in the last five to seven years. Though, in FY 2019, growth in top line and cutting fixed costs as well as R&D expenses has plotted a better picture. Sun Pharma has cut its R&D spending guidance from 8–9% in the current year to 7.0–7.5% for the next year. Dr Reddy’s has reduced R&D expense from 7.5% during FY 2017 to 6% in FY 2018, and management has not indicated any increase for FY 2019 and FY 2020. Now, the focus will be on launching new products post approvals from the Government agencies.

Delay in US FDA Approvals

The U.S. FDA approvals in the pipeline have faced delays due to the U.S. government shutdown in December 2018. In March 2019, the  chief of the US FDA has resigned. The approach of the new chief toward approving new drugs can be the next headwind or tailwind for Indian companies like Dr Reddy’s, Aurobindo Pharma, and Sun Pharma, having 35–50% of revenue from the U.S. market and more than 100 pending approvals.

Company	ANDA Filings	Pending	U.S. Revenue
Dr. Reddy’s	292	103	48%
Aurobindo Pharma	519	122	45%
Sun Pharma	620	129	35%
Cipla	259	95	20%

 

Chinese Drug Market, next big opportunity

Globally, China is the second largest pharmaceutical market. According to a study conducted by the Department of Commerce, US, the Chinese pharma market is estimated to be valued more than $167B by 2020. There have been significant reforms over the past few years for fast-track approval of drugs. The country’s new law allows manufacturers of generics drugs that have passed bioequivalence studies overseas to be able to submit ANDAs in China. During Q3 FY 2019, Dr. Reddy’s reported traction in volume from China. They are planning to increase footprint through joint ventures and focus on oncology. Aurobindo, Lupin, and Cipla also have drugs approved in China and planning to expand through joint ventures.

Domestic Market can Boost Growth
The domestic market is also growing for most of the firms, with the government’s plan to increase healthcare spending under the new National Health Policy expected to increase expenditure to 2.5% of GDP by 2025. It is currently below 1.5% of GDP.

Stock of Interest

Divis Laboratories is a global manufacturer of APIs and intermediates for generic drugs. With a portfolio of 122 products, Divis focuses on diverse therapeutic areas. Its nutraceutical division manufactures more than 65 carotenoids and vitamins used in dietary supplements, food & beverages, and feed. About 87% of its revenue is generated from exports.

In FY 2019, the Company’s manufacturing facilities are back to normal operations without any compliance trouble until the end of 2020. The clearance of both the units has helped Divis benefit from supply chain disruptions in APIs & intermediates from China. Addition of new capacities through brownfield expansion will start adding to revenues from FY 2020.

The number of funds holding the stock has increased more than 85% in the last quarter. The stock is trading at an all-time high with RS line inclined upward. Though the EPS strength is not very good, but it is improving. The momentum is positive as there is good accumulation.

Biocon primarily focuses on chronic therapeutic areas, including diabetes, oncology, and autoimmune diseases. It is the fourth largest insulin producer in the world. The Company’s business is organized into four segments: small molecules, biologics, branded formulations, and research services. About 70% of its revenue is generated from exports.

Biocon has a rich pipeline of 20 biosimilars and insulin analog products, and has 60 marketing authorizations for biosimilar products globally. Syngene’s (subsidiary of Biocon) revenue had a CAGR of 22% from FY 2014 to FY 2018. It has operating margin of 35% and good growth potential. The Q3 FY 2019 results beat consensus estimates. Revenue from its biologics vertical rose 136% y/y to Rs 449 crore is very positive for the Company.

The EPS strength is very good as Biocon has consistently reported good earnings. Since last quarter, the RS line is trending downward and the stock is not able to hold its key moving averages. Biocon should be in the watchlist and any fresh position can be avoided till the technical profile improves, and the resistance is cleared.

Nifty Pharma underperforms the market

The Nifty Pharma is trending down since October 2016. From its high during September 2016 till March 2019, the index corrected more than 30%. During that time frame, Nifty50 advanced more than 20%. In June-September 2018, the index rallied more than 25% but corrected ~20% during October-December. As of April 03, it was trading 1% below its 200-DMA and 2% above its 50-DMA.

In recent times, the big pharma names such as Cipla, Sun Pharma, and Biocon were down 10–30% in quick sessions. It has been observed that most companies in this sector are unable to break out of their resistance level or have witnessed profit booking after they crossed their resistance.

Returns	1 month	3 months	6 months	12 months
Cipla	-6%	1.5%	-18%	-8.5%
Dr. Reddy’s	4.5%	6%	16.5%	32%
Biocon	-3.9%	-1.5%	-2%	-1.5%
Sun Pharma	3%	6%	-22%	-8%
Divis Lab	1%	15%	30%	52%

Cipla had reported muted growth in revenue and decelerating earnings growth during last two quarters, and hence there was selling pressure since poor Q2 FY 2019 results. Dr. Reddy’shad posted good results since last three quarters and new drug launches have resulted in accumulation. Fund holdings have also increased during the last two quarters. Biocon corrected with the general market correction and is consolidating around the 200-DMA. Sun Pharma was down more than 30% in November 2018 after SEBI received a whistleblower complaint against the Company. Otherwise, the top-line grew in double-digits but margins were under pressure. Divis has a good buyer demand as its manufacturing plants got clearance from the US FDA and sales as well as earnings have doubled post supply disruption in APIs & intermediates from China.

Earnings and estimates

Q3 FY 2019 results were mixed in terms of earnings, Dr. Reddy, Sun Pharma, Biocon, and Divis Lab beat consensus estimates by 20–50%, while Lupin, Cipla, and Glenmark missed the estimates by 10–30%. In FY 2019 and FY 2020, consensus expects pharma companies to post good earnings.

EPS Growth Estimates	2019(E)	2020(E)
Cipla	6%	27%
Dr. Reddy	58%	24%
Biocon	99%	48%
Aurobindo Pharma	5%	21%
Sun Pharma	72%	30%
Divis Lab	51%	17%