Indian Pharma took a beating in stock markets on the latest news about US legislators Bernie Sanders and Elijah Cummings demanding a federal investigation into price fixing by generics. Both American and Indian generic firms could potentially face charges if regulators take up an investigation.
The US legislators presented some data showing rising prices for insulin, used to treat diabetes and whose patent expired 75 years ago. They included a chart showing that the price spikes for Humalog and Novalog seemed to happen together over the last twenty years.
Since the news, Sun Pharma, Glenmark,Aurobindo and Dr. Reddy’s stock prices collapsed (Chart 1), with Sun Pharma falling the steepest - more than 11% during morning trading. Sun Pharma and Dr. Reddy’s have been issued subpoenas from the US Justice Department, which requires them to attend a court to testify.
Chart 1: Drop in Pharma stocks in today's trading on news of the Justice Department investigation
However, price collusion is a difficult charge to prove, especially in a market which depends on insurance payments. US pharma companies have already released statements denying the charges, saying that when one company raises prices the others follow through, since it allows the company to also raise the insurance rebate for the patient. The companies thus see increased profits without passing on price increases to the patient - since the insurer covers the increase. However, the price of medicine has emerged as a political issue during an election year, compelling legislators to pay attention to the price shifts in drugs.
The downward pressure on stock prices present investors a buying opportunity on solid pharma stocks. The first three quarters of the 2015 calendar year were bad for Pharma earnings, but earnings have picked up in the past one year. Nifty Pharma aggregate earnings are up 65% in the past 12 months, even though stocks have fallen in the market overall over the past year. The sector may be therefore ripe for a re-rating upwards.Valuations are at two year lows, while market valuations in other sectors are at a peak.
Individual stocks- Dr. Reddy's, Glenmark, SunPharma, Aurobindo Pharma
Dr. Reddy’s stock had soared recently on the announcement of its alliance with the US firm Gland Pharma to develop drugs for the US markets. The company’s sales are expected to grow over the next financial years with launches of new drugs like gGleevec and gCopaxone - generic versions of anti cancer and multiple sclerosis drugs, both large multi-billion dollar drug segments.
Glenmark in particular, may also be less prone to headwinds from the continuing US investigation - its focus is on more niche sectors like oral contraceptives, skin treatments and respiratory care, where it faces less competition. Its debt/EBITDA has improved from a high of 4.6x in FY09 to 2.5x in FY16 as it has expanded its market beyond US and India and to Asia and Europe. And Sun Pharma’s latest quarter results beat expectations on both export and domestic earnings - recent research reports consequently raised recommendations and targets on the stock (Chart 2)
Chart 2: Sun Pharma saw its targets revised upward in research reports (see the brokerage reports list)
At first glance Aurobindo Pharma also looks strong, with recent approvals for selling multiple generics in the US, including blockbuster drugs to treat osteoporosis and HIV. However, a recent recall of drugs supplied to US market in September due to mixing of two different drugs in a bottle, raises the question of process quality in the company’s Mahboob Nagar plant.
Overall however investors looking for a good entry point into these stocks may very well pick the present, as US legislators with an eye on public sentiment release aggressive remarks that spook markets. Pharma has always been a defensive sector and with the broad market coming off its peak and with today’s meltdown, there may be opportunities in the coming days.
