For several years, the US generics space was the golden goose for the Indian pharma sector. Generics are a relatively easy sector for Indian pharmaceutical companies - from Sun Pharma to Dr Reddy’s and smaller players - to compete in. They would manufacture legal, imitation formulations of existing brand-name drugs at low cost, and sell it for cheap in the US market, while still getting a good margin.

The dynamic has now changed for Indian pharma. The once-lucrative, US branded generic formulation space is seeing intense competition, and margins are shrinking. Opportunities in the Indian market are saving the day for drug makers going forward.

Top listed drug makers like Sun Pharmaceutical Industries, Cipla, Dr Reddy’s Laboratories (or DRL), Torrent Pharmaceuticals, and Zydus Lifesciences posted higher revenues on a YoY basis in Q4FY22. But one-time costs and pricing pressure in the US hurt their bottom lines. An increase in raw materials and freight costs have also led to lower operating profit margins.

These companies are now focusing on segments and products that have lower competition in the US. Sun Pharma is focusing on specialty products, while Cipla on its respiratory products. Biosimilars and injectables segments are other areas pharma companies plan to focus on as these segments have relatively lower competition and high revenue growth. 

Drug makers with a higher revenue contribution from India, and a strong product pipeline in the US, are set to continue their growth momentum in Q1FY23. New product launches and India business currently boast of higher revenue growth and higher profitability. 

Quick takes: 

• The domestic formulation business outperformed the US business in Q4FY22 for top listed drug makers in terms of revenue growth
• Top pharma companies’ net profit fell YoY in Q4FY22 due to high one-time costs
• Pricing pressures in the US and high raw material costs hurt margins
• USFDA approvals and new product launches to play a major factor in profitability
• Pharma companies plan to diversify their geographical revenue mix
• Trendlyne’s Forecaster estimates a single-digit revenue growth in FY23

India business helps revenues grow, but one-time costs hurt profits

Barring Aurobindo Pharma, revenues of all other top listed pharma companies rose YoY in Q4FY22. Price hikes and strong demand in the Indian markets offset the prevailing pricing pressure in the US.  

However, this growth in top line did not translate into higher profits. Net profit decreased YoY in Q4FY22 for all companies. In fact, Sun Pharma and Torrent Pharma reported losses mainly due to one-time costs. Sun Pharma and Torrent Pharma posted a loss of Rs 2,277 crore and Rs 118 crore loss, respectively, in Q4FY22. Net profit of Cipla, DRL, Auro Pharma, and Zydus Lifesciences fell around 28%-83% YoY in Q4FY22. The pricing pressure in the US continued in Q4FY22 leading to price erosion in the US generic formulation product portfolio in low double-digits. 

One-time costs were a major factor in the fall in net profit in Q4FY22. Sun Pharma reported a whopping Rs 3,975 crore one-time exceptional cost in Q4FY22 as part of a settlement of a class-action lawsuit in the US. 

While Cipla reported a one-time cost of about Rs 200 crore, DRL had a Rs 751.5 crore impairment of its non-current assets. Torrent Pharmaceuticals closed its liquid business facilities in the US due to intense competition, leading to an exceptional loss of about Rs 485 crore. 

Price erosion in the US and high raw material and freight costs also contributed to the fall in net profit. As a result, the operating profit margins of pharma companies took a big hit and fell YoY in Q4FY22. Aurobindo Pharma’s operating profit margin fell 4.5 percentage points YoY to 16.8% in Q4FY22. Margins are expected to be under pressure in FY23 as well.

To some extent, price hikes, new product launches, and robust demand in the Indian pharmaceutical market (IPM) compensated for the high raw material, freight costs, and pricing pressure in the US. In addition, the price hike allowance for scheduled drugs makes the Indian market more lucrative. 

India's drug pricing agency, National Pharmaceutical Pricing Authority, allowed a price hike of up to 10.7% for price-controlled drugs in April 2022. As a result, over 800 drugs, including painkillers, antibiotics, and anti-infectives, which are under the national list of essential medicines (NLEM) will see a price rise. 

Companies with high exposure to NLEM products like Zydus Lifesciences (30% of its India formulation revenue), Cipla (30% of its India formulation revenue), and DRL (31% of its India formulations sales) will benefit from this price hike in FY23.

India business revenue growth outpaces the US, trend may continue in FY23

Revenue growth in India was higher than in the US in Q4FY22 for pharma companies. This was helped by price increases and strong demand for branded formulation products. Pricing pressure in the US comes at a time when the pharma companies are combating high raw material and freight costs. This is pushing drug makers to focus on their Indian businesses and emerging markets. 

Despite the headwinds in the US, companies like DRL and Cipla continued their growth momentum in Q4FY22, thanks to their presence in spaces with lower competition, and new product launches. In the Q4FY22 earnings call, DRL’s CFO, Parag Agarwal said “price erosion in the US business is in the double digits and that is more than offset by the new product launches and market share gains.”

Cipla’s US revenues rose 17% YoY to Rs 1,209 crore on the back of strong demand in its respiratory portfolio led by a market share gain in Albuterol and Brovana drugs. Cipla also has a respiratory product portfolio in clinical trials because of which its research and development costs are expected to remain at higher levels (up to 7% of the sales) in FY23. DRL’s US revenues rose 14% YoY to Rs 1,479 crore in Q4FY22 on the back of three new product launches in the US.

Delays in USFDA approvals and facility inspections may hurt margins

New product launches play an important role in the profitability of a product as the margins are usually the highest at the initial phase of the launch. After which competitors drag down the prices, leading to lower profits. New product launches in the US come after approval from the United States Food and Drug Administration (US FDA). For a company to apply for USFDA approval, its manufacturing facility must be inspected and cleared by the USFDA. As a result, the turnaround time for all these approvals impacts profitability. This is crucial for companies with higher revenue contributions from the US markets. 

Sun Pharma, DRL, and Zydus Lifesciences derive a major part of their revenues from US businesses. Sun Pharma’s US revenue growth was driven by its specialty product segment, which rose more than 24% YoY in Q4FY22. 

Given the high pricing pressure in the US generic markets, drug makers are focusing on segments with lower competition. Sun Pharma is now relying on specialty products and Cipla is focusing on the respiratory products in the US. Pharma companies that have previously adapted and grown in new segments are expected to come out ahead. Cipla’s revenue from the respiratory segment, for example, constituted 28% of its US sales in FY22 from almost nil in FY17.

A high covid base in FY22 could mean modest revenue growth in FY23

Even though Indian markets appear to be lucrative, a high Covid base in FY22 will affect companies that had higher Covid revenue contributions like Cipla, DRL, and Sun Pharma. As a result, Trendlyne’s Forecaster estimates single-digit revenue growth in FY23 for these companies. 

Despite the high revenue base in FY22, drug makers with higher market share in the Indian market are poised to benefit as the domestic business has relatively lower competition. 

Pharma companies will increasingly rely on segments with lower competition in the US to ease pricing pressures. In addition, USFDA approvals, and facility inspections will play a major part in deciding future US market profitability.