Indian drug formulation companies are adapting to the fast-changing dynamics of the pharma industry. Top-listed players have been making their bets and changing the pattern of their capital allocation in the past two years.
Until FY15, Indian drug makers thrived on their cash cow, the US generics drugs sector, with its low-cost exports. However, the generic space has been under intense competition for the past two years. To counter this, formulation companies are looking at different segments to drive revenue growth.
Top pharma companies like Sun Pharmaceutical Industries, Cipla, Dr. Reddy’s Laboratories and Torrent Pharmaceuticals are trying to carve a niche to grow in segments where the competition is relatively low. As a result, India and US business revenue for all companies rose in Q2FY23.
While Sun Pharma is leveraging its specialty products to grow in the US, Cipla’s respiratory product portfolio and peptides are driving its US revenue. Dr Reddy’s in its investors' meeting, laid out a long-term strategy to focus on biosimilars, generics and active pharmaceutical ingredients. Torrent pharma’s management in the Q2FY23 earnings call, confirmed that it has reduced its R&D spending in the US to focus on Indian businesses.
Unlike the US generic market, Indian pharma markets are a relatively safe bet. The Indian Pharma Market (IPM) continues to grow consistently, offering strong revenue visibility. Over FY08 to FY22, IPM increased at a CAGR of 11% and is expected to rise by the same rate over the next five years.
Top branded formulations company outperform Nifty 50 in the past quarter
Pharma companies have been on an uptrend since the past quarter. Sun Pharma leads the pack in terms of share price change, rising 11% in the past quarter. All other companies managed to outperform the Nifty 50 in the past quarter.
Strong Q2FY23 results helped the companies’ share price to continue on the uptrend as net profit of all drug makers in focus, except Torrent Pharma, beat forecaster estimates by a significant margin.
Net profit of the pharma companies in focus, except for Torrent Pharma, rose in Q2. While the high-margin Revlimid drug (used to treat cancer) helped post higher profits for Cipla and Dr. Reddy’s, Sun Pharma’s specialty products helped its profits grow. Higher other expenses and lower other income led to Torrent Pharma’s marginal fall in net profit.
Revenues of all drug formulators in focus rose YoY on the back of strong growth in India and US businesses. This is despite a high revenue base in Q2FY22, which included revenue from Covid.
Specialty products and Revlimid help drug makers post high revenue growth in the US
Drug makers’ decision to shift away from the US generics segment in the face of intense competition seems to have paid off. Sun Pharma, which invested significant capital in specialty products in the past three years, is now reaping its benefits in the US. Specialty products’ revenue contribution rose to 15% in Q2FY23 from 11% in FY22. Sun Pharma’s specialty business grew 27.5% YoY in Q2 to $200 million, largely on the back of Cequa, Illumya and Winlevi prescriptions, and the management expects this growth momentum to continue.
Cipla, on the other hand, banked on its respiratory and peptide products to drive growth in the US. The company currently enjoys a 16% (16.5% in Q1) market share of the total Albuterol market and a 38% (33.4% in Q1) share of the Brovana market. Its Lanreotide drug reached a 9.6% market share in Q2 vs 4.6% in Q1 and is on target to expand to 15% in H2, according to management.
US revenue of Dr. Reddy’s was mainly driven by new product launches in Q2, including Revlimid. The management has guided a meaningful contribution from Revlimid in the coming quarters as well. Dr. Reddy’s launched seven new products in Q2 and the management plans to launch more in H2FY23. In addition, the company has set aside a capex of Rs 1,500 crore in FY23 towards building capacities for biosimilars and injectables as a part of diversifying from the generics market.
Meanwhile, Torrent Pharma continued to face double-digit price erosion in its base business in the US. As the company already derives a majority of its revenue from India, it is focussing on the domestic market by reducing spending in the US market.
India business continues growth momentum, offers high revenue visibility
Top drug formulators' revenue from India grew in Q2 despite a high Covid base in the same quarter the previous year. Price hikes, new product launches and volume growth contributed to revenue growth. In addition, EBITDA margins were higher at 25%-35% in India, against 15% in the US market due to less stringent regulatory requirements.
Pharma companies rely mainly on volume for revenue growth as price hikes have regulatory hurdles. Umang Vohra, Managing Director and Global CEO of Cipla, explained, “India is a price-sensitive market. Every time prices come down, volumes shoot up. The 1.5 billion people we have is something that is at the bottom of the pyramid.” He added that the Indian pharma market sets the stage for companies to drive revenue growth. Companies that derive a significant part of their revenue from India are expected to grow at a higher rate, with a clear growth path in the domestic market.
Cipla and Torrent pharma have a strong footing in India as they both derive over 40% of their revenue from here.
Apart from India and the US, emerging markets also offer revenue growth along the same lines as the domestic market. But currency and country-specific risks make them less lucrative.
PE ratios rise due to a run-up in share prices, but analysts still see an upside
As the top drug formulators’ share price rose in the past quarter, their price-to-earnings ratio also improved. Sun Pharma and Torrent Pharma are in the PE sell zone–meaning their current PE is high compared to their historical PE. In fact, both these companies are classified as ‘Expensive performers’ according to Trendlyne’s DVM classification. Expensive performers are companies with high to medium durability scores, expensive valuation and midrange momentum.
Despite high PE ratios, analysts see a 6% and 12% upside in the share prices of Torrent Pharma and Sun Pharma respectively.
However, Dr Reddy’s PE TTM is lower than its historical PE and also its sector PE. One reason for the relatively lower PE ratio could be low revenue visibility in its US business, where it derives a majority of its revenues from. According to a report by Nirmal Bang, Dr Reddy’s US revenue is expected to grow at 4.3% CAGR in the next three years. With expensive valuations, these drug makers score low in Trendlyne’s valuation score.
However, all pharma companies in focus fall under the ‘good’ category when it comes to durability score. Durability score is based on the quality of a company’s financials, management and long-term performance.
Outlook bright for pharma companies adapting to change, India business to drive margins
Top drug formulators’ revenue is expected to rise by at least 12.5% in Q2FY23 as analysts expect the strong momentum in Indian business to continue with headroom for growth in the US business, especially in segments other than generics.
New product launches will be critical to driving revenues higher and improving profitability, as they have higher margins before the competitors catch up. For new product launches in the US, timely approvals from the US Food and Drug Administration (USFDA) are key. Any delay in approvals can cost companies considerable revenue. In order to receive USFDA approvals, manufacturing facilities must be cleared to produce drugs. This poses a significant risk to companies as any serious observations by the USFDA can lead to delays in manufacturing.
In September, Torrent Pharmaceuticals, in its filing, said the USFDA issued Form 483 to the company with three observations after an inspection at the drug maker's Indrad-based manufacturing facility. An FDA 483 observation is a notice that highlights potential regulatory problems, while a warning letter is an escalation of this notice. In the Q2FY23 earnings call, the management said the company has responded to the USFDA and expects a response in 90 days. As of Q2FY23, 19 abbreviated new drug applications or ANDAs are awaiting approval from the manufacturing plant. The management added that after USFDA clearance, it will take 9-12 months for product launches.
Sun Pharma's Halol facility remains under Official Action Initiated (OAI) status from the USFDA. This means the USFDA may withhold approval of any pending product application or supplements from this unit. The company’s management updated that the Halol plant’s resolution could take longer, delaying USFDA approvals for pending ANDAs.
Regulatory hurdles in the US continue to be a key risk for Indian drug makers. This is also one of the reasons why the Indian pharma market looks attractive for drug makers, as it has less stringent regulatory requirements. Also, pharma companies’ focus on India is helping them shift the product mix towards more remunerative segments.
However, drug formulators will also continue to search for growth in the US by shifting their focus to segments with lower competition, and away from the generics space. There is great, long-term revenue upside for whoever wins in this market.
This analysis by Trendlyne is meant for investor education - to help understand companies and make informed investment decisions on their own. It should not be considered an investment recommendation.