India’s pharmaceutical industry, which caters to around 20% of the global supply chain, has been gaining traction in the past couple of quarters. Indian pharmaceutical industry, the recovery in prospects and prices, which began in earnest in June 2023, is a welcome one, after several quarters under pressure due to declining volumes and price erosion in the US. 

The Q3FY24 earnings saw industry trends stabilize further. The price erosion in the US moderated, while new drug launches provided a cushion. Input costs declined, reducing the pressure on margins. Domestic formulations saw volumes tick up along with price increases. The Nifty Pharma gained 15.1% in the past quarter outperforming the benchmark Nifty 50 index by 11.5%.

India business drives volumes, while limited price erosion in the US helps margins

 The US market has been critical for Indian manufacturers – it's a high-margin business that accounts for 30-35% of the total revenue. Since the start of FY23, pharma firms have seen price erosion and contracting margins. However, prices stabilized in Q3FY24, with US revenues for Indian pharma expected to grow at 11-13% in FY24. Zydus Lifesciences reported 18.7% growth in the US market in Q3FY24, while Sun Pharmaceuticals reported 13.9% growth. According to Pranav Amin, MD of Alembic Pharmaceuticals, “Supply shortages in the US market have boosted demand and limited price erosion” 

Operating profits in the pharma industry improved in the past three quarters

The Indian market is also looking up. The domestic formulation business has revived on higher volumes and an increase in domestic prices. Manufacturers are developing flagship brands to facilitate the premiumization of products. The increased penetration in Tier II and rural areas along with wellness products is helping drive the volumes. According to HDFC Securities Indian pharma market is expected to to grow at around 8-10% in FY25.

Product diversification and ANDA approvals to help scale revenue

Indian drug formulations are facing intense competition in the US genetic space, leading to price erosion. Firms are instead focusing on new product launches and exclusivity. For instance, Revlimid (used for Cancer treatment) is expected to generate $372 million and $165 million in FY24 revenue for  Dr Reddy’s Laboratories and Cipla. However, exclusivity is expected to end FY26 January and other big players like Aurobindo Pharma are in the fray to win exclusivity. Thus the launch pipeline of new drugs is essential. Aurobindo Pharma has the highest number of pending approvals on abbreviated new drug application (ANDA) with the US Food & Drug Administration

Indian pharma’s pending ANDA & NDA approvals to help product launches

Cipla’s launch pipeline includes respiratory drug Advair and cancer drug Abraxane, both commanding a $700 million revenue opportunity each to make up for the loss of Revlimid sales. Sun Pharmaceuticals is expected to launch Deuruxlitinib (used to treat a specific type of hair loss) in FY25 with a potential revenue of $200 million.

The Indian pharma industry needs to be self-reliant with input chemicals

India depends on China for key starting materials (KSM) and active pharmaceutical ingredients (API) for drug manufacturing. India’s KSM imports from China account for nearly 50% of India’s demand. For instance Aurobindo Pharma sources 55% of its raw ingredients from China.

To cut down on this dependence, the Indian government implemented the PLI scheme for bulk drugs and API manufacturing in FY21. Under the scheme, Rs 25,813 crore investments have been made and Rs 1,16,121 crore in sales recorded (including Rs 75,141 crore exports). However, to compete with China, India requires consistent investments over the next 4-5 years. For now, India depends on China for even common antipyretic drugs like paracetamol.

Major input APIs for pharma industry have seen declining prices in the past two quarters

The top 15 APIs imported from China as raw materials to the Indian pharma industry saw a price decline of 13% YoY in Q3FY24. The decline in prices has been on account of lower chemical production in China, and oversupply in Indian markets due to the PLI scheme for chemicals. For instance, Meghmani Organics has set up an installed capacity of 13,500 tonnes for paracetamol manufacturing under the PLI scheme. 

Indian manufacturers unable to benefit from lower raw materials cost

Indian manufacturers have been unable to take advantage of lower raw material costs in Q3FY24. Lower input costs in the past two quarters have not translated into operating margin expansion. Pharma firms have instead been passing on the benefits to end-customers resulting in price erosion in major markets like the US and EU. However,  price erosion has moderated in the Q3FY24.

Freight cost in Q3FY24 also declined below $1,500 (per 40-foot container). However, post-January 2024, freight prices have more than doubled to $3,000. This might increase the logistical cost for pharmaceutical exporters.

Pharma industry did not benefit from declining raw material cost

Domestic drug prices in India are regulated by the National Pharma Pricing Authority (NPPA). The NPPA announces the ceiling of drug prices based on wholesale price inflation (WPI). Considering WPI has been negative (-1.1%) for 9MFY24, the price increase in FY25 should be marginal (roughly 0.01% increase). 

Contract development and manufacturing to pick up pace with China +1 policy

China has been the preferred destination for contract development and manufacturing organization (CDMO) due to its cheaper costs. However, the escalating US-China trade war has given India a golden opportunity. US pharma majors are looking at India, to avoid the supply chain constraints caused by trade wars. India has the largest number of US FDA-approved manufacturing sites outside of the US. This makes it easier for outsourcing for US majors.

However, quality concerns with Indian manufacturers, with deaths In Africa and Central Asia due to contaminated Indian-origin cough syrup, and blindness caused by India-manufactured eye drops, have raised flags with the FDA.  The regulator said that it plans to ramp up unannounced inspections on India-based manufacturing units.

The Indian CDMO business is currently at $15.6 billion (China at $27.1 billion )and is expected to grow at 11% CAGR (9.6% for China) for the next two years. However, the individual firms expect the growth to be above 15%. India’s largest listed CDMOs, Piramal Pharma and Syngene International have reported increased interest in contract manufacturing and are expecting major order inflows in FY25.

Nifty Pharma is trading at high valuations

Nifty Pharma has gained 60.7% in the past year, beating the benchmark index by 32.1%. The rise in Nifty Pharma has sparked a debate around its valuation. The pharma sector’s earnings have grown around 21% YoY in Q3FY24. However, the current PE valuation at 35.1 is higher compared to its short-term and long-term averages.

 Nifty Pharma PE trading higher than historical averages

Nifty Pharma’s 1-year forward PE of 27.8 offers some comfort. The future growth in pharma is looking upbeat, thanks to a reversal in price erosion trends, and a focus on new products. Also, the volume-led growth in the Indian market will help in maintaining the topline. The increasing API and bulk drug production in India will be key in lowering input costs.