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Pharma: Back in action?

Mar 20, 2006

The BSE Healthcare index has not been able to keep pace with the broader market movement and infact, has under-performed the BSE-Sensex over the last one year. This can be gauged from the fact that while the Sensex gained 57% in the last one year, the BSE Healthcare index gained 32%. Here is our take on the same.

The fundamental view...
An improved scorecard: Pharma companies have limped back to normalcy in the last three quarters after the VAT and MRP-based-excise-related concerns that mired performance in the first quarter of the calendar year 2005. Most of these companies have performed well in the domestic market in the last three quarters, signaling a revival in fortunes. Exports have also contributed to growth, especially in the semi-regulated markets of Russia, Latin America and Asia. However, severe price erosion in the US generic markets continued to bog down companies like Ranbaxy and Dr.Reddy's and is likely to remain a cause for concern going forward.

The 'A' word: Consolidation in the global generics industry has been gathering steam, as major players are looking to acquire scale (Teva's acquisition of Ivax and Sandoz's acquisition of Hexal and Eon Labs are examples of the same). Domestic companies, not wanting to be left behind, are also firming up plans to acquire companies abroad and increase geographical reach. Dr.Reddy's acquired Betapharm recently (Germany's fourth largest generics company). This acquisition is pegged to be the largest in the Indian pharma industry. Wockhardt and Ranbaxy have clearly identified acquisitions as a part of their growth strategy.

With intense competition and brutal price erosion, the consolidation story is expected to gather momentum. Amidst the brouhaha surrounding the news of an acquisition, what needs to be considered is whether the acquired company is worth the price paid. In this context, the product profile, geographical spread, size, revenue and profitability are the areas to watch out for. If the synergies exist and the management is able to effectively integrate operations, then the acquisition will provide value, even if the payback period is long.

New product launches: As we mentioned in last week's write-up, prospects of new products launches from the parent's global portfolio has led to the sharp rally in the MNC pharma stocks such as GSK Pharma, Pfizer and Aventis. Here again, investors should note that these product launches are likely to take around two to three years to capture significant market share and investors need to accordingly attune their investment horizon.

Going hand-in-hand: Most of the pharma companies, be it domestic or MNC, are adopting the partnership route to drive growth. To cite examples, Cipla is focusing on contract manufacturing, wherein it supplies bulk drugs at a cheaper cost to global generic companies. With the product patent law now in place in India, contract research is another area that is attracting interest from innovator companies in a bid to prune their R&D costs. Domestic pharma majors like Ranbaxy and Dr.Reddy's are entering into collaborations with international pharma companies to carry out their R&D programme, which is a high-risk-high-return business. In-licensing is also proving to be the 'in-thing' for all companies. This is because competition in the domestic pharma space is set to hot up and a varied product portfolio is critical to sustain growth.

We continue to remain positive about the growth prospects of the pharma companies, who are leaders in respective focus areas (be it generics, contract manufacturing, MNC plays, biologics and the like). As far as the domestic pharma majors are concerned, though the likes of Dr. Reddy's and Ranbaxy have had a roller coaster ride over the last three years, the prospects of these companies are not based on one or two drugs (as it is made out to be). It is therefore, pertinent to take a long-term view.

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