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Pharma: Signs of revival...

May 8, 2006

The March 2006 quarter has seen robust performances by Indian pharma companies, both in the domestic and exports markets. In this write-up, we shall analyse the performance of the Indian pharma companies under our coverage and see what lies in store for them in the future. We have not included companies such as Dr. Reddy's and Sun Pharma as they are yet to declare their results.

Domestic players: A look at the numbers
(Rs m) Mar-05 Mar-06 Change
Net sales 24,495 31,591 29.0%
Expenditure 20,941 26,652 27.3%
Operating profit (EBIDTA) 3,554 4,939 39.0%
EBIDTA margin (%) 14.5% 15.6%
Other income 339 711 109.7%
Interest (net) 282 343 21.6%
Depreciation 795 1,108 39.4%
Profit before tax 2,816 4,199 49.1%
Tax 641 357 -44.3%
Extraordinary item 295 (630)
Minority interest 4 (4)
Profit after tax/(loss) 2,466 3,216 30.4%
Net profit margin (%) 10.1% 10.2%
* Includes Ranbaxy, Cipla, Wockhardt, Biocon and Nicholas

What does the analysis say?
The India story: The five companies posted a robust 29% YoY growth in total revenues during the quarter in question backed by a strong performance in the domestic markets. However, it must be noted that in the same period last year, de-stocking at the retailers' level in anticipation of VAT had led to a sharp fall in revenues. As a result, part of the robust performance this year is due to the low base effect. That said, strong growth of existing products, especially in the lifestyle segments, and increased contribution from new product launches also contributed to the topline growth.

Exports scenario: Exports for the sector were a mixed bag. The generics market in the US continued to be plagued by increased competition and pricing pressure. Europe painted a mixed picture with Germany logging good growth rates in comparison to the UK, which was also prey to a competitive pricing environment. For example, while Ranbaxy's US business grew at a double digit pace, this growth was largely attributed to increase in volumes. Companies following the contract manufacturing model like Cipla witnessed superlative growth in exports. In Cipla's case, while formulations did record healthy growth, the impressive growth in bulk drugs (mainly supplied to the regulated markets) was the real show stealer. The semi regulated markets of Asia, Middle East, Russia and Africa continued to grow and contribute to the revenue streams of these companies.

Operating margins and profitability: Though margins on an overall basis expanded by 110 basis points, if one were to look at the individual snapshot, each had a different story to tell. Nicholas' margin expansion was considerable, as it had reported a negative EBIDTA margin during the March 2005 quarter. Most of these companies witnessed a significant rise in raw material costs and R&D expenditure. Ranbaxy's R&D expenditure (as a percentage of sales) declined, as the company has shifted most of its R&D in-house. Nicholas' R&D expenditure increased after the acquisition of Avecia. The savings in costs for most of these companies was mostly on the ‘other expenditure' front. Net profits of the sector grew by 30% YoY driven by strong topline growth, rise in other income and a lower tax outgo. Extraordinary items for the period included expenditure incurred by Wockhardt for due diligence of acquisition opportunities in the US.

What lies ahead?
While the fundamentals driving the generics market continue to remain strong, the brutal pricing environment is a cause for concern. It must be noted that the competition has tremendously increased, escalating the extent of price erosion. Having said that, while the competition most probably will show no signs of abating, a considerable rise in the patent expiries of blockbuster drugs in the coming years is likely to provide a breather to generic companies and boost revenues. The ability to manufacture drugs at the cheapest cost and leverage one's marketing and distributing network to increase reach will be the key to survival.

We believe that partnerships are likely to play a crucial role in driving growth. This could be in generics (contract manufacturing, authorised generics) or research (R&D collaboration, contract research, out-licensing of molecules) or custom manufacturing for innovator companies. In the domestic markets, with the introduction of the patent law and subsequent slowdown of product launches, albeit at a gradual pace, companies entering into in-licensing agreements with innovator companies will have the upper hand. This will ensure a steady flow of product launches in the domestic market.

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