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Pharma: CRAMS gaining momentum... - Views on News from Equitymaster
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  • Jun 26, 2007

    Pharma: CRAMS gaining momentum...

    Domestic pharma companies following the CRAMS (custom manufacturing and contract research) model have in the last six months evinced much investor interest with the stock prices of these companies registering stronger gains as compared to the large caps such as Ranbaxy, Dr.Reddy's, Cipla, Sun Pharma and GSK Pharma. In this write-up, we shall take a look at what potential this model holds and the challenges going forward.

    CRAMS: Registering strong gains...
    Company Price on
    June 25, 2007 (Rs)
    Price on
    Jan 02, 2007 (Rs)
    BSE Sensex 14,488 13,942 3.9%
    BSE Healthcare 3,794 3,820 -0.7%
    Divi's Labs 6,011 3,068 95.9%
    Shasun Chemicals 145 115 25.7%
    Dishman Pharma 321 258 24.1%
    Nicholas Piramal 294 263 11.8%

    The positives...
    Global pharma looking to cut costs: Increasing R&D costs, low R&D productivity, impending patent expirations and at the same time, pressure to reduce healthcare costs have propelled global pharma majors to cut costs and improve overall profitability. This is expected to translate into a strong outsourcing potential for low cost manufacturing destinations like India and China.

    India has the advantage: The introduction of the product patent law in India has opened the doors for global pharma companies to establish either a manufacturing or research base in the country. At the same time, India has developed world class manufacturing skills, which can be gauged by the fact that currently, India has the highest number of plants approved by the US FDA outside the US (75 in FY07). Another point to be noted is the low cost advantage offered by the country. India has 6 times the number of trained chemists in the US at a tenth of the cost (Source: Nicholas Piramal). Indian labour costs are one seventh that of the US. At the same time, a majority of the Indian pharma companies are present across the value chain and are able to provide end-to-end capabilities right from custom chemical synthesis (CCS) to formulations. This gives them an edge over its US and European counterparts.

    Stability in revenues: Considering the fact that contract manufacturing agreements are long term in nature i.e. around 5 years or more, there is stability at the topline level as compared to companies competing directly in the generics market. Companies such as Nicholas Piramal have chosen to adopt a 'collaborative' approach as opposed to a 'confrontational' approach and hence, the focus on partnering with global innovators.

    The challenges...
    Strong customer relationships required: Custom manufacturing considerably stresses on building strong relationships with clientele. It tends to be a lengthy process, as the time gap between acquiring customers and the actual revenue flow tends to be around two years. That said, considering the time lag, majority of the Indian players focusing in this area are looking to grow this business through the inorganic route. The rationale for the same is simple - access to a wider client base and new technology platforms.

    Flexibility issue: For patented products, a CMO can manufacture products only for the innovator of that particular product and not for any other company. This is in contrast to contracts with generic companies, where there is flexibility. Therefore, despite the growth potential in this industry, there is likely to be a shortage of clients - a risk, which custom manufacturing players partnering with global innovators will have to contend with.

    Type of product and product approval: Product approval is a critical issue, which will determine the revenue generating potential for contract manufacturing players in India. For players partnering with innovator companies, the type of product assumes significant importance. For instance, if the agreement is for a product, which has just been launched in the market, revenues generated in the initial years will be lower. This is because the product is yet to contribute significantly to the innovator's revenues. However, if the product is already established in the market, then the revenue potential is high.

    Looking ahead...
    CRAMS will be an important export strategy for domestic companies who do not have the required scale to compete directly in the global generics market or for those who do not want to compete in the generics market. Also, consolidation in this area is expected to pick up pace globally as innovator companies look for CMOs that are present across the value chain. Despite the challenges in terms of acquiring and retaining customers, with the product patent era triggering domestic pharma majors to look at different business strategies to fuel their growth trajectory, CRAMS could be instrumental in further augmenting revenue streams.



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