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Pharma: The DPCO effect! - Views on News from Equitymaster
 
 
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  • Jul 26, 2006

    Pharma: The DPCO effect!

    Government policies affect the economy and financial markets in a big way. The effect of politics has been apparent in the energy sector wherein products such as kerosene, petrol and LPG have been subsidised despite rising crude prices, consequently causing oil-marketing companies to bleed. In the pharma sector, it is the DPCO (drug price control order), which as been the bane of the industry since 1979. While the government has not officially announced the new and much-debated DPCO policy, here are the likely implications of the same in the event that it gets passed.

    Likely implications of the policy
    'Accessibility' is the key: The new policy proposes to bring 354 essential medicines under price control as against the 74 drugs under price control at present. Should the policy go through, a large part of the industry turnover is likely to be impacted by the effect of price control. One of the main reasons cited by the ministry for increasing the span of control is to make cheaper medicines more 'accessible' to the population. That said, despite the fact that drug prices in India are one of the lowest in the world, drugs still remain inaccessible to around 70% of the population (as per our interaction with a leading pharma major). This highlights the fact that it is the 'accessibility' issue that needs to be addressed by the government and not the 'affordability' issue.

    Impact on growth prospects: The proposed policy is expected to affect profitability of the entire pharma industry and not just a few companies. For instance, domestic pharma companies have been ploughing back profits earned from the domestic and international markets into their R&D programme, which has picked up pace since the introduction of the product patent law in the country. This means that significant reduction in prices will hamper the R&D efforts to a certain extent. That said, international focus of the domestic companies will provide some cushion to overall earnings and profitability. The impact of this law is likely to be more pronounced for MNC pharma majors, whose focus is largely on the domestic markets and do not have export revenues to insulate themselves from the impact of the policy.

    Threat of spurious drugs: The industry over the years has had to contend with the presence of spurious and counterfeit drugs with this practice being more rampant in the North and a part of the East. While the government has been reasonably successful in curbing this practice, it is likely to rear its ugly head in the event that this new policy becomes effective. Another problem that the industry could face is the shortage in availability of drugs. This is because companies may choose to stop the manufacturing of those drugs, where margins get severely impacted.

    Our view...
    Since the new DPCO law has not been passed, it is difficult to assess the exact impact of the same on the financial numbers of pharma companies. The industry has been making representations to the government highlighting the negative impact of the policy. That said, whatever the result, it is imperative that the issue gets resolved as soon as possible. While price control is not a desirable option for the industry, the government can monitor the prices to make sure that they do not rise steeply. This practice is followed in Europe, where the prices of branded drugs on an average tend to be around 20% lower than the prices in the US. Investors should note that excluding the DPCO, growth is visible in most of the pharma companies under our coverage. That said, valuations will be the key and we advise investors to adopt a stock-specific investment strategy.

     

     

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