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Pharma: Where does the focus lie?

Aug 7, 2007

Pharma stocks have evinced mixed interest from investors in the past one-year and some good results announced by certain companies in this period have not done much in enthusing the investors. In this article, we shall take a look at some of the main business models and whether companies focusing on these models have garnered much buying interest of late.Generics: Companies focusing on the generics market have not really been on the investors' radar of late. This could largely be attributed to the competitive nature of the global generics market and persistent price erosion witnessed on generic products. Hence to counter the same, domestic companies such as Ranbaxy, Dr.Reddy's, Sun Pharma and the like have been focusing on niche generic products having lesser competition, challenging patents to garner the 180-day exclusivity period and acquiring companies in the global market to attain scale.

While there are definite upsides from the same, challenges abound as well in the form of regulatory changes and pricing pressure in the country in which the acquired company is located, mounting legal costs, pressure posed by authorised generics and scramble by pharma companies to look for niche areas (which after a while are no longer likely to be niche when competition intensifies).

Despite this, some of the positive moves undertaken by companies such as Ranbaxy and Dr.Reddy's have been to either enter into authorised generics deals themselves or settle the patent challenges with innovators. The latter move not only obviates the need for further legal costs but also lends some semblance of certainty to the outcome of these legal suits. Hence, for generic companies besides valuations, strategies undertaken to counter this pressure and maximise revenues and profitability will be critical going forward.

CRAMS: 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. Also, 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. However, challenges abound in the form of stronger customer relationships required and a likely shortage of clients.

Having said that, CRAMS will be an important exports 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. With domestic pharma companies looking at different business strategies to fuel their growth trajectory, CRAMS could be instrumental in further augmenting revenue streams and hence explains why investors have lapped up stocks such as Dishman, Divi's amongst others recently.

MNC Pharma: MNC pharma stocks have taken a backseat since the steep correction in May 2006 and have failed to enthuse investors since then. For instance, in the domestic market where the MNC pharma companies are largely focused on, they have not really been able to outperform their domestic counterparts. For instance, on an average, while the domestic companies under our coverage have grown their topline by around 12% to 16% in FY07/CY06, MNC companies have been able to clock topline growth in the range of only 9% to 10%. Various factors contributing to the lower growth have been increasing competition, low number of new product launches, trade related issues, divestment of certain businesses and the like.

New product launches from the parent's product stable will be critical for MNC pharma companies going forward, as this is one factor that gives then an edge over their domestic counterparts. Besides this, MNC majors are looking at in-licensing products from other global companies given their strong reach in the domestic market. Having said that, launch of patented products in the country are unlikely to take place before late CY07 or CY08.

To conclude...
We believe that it is more prudent for investors not to invest in the sector based on 'themes' but to adopt a stock specific approach while investing in pharma stocks. This means that besides CRAMS, there are good investment opportunities in generics focused companies and MNC pharma companies having sound business fundamentals and cheap valuations. The trick of course lies in identifying the same!


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