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Pharma stocks: Exercise caution... - Views on News from Equitymaster
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  • Sep 18, 2003

    Pharma stocks: Exercise caution...

    Indian pharma stocks (especially mid and small sized ones) have come to the fore off late and they have been attracting a lot of investor attention. So what has driven these stocks up on the bourses? Before we dwell upon this aspect let us first review in brief the status of the Indian pharmaceutical industry.

    The Indian Pharmaceutical industry is highly fragmented. There are over 22,000 players with merely 260 in the organized sector. The main reason for this fragmentation was the absence of product patents. Resultantly, Indian pharma companies were able to manufacture generic version of patented drugs and sell them at very low prices. Not stopping at this, Indian companies even started manufacturing 'Generic generics', i.e., the drug is sold by its chemical name. In this manner, Indian pharma companies were able to sustain growth. However, come 2005, and things may not remain the same.

    India is a signatory of WTO agreement on Trade-Related Aspects of Intellectual Property Agreement (TRIPS). Hence, post 2005 product patents will become applicable in India. Indian pharma companies will no longer be able to manufacture generic version of patented drugs. Consequently, companies that had 're-engineering of patented drugs', as their only source of revenues will become unviable and would have to shut shop. So, is this the end of road for small pharma companies?

    Most of the small sized pharma companies have realized that drug discovery and research is the next growth driver. However, in view of their small size and limited resources, small sized pharma companies are unlikely to develop new molecules and conduct clinical trials. Consequently, these companies are identifying a business segment in which they are strong and concentrating on the same. Let us briefly understand the various niche business segments in which mid-cap Indian pharma companies are focusing on.

    One of the biggest opportunities available for smaller pharma companies is that of outsourcing. Outsourcing could be either contract manufacturing or contract research. In contract manufacturing, the company could either specialize in bulk drugs manufacturing or in the manufacture of formulations. Some of the companies in the field of contract manufacturing of bulk drugs are Matrix Laboratories, Divis Laboratories and Nicholas Piramal, while Torrent Pharma and Aurobindo pharma are key players involved in contract manufacturing of formulations. These companies can capitalize on their US-FDA approved plants and manufacturing expertise and become the partner of choice for MNC companies.

    Contract research agreement is another opportunity, wherein these companies can carry out drug discovery and clinical research on behalf of MNC pharma companies. Although this avenue has not yet been exploited in a big way, many companies like Divis Laboratories are contemplating an entry in this field. This apart, many small-sized pharma companies have also entered into co-marketing agreement with MNCs. In this case, Indian companies will distribute the MNC's drugs through their already established distribution network for a commission. Zydus Cadilla has taken a lead in this field and has entered into an agreement with German company Schering for the marketing of latter's drugs in the Indian market.

    Apart from this the global generics market holds tremendous potential for these companies. It is expected that drugs worth US$ 55-65 bn are expected to go off patent in the next 5 years. Some of the companies that are targeting this avenue as a potential growth driver are Lupin, Aurobindo Pharma and Orchid Chemicals. However, small-sized pharma companies will find it increasingly difficult to enter this market as they face competition from larger companies. Finally, the recent WTO agreement on the supply of essential drugs to least developed countries could usher in new streams of revenues for mid-cap pharma companies.

    Thus, while small-sized Indian pharma companies have taken proactive steps and have specialized in their respective niche segments, they are at the initial stages of the life cycle of a pharma company. The small-sized companies are utilizing the funds generated from these opportunities and are aiming at becoming a research based global pharma company in the long-term. The company that does succeed in doing this will be the real multi bagger. Lupin has already started moving up the value chain and has one ANDA approval and four ANDAs pending approval. This is a perfect example of a company utilizing its resources generated from the generics business and focusing on R&D.

    Comparative analysis…
    Company Net sales (Rs m) PAT (Rs m) Net profit margin P/E
    Lupin 10,302 731 7.1% 28.8
    Aurobindo Pharma 11,904 1,031 8.7% 13.1
    Matrix Lab 2,669 1,089 40.8% 5.9
    Divis Lab 2,465 549 22.3% 19.4
    Torrent Pharma 4,472 518 11.6% 15.5
    Nicholas Piramal 9,642 1,781 18.5% 12.3
    Note: All figures as per latest declared annual results

    The above table gives a brief picture of the size and efficiency of the small-sized pharma companies. The P/E of some of the companies does make them ideal candidates for investing. However, investors need to look at the broader picture. Small-sized stocks are inherently risky due to lack of critical mass. Moreover, since these companies focus on niche segments, the risk profile of these companies rises further. Investors, hence, need to exercise caution while investing in such companies.

    Management vision is the most crucial aspect that investors need to check in. This is because only a company with a visionary management will be able to identify and take advantage of the opportunities that may come up in the future and move up the value chain. It is to be noted over here that not all companies will be successful in the segments in which they are operating, making some of them unviable and running the risk of being taken over (impending consolidation) by other companies. Researching the viability of businesses of these companies hence becomes all the more important.



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    Aug 22, 2017 11:20 AM