If one were to compare pharma stocks with stocks from other sectors, the former have not exactly been the cynosure of investors eye in the past year. This can be attributed to the increasingly tough conditions in global generics market due to rise in the level of competition and severe price erosion. Besides, the domestic market has not been spared from competition either, as can be evinced from the fragmented nature of the industry.
Having said that, the pharmaceutical industry is dynamic in the sense that companies need to constantly innovate and employ new strategies if they want to withstand competition and come out on the top. Thus, what do investors need to look at while investing in pharma stocks? Here are a few key questions, which we believe investors need to consider while investing in this sector.
Domestic market: The domestic market is highly competitive with both Indian and MNC companies vying for a majority market share. Three main factors are crucial to the growth of revenues from the domestic market - introduction of new products, government policies for price control (DPCO and NPPA) and composition of product portfolio. In such a scenario, investors need to ask themselves the following questions -
- How many new products has the company introduced every year?
- Have MNC pharma companies stepped up product launches from their parents' folio?
- What strategies are domestic companies adopting to keep their product portfolio fresh in light of the product patent regime?
- Is the product stable inclined towards the acute or the chronic therapy segment (the latter enjoys higher realisations and margins)?
Exports: In the international markets, the focus of most of the Indian companies has been on generics. In the generics market, the number of ANDA filings made and more importantly, the approvals for the same are important. Besides, the type of ANDA filing made is also significant. A Para III filing tends to generate more revenues than a Para II filing, as in the case of the former, the drug gets launched on the first day of patent expiry. While the pricing conditions tend to be highly competitive even on day 1, companies do have the benefit of garnering a relatively higher market share, which would have been a bit difficult if the generic version gets launched later.
In terms of filings also, investors have to put more emphasis on the number of Para IV filings made, as the legal costs for these filings are high and the outcome highly unpredictable. More importantly, investors should not make their investment decisions based on the success or failure of one single legal suit. For companies focusing on contract manufacturing and research (CRAMS), the ability to strike alliances and maintain relationships with global generic majors or global innovators, as the case may be, will be crucial growth drivers.
Research and development: R&D is the backbone of the pharmaceutical industry, both globally and in India. Given the fact that most of the major domestic companies are investing anywhere between 5% and 10% of total sales on R&D, the importance of this area cannot be undermined. Thus, the points of introspection are -
- What is the progress of molecules under clinical development?
- How many molecules are under clinical development?
- What is the therapeutic area that is being targeted?
- Is there a well-established market for the same?
- Is the company developing these NCE assets on its own or is it doing so in collaboration with global innovator companies?
- Is the company open to suitable out-licensing opportunities in the future?
Given the fact that R&D initiatives of Indian pharma companies are still in their nascent stages in comparison to global pharma majors, collaboration and out-licensing (to monetise NCE assets) should be construed as positives.
Management: Management is the most crucial aspect for any company's success. While this is true for every industry, it attains even more significance in the pharma sector. Being an extremely specialised sector with ever changing dynamics, it is very important that the management has the requisite expertise and skills to handle the complexities involved in this business. This means that investors need to ask -
- What is the management's vision in the next five years?
- Does a company want to position itself as a research oriented pharmaceutical company or a contract manufacturing company?
- Has this vision been consistent? Has it successfully been able to tide over adverse conditions?
Regulatory policies: Governments across the world aim to make medicines affordable to the public. This means that even though the pharma sector is not as regulated as the energy or the fertilizer sectors, government policies, especially with regards the pricing of the drugs, assumes significant importance. In the domestic market, the NPPA and the DPCO have imposed price control on certain drugs. In the international markets, governments of certain countries are making price cuts on generic drugs mandatory to cut down healthcare costs. Thus, the points to ponder are -
- How much do drugs under DPCO cover contribute to total revenues?
- In which countries is a particular company present in and have there been any major regulatory changes to impact performance?
- More importantly, is the company geographically diverse enough to counter the negative impact of regulatory policies?
To answer these questions, investors need to study the companies carefully and understand the fundamentals of sector and specific businesses. As with other sectors and companies, valuations are also important. Given the highly competitive nature of the industry and the fact that certain initiatives (product launches from parent's folio, commercial launch of NCE assets and generics penetration in certain global markets) will take a longer time to contribute to revenues, investors need to accordingly attune their investment strategy.