The One Sector Set for Big Rebound in 2020 and Beyond - Views on News from Equitymaster

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  • Dec 27, 2019 - The One Sector Set for Big Rebound in 2020 and Beyond

The One Sector Set for Big Rebound in 2020 and Beyond podcast

Dec 27, 2019

In this video, Tanushree Banerjee talks in great detail about pharma sector. She tells us where the sector stands now and also about the potential for a rebound.

Watch Now...

Here's more on Rebirth of India:

This sector has recently had a rough few years. Regulatory and pricing issues kept businesses volatile and USFDA uncertainty was the dominant theme for Indian pharma....

The US drug regulators' warnings kept the stock prices of most Indian pharma companies near 5-year lows, so far.

Not just that...the sector faces pricing risks from the regulator even in the domestic market.

The persistent regulatory issues have had such a negative impact on operating performance that investors have chosen to completely sideline the Indian pharma sector.

But let's understand that apart from the regulatory woes...where does the sector actually stand, and does it have the potential for a rebound. Not just in the next year, but in the years ahead.

The Indian pharmaceutical industry responds to over 50% of the global demand for various vaccines, 40% of the demand for generics in the United States and 25% of all drugs in the United Kingdom.

Cost-effectiveness of production is the key advantage of Indian pharma sector. In fact, the low manpower and R&D costs increases the efficiency of Indian pharmaceutical companies. India's production cost is about 33% lower than that of the US. Due to lower treatment costs, India is also emerging as a primary destination for medical tourism.

Also, India intends to continue to diversify its portfolio, which currently weighs 10% on global pharmaceutical production. The country has more than 60,000 generic brands in 60 therapeutic categories.

But most importantly, India positioning as the low-cost drug innovator for the world is unlikely to change.

Now... 2019 has been the year of the Big divide between domestic and MNC companies in India. Both... in terms of operating and stock price performance. While the domestic majors continue to be the laggards, the MNC drug majors have been hot favorites with investors this year.

MNC pharma companies focus on a few branded products and enjoy premium pricing on these products as they are restricted to the top end of the market

They also are 100% focused on the India market where there is less regulatory risk.

Their Indian counterparts, on the other hand, have about 30% of their revenue coming from the domestic market, and the rest is from overseas businesses.

So, while Indian pharma majors are battling USFDA issues, MNC pharma companies are riding on the innovation done by their parent companies and are operating in niche therapies where there is less competition. This led to a huge valuation gap between MNC and domestic pharma this year.

Now ...what are the possibilities of a rebound in the sector? Why do I believe that at least a few players in the India pharma sector could do exceptionally well in the coming years?

I have three key reasons...

The China Opportunity

The opening up of the Chinese market could drive the next leg of growth for the Indian pharma.

The Chinese pharmaceutical industry has undergone a critical transformation toward high-quality and innovation-focused development. It has reflected in the explosion of new drug and clinical trial approvals in recent years.

A rapidly ageing society, drug regulation reforms, higher healthcare demands and increased investment inflows have helped the industry mature at a feverish pace in China.

So how is the consolidation of the Chinese pharma beneficial for India?

Indian pharma companies can carve a niche in the generic segment in China.

The increased focus on innovation and research and development means that Chinese players are not as focused on generics, and that is where Indian companies can step in.

The Chinese generic segment is four times the size of the Indian pharma market. It generates sales of about $84 billion in 2018, largely dominated by multi-national companies.

China has also adopted a new drug approval framework, which focuses on fostering confidence with both public and physicians so that they switch to generics instead of foreign brands.

The exit of MNC companies that have dominated the Chinese generic market for years, could make way for Indian drug makers.

The Chinese players have limited experience in developing complex generics. While Indian players, by virtue of their US filings, are well prepared to do so. They are already entering into joint ventures and out-licensing arrangements to get a share of the Chinese pie.

Better Response to USFDA warnings I said before the USFDA warnings have been a big overhang on domestic pharma valuations

USFDA has sent a record number of 'warning letters' in 2019.

It issued 23 warning letters in the last 11 months (until November) - three times that of last year - to the country's top drug majors such as Lupin, Glenmark Pharmaceuticals, Torrent Pharmaceuticals, Aurobindo and Cadila.

But despite that the sector continues to successfully gain FDA approval to sell generic drugs in the American market.

Indian firms accounted for 43% of the total approvals in 2019.... compared to 36% in 2018 and 27% in 2017.

The FDA handed out 476 ANDA approvals worldwide in the first half of 2019, of which, 207 were given to India.

So...the surge in new drug approvals shows that warning letters are not impacting the new business opportunities of Indian drug-makers in the US

Indian drug-makers are responding well to the new regulatory environment.

Some like Lupin and Cadila have introduced changes such as

  1. automating the entire production cycle,
  2. training employees to tackle audits and inspections,
  3. empowering employees to point out lapses,
  4. rejecting batches with minor deviations or
  5. developing proprietary digital tools for risk mitigation.

Therefore, there is a good chance that Indian drug majors will increasingly use technology to counter USFDA issues.

Third and most important factor for a rebound could be...Indian pharma leveraging the patent cliff

Patents for branded drugs worth over US$ 251 billion are expected to expire in the next five years. This is being called the patent cliff.

The Indian generics industry can benefit substantially from the patent cliff, given an increased new drug I just explained and faster time-to-market.

The industry may need to formulate a sharp molecule-level strategy, coupled with superior regulatory and market execution.

To leverage the patent cliff, Indian pharma must aspire to become the world's largest supplier by volume. So, the next wave of growth could even come from increasing exports to large and traditionally underpenetrated markets such as Japan, China, Africa, Indonesia and Latin America.

This is not to say that the challenges for Indian drug makers are over.

India continues to have heavy dependence on China for bulk drugs...which is the basic version of the generic drugs. And rise in prices or supply disruptions from China could have a big impact on India's production.

Secondly...The US still accounts for a third of India's exports and growth in the US markets could continue to moderate due to price erosions.

Having said that...I do not think it will be impossible for Indian pharma sector to rebound and achieve the 2030 target of doubling its global market share from the current 3.6% to about 7%. But that can be achieved by companies tapping uncharted markets, developing technology platforms and offering next-generation generics.

However, instead of betting on the sector as a whole, I believe investors would do well to focus on few niche businesses that are well placed to capitalize on the opportunities that I just mentioned and even a slight improvement in the valuation multiples could offer a big upside.

Do stay tuned for more updates on the sector by signing up for The 5 Minute Wrapup...

Tanushree Banerjee

Tanushree Banerjee (Research Analyst), is the editor of Stock Select and, ValuePro Equitymaster's oldest recommendation services. She is also the editor of Equitymaster's most popular newsletter read by over 300,000 subscribers, The 5 Minute WrapUp. Tanushree started her career at Equitymaster covering the banking and financial sector stocks and scrutinising RBI policies. Over the last decade, she developed Equitymaster's research processes that helped us pick out various multibaggers, across all sectors. A firm believer of "safety first" when it comes to investing, Tanushree closely follows the investing philosophies of Warren Buffett, Jeremy Grantham, and Joel Greenblatt.

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Sep 28, 2020 03:14 PM