As the pricing pressure in the United States and Europe and orderly inspections continue to hurt the pharma sector, it may be a good time to relook at SIPs (systematic investment plans) in pharma funds, said HDFC Securities in a report. While we do not expect a sharp and immediate up move from here for pharma stocks and hence pharma funds, SIP in pharma funds could generate decent returns over 1 to 3 years at a time when the other sectors/stocks seem to be close to topping out/have already have topped out, HDFC Securities added.
Aggressive investors could opt for large value small period SIP. Pharma is more of a long-term play and investors who can remain invested for long should only venture into this sector and deploy a buy-on-dips / SIP strategy to accumulate quality bets. There are two Key risks that are weighing on pharma sector since the last two-three years which are Pricing pressure and inspections.
Pricing Pressures in the US/Europe
Prices of drugs have fallen with rising competition and distributors buying jointly. As new companies enter US and existing ones seek to introduce more products, competition has increased, depressing prices and making it tough to maintain market share. This increased competition has squeezed the revenues and margins of the companies. For eg, generic oral solid drugs, which fetched 40-60% margins till about five years ago, now earn only 20-25%. Also, the Drugs (Price Control) Order of 2013 in India which inducted a list of 348 drugs under the price control mechanism has been hurting the domestic profitability of the pharma companies as well.
Uniformity in inspections
With India accounting for 40% of US generic drug filings, FDA has over the last few years decided to ensure the drugs from India are of top quality. Inspections rose from 108 in 2009 to 290 in 2015. India has the highest number of US FDA-approved plants outside the US, with the total at 572 currently, compared with 433 in 2013. It has cut prior intimation time for plant inspections to as little as 24 hours from 25-30 days and inspection frequency has increased to once or even twice a year from once in two-to-three years earlier.
Outlook for the pharma sector:
- Large companies remain under pressure as they await approval for complex/niche products to take some pain off in the wake of intense competition. Small companies, which are yet to gain scale in the US, are yet to gain critical mass. Even on the domestic front, sales are expected to decline by a mid-single digit for the Q1FY18 because of the disruption caused by destocking as a result of Goods and Services Tax or GST implementation.
- Improving outlook for accelerated new ANDA approvals and resolution of outstanding FDA queries while consolidation of distribution channel in the US is almost over.
- The domestic players have now started to look at the specialty drugs business with increased focus and importance. Specialty margins are significantly higher and much more stable than the generic side. Typically, brand margins are 90% plus, generic margins are 50% or thereabout.
- Inorganic growth can help Indian pharma firms access new markets and enhance technological capabilities in developing new drugs. Collaborations in areas such as R&D, manufacturing, and marketing, can also help enhance value by reducing cost and increasing efficiency.
- US FDA inspections might prove to be a short term pain, long term gain scenario as companies will improve upon their quality standards which will, in turn, help them fare better competitively and obtain a certain degree of pricing power.
- Local pharma policy may come in for a change, going by the pronouncements of the PM recently to promote affordable drugs. Though this could be negative if implemented with full zeal, the impact of this on R&D efforts in India and Make-in-India initiative may prevent any drastic negative impact on the sector.
BSE Healthcare index rose at a CAGR (compounded annual growth rate) of 35% per annum between March 2009 and March 2015. It has later fallen -18.39% in absolute terms till now. Similarly, NAV (net asset value) of SBI Pharma fund rose at a CAGR of 39% over the same period and later fell -1.28% till now.
However, the performance of the mid-cap pharma players relative to the larger peers has been healthier. Revenue growth over the past five years for the mid-cap pharma firms has been higher and they have clocked faster-operating profit growth of 17.18% compared to large-cap firms’ 14.76%. Also, while operating margins for the latter have remained constant at around 22.5% over the past five years, the smaller players have exhibited a 314 bps expansion.
Meanwhile, today the shares of Cadila Healthcare advanced over 8% on Thursday drugmaker announced that Zydus Cadila received final approval from the USFDA to market candesartan cilexetil tablets used for the treatment of hypertension. The stock of Cadila Healthcare rose as much as 8.93% to the day’s high of Rs 504 on NSE. The Nifty Pharma index gained 3.55% to 8,921.4 points and was the biggest gainer today led by the upsurge in Cadila shares.