Companies with emerging focus on chronic therapies are likely to sustain India growth; lower US exposure limits US FDA risk.
Secular growth in domestic India pharma market (IPM) to continue, despite short-term regulatory issues. Companies with emerging focus on chronic therapies are likely to sustain India growth; lower US exposure limits US FDA risk. Initiate on Alkem Lab with a Buy (target price R1,945) and Alembic Pharma with a hold (TP R645).
The past 15-18 months have been difficult for Indian pharma players. The numerous regulatory red flags raised by the US FDA have hurt sentiment and growth. Domestic price controls haven’t helped either, so little wonder that the sector has underperformed in the last year. Despite this, we think long-term growth opportunities remain intact in India, while a US recovery will depend on resolving FDA issues.
Better India prospects
Strong growth – the Indian pharma market has tripled in the last 10 years – is being driven by a higher incidence of lifestyle diseases, growing healthcare awareness and increasing affordability. Chronic therapies for lifestyle-related disorders (e.g. diabetes) are likely to contribute to higher sales for emerging players like Alkem Lab and Alembic Pharma, the focus of this report.
The two companies have a much lower share of sales from the US (c25%) than larger peers like Sun Pharma, Lupin and Dr Reddy’s (c45%). We believe this makes them less exposed to regulatory risk (to date they have a good US FDA record). We think better compliance, quality control and increased spending on R&D make a case for the US being a long-term driver for these companies. We forecast Alkem’s earnings will rise at a CAGR of 22.5% over FY16-19e and Alembic’s c11%.
We initiate on Alkem Lab with a Buy (TP R1,945) and Alembic Pharma with a Hold (TP R645). We prefer Alkem for its sustained growth outlook in India due to its strong brand positioning and expected market share gains in chronic therapies, as well as product launches in the US. We like Alembic’s long-term story but see limited upside from current levels. We value Alkem at 22x Sep-18 EPS of R95.2 and Alembic at 22x Sep-18 EPS of R31.6 and discount back the values to derive our TPs. Key risks: higher-than-expected price cuts in India and regulatory issues in the US.
India secular growth to continue despite challenges
The India pharma market is one of the fastest growing drug markets, increasing from c$5 bn in 2005 to current sales of c$15 bn. Despite this, healthcare spending in India remains low – expenditure per capita is just c$74 p.a. vs the global average of $1,061. Similarly, India’s pharma expenditure per capita at c $20 p.a. is far lower than in the US (c$1,100), and even emerging markets such as Brazil, Russia and Mexico ($150-200). This implies significant growth opportunities in India and CRISIL Research forecasts that its pharma market will grow at a CAGR of c13-15% to reach c$20 bn by 2019-20.
While the secular growth story remains intact, recent regulatory events have slowed down overall market growth. The government has issued a series of regulatory updates in the last 8-10 months. These include putting additional drugs under price controls as well as reducing prices for certain drugs in line with the negative wholesale price inflation (WPI) for 2015. The government has also proposed banning several hundred FDC medicines.
These regulatory changes have created uncertainty among manufacturers and trade channel participants who have reduced/delayed product uptake from manufacturers, impacting sales growth. As a result, sector growth has fallen from the historical trend of 12-15% to single digits in recent quarters.
The overall Indian pharma sector has also been faced with a series of regulatory issues raised by the US Food and Drug Administration (US FDA) and other global regulatory agencies with regard to some of the larger companies’ facilities. These regulatory issues, as well as a challenging pricing environment due to channel consolidation and increasing competition, have slowed sales growth in the US, an important market for most of the Indian pharma companies.
While investor sentiment has remained cautious due to these concerns, we believe growth prospects in the domestic Indian market continue to be bright. We believe government-mandated price revisions are scheduled every two to three years and therefore the next round of revisions will likely take place in India in 2018-19. Additionally, companies are consciously launching brands in discretionary areas where pricing may be flexible.