Drug Cos’ Stumbling Specialty Drug Plan In US To Dent Earnings

India’s top drug makers, who had seen specialty generics as a means to overcome the decline in growth of their mainstay generics business in the US, now have an uphill task as stricter regulatory scrutiny and delay in key product launches have thrown a spanner in their strategy.

The delay in specialty generic products materially contributing to sales and the resultant impact on profitability because of high investment costs means that these companies are now staring at sluggish earnings growth in the quarters to come.

The Jan-Mar earnings of top pharmaceutical companies have affected investor optimism, after they invested heavily in these companies in 2018 on hopes that their US businesses will see fast recovery.

Domestic mutual funds have had an “overweight” stance on the sector since the end 2017-18 (Apr-Mar) on hopes that the worst of the pain in the US was likely over.

However, investors are now concerned that the multi-billion dollar investments made by companies like Sun Pharmaceutical Industries, Lupin and Dr Reddy’s Laboratories on specialty or differentiated products are at a risk of losing their potential returns because of the delays.

These concerns have led investors to reassess their expectations from listed drug companies, causing an erosion of nearly 13% in the value of Nifty Pharma index in over a month. In the fortnight ended May 31, foreign investors alone sold nearly 24 bln rupees of shares of drug companies.

“Some pain is expected for the coming one to two quarters…also US regulatory issues are not going away,” said HDFC Securities’ Amey Chalke, who has been tracking the sector for over a decade.

At the end of 2018-19, investors had cut their earnings estimate for Indian drug companies for the third successive year. After the Jan-Mar earnings, investors lowered their expectations for 2019-20 earnings by 5%, reflecting the growing scepticism.

Indian generic drug makers have thrived over the past two decades, making copycats of the world’s most popular branded drugs, and in the process brought down costs remarkably through their cost-efficient production techniques.

However, the last five years have seen companies from China and other emerging markets also flooding the US drug market, hitting the margins and sales of Indian companies.

Furthermore, since the harrowing episode of data fudging at Ranbaxy Laboratories in 2013, the US Food and Drug Administration has tightened standards of auditing. This has led to many facilities in the country coming under the regulatory scanner.

This has impacted Indian drug makers’ ability to constantly push new generic products in the US market to sustain the high sales growth rate seen in the 2000s.

With margins and sales shrinking, companies like Sun Pharma, Lupin, Dr Reddy’s have invested billions of dollars to move away from generic drugs and into specialty drugs to improve their earnings prospects.

However, these companies are now realising that the innovation drug market is a different ball game altogether, and the high gestation period for returns on investment is making their investors anxious, said fund managers.

Sun Pharma is facing an uphill battle to monetise its specialty drug pipeline in the US as it contends with delays in distribution and higher competition.

The country’s largest drug maker saw its stock downgraded to “sell” by Goldman Sachs on Tuesday on concerns that Sun Pharma’s specialty drug business may take longer to take off than what the company had earlier envisaged.

“We are a new entrant competing with some of the stronger giants and we have to fight our way through…that’s the bottomline,” said Abhay Gandhi, chief executive officer of North America business in a post-earnings conference call.

The longer-than-expected fruition from the investment into specialty drugs and a persistent need to have new products in the pipeline has meant that profitability of most of the top Indian drug makers will take a hit in the coming quarters, said analysts.

Managements of most Indian drug companies, with sales of over $500 mln, have indicated an urgent need to invest in specialty products to ensure sustainable growth in the US drug market, where opportunities for meaningful growth are few.

Glenmark Pharmaceuticals Managing Director Glenn Saldanha claimed that growing sales beyond 10% from selling generic drugs in the US is now unrealistic. “Organic growth (of generic business) in the US can’t be more than 10%,” he said.

The push for innovation has meant that profitability has taken a back seat as most companies enter a long investment phase. Operating margins of

Indian drug makers shrank 230 basis points on year in the March quarter due to higher spending on promotion, said Edelweiss Securities in a report.

Furthermore, companies like Aurobindo Pharma, Lupin, and Cipla recently came under the US Food and Drug Administration scanner for not meeting the good manufacturing practices at their facilities.

Thus, the wait for those investors who are still recovering from the losses they suffered during the sell-off in the sector between 2015 and 2017 has just got longer. – Cogencis 

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