The Trials And Tribulations In Pharma Sector May Continue In The New Year

The year is ending on a sour note for Indian pharmaceutical companies, with the Nifty Pharma index down about 10% so far. In comparison, the Nifty 50 index has risen about 10%.

Unfortunately, the pharmaceutical firms may not be out of the woods in 2020. Heightened risks to the sector are likely because of an increase in the number of US FDA (food and drug administration) inspections. The domestic market could also be roiled by trade-margin caps and additions to the National List of Essential Medicines (NLEM), which is being seen as a huge overhang.

US FDA inspections increased considerably in 2019 and led to Indian drug makers receiving about 23 warning letters. Indian companies account for about one official action-indicated (OAI) letter for every six inspections, which is worrisome. The global average, by contrast, is one OAI for every 12 inspections.

In 2019, “we saw strict FDA action. To my knowledge in the past few years, we have not seen so many warning letters given to Indian companies in a single year”, said Anshuman Gupta, analyst at Investec Capital Services (India) Pvt. Ltd.

In fact, most pharma stocks that got observation letters, OAI letters, or warning letters went into a tailspin. As the US FDA inspects about 400 manufacturing plants in India every two years, risks of adverse observations remain high.

What could stand in good stead for the sector is its control on costs, with the added element of curtailing capacity expansion. This would shore up returns on equity in the long run.

Still, some of the bigger risks for domestic pharma could come from issues such as NLEM and price controls. Drugs in India are considered expensive, but any move to check prices could severely eat into margins of pharma companies. In fact, the domestic pharma market has lately been clocking faster growth rates than the US market, which aided profitability improvements. If domestic pricing pressures increase, margins and profitability could be eroded.

A good thing is that the earnings downgrade cycle has moderated. “The pharma sector was going through an earnings downgrade cycle over the past few years and the consensus earnings cut in large cap pharma companies has been high. Downward revisions in the past one year have moderated to some extent at 2-26% (average 15%) and in the past three months to 1-7% (average 4%),” said ICICI Securities Ltd in a report.

For now, though, the market is factoring in higher (about 17-20%) potential earnings growth for 2020. Given the heavy and looming overhangs, such high earnings growth could be at risk.

If the actual growth rate contracts, the sector could still be in for a topsy-turvy 2020.-Live Mint