Pharma margins expected to remain stable in FY2021 despite challenges: ICRA

The growth trajectory for the Indian pharmaceutical industry is likely to remain at 10-13 per cent in FY2021, on the back of healthy demand from the domestic market given increasing spend on healthcare along with improving access. This, along with abatement in pricing pressure for the US market, new launches and market share gains for existing products and consolidation benefits will drive growth in FY2021. Several companies have acquired US ANDA portfolios (Aurobindo, Dr Reddy, Glenmark) which will aid growth going forward. Approximately, $62 billion worth of small molecules are expected to go off-patent (CY2019-2022e) which will result in overall US Generics market growing by 5.6 per cent CAGR over the CY2018-2022e period compared to -5.6 per cent CAGR during CY2016-CY2018 period.

According to Gaurav Jain, Vice President and Co-Head, ICRA, “The Indian pharmaceutical industry’s growth remained stable at 12.2 per cent during H1 FY2020 led by rebound in domestic growth in Q2 FY2020 to 14.2 per cent (Q1 FY20 at 4.8 per cent, H1 FY20 at 9.5 per cent) supported by seasonal factors and stable growth in chronic therapies. During Q2 FY2020, India witnessed outbreak of many diseases in many parts, aiding the growth of the anti-infective segment.”

The operating margins which tapered off from 24-25 per cent seen prior to FY2017 have stabilised with H1 FY2020 EBITDA margins of 21.6 per cent and 20.6 per cent in FY2019. Though margins remain healthy, pricing pressures for the US base generics business (albeit moderating), lack of limited competition products and manufacturing quality issues will continue to put margin pressure. Higher share of domestic business and operational efficiencies will provide overall cushion to margins.

The key sensitivities to our growth and profitability estimated will be regulatory interventions such as price controls and compulsory genericisation for domestic market and continued regulatory overhang with respect to manufacturing quality deficiencies during USFDA audits. There has been resurgence in the quantum of warning letter (WL) issued with 15 issuances in 10m CY2019 compared to seven in CY2018 and 16 in CY2018. Apart from WLs, several leading companies’ manufacturing plants have also been put on OAI (Official Action Indicated) status or 483s issued and could receive Warning Letter or Import Alert in future.

He added, “The US market growth at 13.6 per cent in H1 FY2020 was impacted by regulatory overhang in the form of warning letters, one-offs such as delayed shipments, voluntary recall though few limited competition products, lower pricing pressure, volume expansion for existing and new product launches supported growth. Base business in the US is expected to reflect high single- digit to low double-digit growth in the near term led by abatement in pricing pressure and healthy ANDA pipeline of various companies. The price erosion has dropped to mid single digits from low-teens seen in FY2018. The aggregate revenues of our sample of 21 entities registered growth of 12.4 per cent and 12 per cent in Q1FY20 and Q2FY19 respectively on Y-o-Y basis leading to H1 FY2020 growth of 12.2 per cent.”

Unlike in the past, when several Indian pharma companies ramped up their R&D spend, targeting pipeline of specialty drugs, niche molecules and complex therapies, this time around, companies are optimising their R&D spend. This is led by challenging US market conditions characterised by pricing pressures, high competitive intensity led by faster ANDA approvals and lower than expected revenue growth. Also, with competitive pressures expected to sustain in the near-to-medium term, companies are exiting product development of easy to manufacture, simple generics with multiple players and focussing on complex generics and speciality products.

The aggregate R&D spends of top few domestic companies moderated to 7.1 per cent in H1 FY2020 from nine per cenr in FY2017, 8.8 per cent in FY2018 and 7.8 per cent in FY2019. ICRA expects R&D budgets to remain at seven to eight per cent for the sample set given the growing focus both on regulated markets and complex molecules/therapy segments such as injectables, inhalers, dermatology, controlled-release substances and bio-similars. Indian companies have gained adequate scale and drug development capabilities over last decade of growth which will keep them in good stead to capture new opportunities in the developed market. Companies will opt for co-development of biosimilars that need expensive clinical trials to diversify their risk across portfolio of such products while benefitting from commercial and marketing prowess of their JV partners.

Jain also said, “The credit metrics of leading pharma companies are expected to remain stable in view of future growth prospects in regulated markets and relatively strong balance sheets. The capital structure and coverage indicators are expected to remain strong despite pressure on profitability and marginal rise in debt levels given inorganic investments. The key sensitivity to ICRA’s view remains productivity of R&D expenditure, increasing competition in the US generics space and operational risk related to increased level of due diligence by regulatory agencies.”