Pharma trends in 2018 and beyond

Anil Khanna, Partner, Wisdomsmith Advisors, gives an insight about pharma trends in 2018 and how the sector can go forward by overcoming the challenges

“I am looking forward to the future and feeling grateful for the past” – probably sums up best the sentiment of the Indian pharma industry, as it enters 2018, and plans its future.

It should be grateful about the past, as the industry did really well during the last decade, with both domestic and export growth engines speeding ahead. The industry grew strongly, profitability increased, balance sheets strengthened, shareholders were happy, retail investors made money.

However, at the end of 2016, and right through the 2017, industry grappled with two significant challenges – demonetisation and GST. While demonetisation, essentially became a working capital issue, as distributors – who largely deal in cash (no longer now!), were forced to reduce their inventory, as they couldn’t make timely payments to the companies. And a month prior to the GST implementation, stock off take virtually came to standstill. Even more than three months after the GST roll-out, normal inventory days (45) of the distribution pipeline is yet to be restored. Most companies lost 45-60 days of sales due to GST.

Nevertheless, the pharma industry would heave a sigh of relief that all this is behind us, and by-and-large, the industry has come out of these challenges, without much of a bloodbath.

So, what’s next?

Both the growth engines of the Indian pharma – exports and domestic business, are facing challenges. On the domestic front, while there aren’t going to be any immediate radical challenges during 2018 (thankfully, Modiji will now be
focussed on 2019 elections), like demonetisation or GST, but the industry will still continue to face other challenges, about which we will discuss later.
It’s on the exports front, which contributes more than 60 per cent revenue of the large pharma, primarily the US, where the challenges are bigger in magnitude.

Export market trends for 2018

Two years ago, many of the big generic pharma companies seemed invincible. But as generic pharma companies issue their results, there is a clear pattern emerging – underperformance and changes in quarterly and annual guidance to the market. It’s a trend that has hit publicly listed US companies like Teva, Mylan, Sun Pharma, Hikma and Lupin, to name a few.

Since January 2016, the index for listed generic companies dropped by 57 per cent. Meanwhile, the broader S&P index grew well over 20 per cent in that same period
of time. The truth is, this is not just a passing storm which has hit the industry; this is a drastic ‘climate change’ – and it’s here to stay.

Many generic companies in the US market are currently struggling. Many analysts and managers in the US pharma industry have been taken by surprise at how fast this has happened. Others are in denial, asking ‘How did this happen?”

The recipe for a perfect storm

The consolidation of the US generic pharma customer base has been occurring since the formation of a true substitutable market. Wholesalers have started teaming up with retailers in joint ventures that allow the partnership to act as one unit. Currently, there are three material customers in generic pharma: WBAD, ClarusOne, and Red Oak.

Together, they control around 90 per cent of the entire US generics market.
There has also been enormous consolidation among payers. Today, three main
payers in the US market — Express Scripts, Caremark and OptumRx — process more than 75 per cent of the store-based retail prescription claims. This has put more pressure upstream in the channel and forced the three large wholesalers/retail groups — WBAD, Clarus One and Red Oak — to pass price savings to them. The result has been a similar loss in profitability for WBAD, Clarus One and Red Oak, which in turn has created more pricing pressure on manufacturers.

Until 2015, the industry was at its peak with many generic companies acquiring assets at high prices. We saw transactions close for multiples exceeding 15x EBITDA. This was done to create future growth in an over-inflated
industry. As companies started to see price erosion, the fight for market share intensified, and the basis for synergies and acquisition multiples of past acquisitions were no longer justified. Unsurprisingly, this has caused widespread panic, which has essentially changed the industry overnight. The whole industry entered into a downward spiral.

What lies ahead?

Looking forward, period of massive consolidation is predicted. Some companies will struggle with debt — divesting assets, merging and selling. Others may even go bust, a phenomenon almost unheard of in our industry. However, any company with access to cash will be better positioned to take advantage of the current situation.
The second key trend would be focus on biosimilars. Today, the largest pharma products are biologics and many generic companies would need to invest in biosimilars today to position themselves for the market of the future. Within the next 10 years, a top 10 generic company in the US will be unable to maintain growth or profitability without a biosimilar pipeline. It won’t be long before the largest generic products in the world emerge from launches of biosimilars into the US market, it could be as large as $1 billion.

One key thing the generic pharma industry need to realise is that the industry has changed suddenly and permanently. And while there will be a lot of turbulence going forward, in 2018 and onwards, there will also be opportunities. It is now up to each stakeholder to determine the best way forward for them.

In a nutshell

• In 2018, global pharma will likely grow in the low-single-digit range, about three per cent, slower than recent years due to patent expirations and a continued negative pricing environment for generic and some speciality products.
• Patent expirations abound in 2018, with several large companies like Merck & Co. Inc., Novartis, Eli Lily & Co, and Valeant Pharmaceuticals International, face headwinds from drugs going off-patent.
• Generic pharma industry will remain challenged in 2018, as high-single-digit price declines on older generics will not be offset by new product launches.
• Margins will more or less remain flat in 2018
• While M&A slowed somewhat, due to environment challenges and the tax reform, but slower organic growth, decreasing profitability, higher volatility of revenues, increasing development and marketing costs, will eventually lead to increased M&As, to drive revenue growth. Still, most large players in pharma have healthy balance sheets and debt capacity

Domestic market trend for 2018

In the domestic market, pharma industry will not have challenges in the classical sense of terms, but 2018 would be the harbinger of the paradigm shifting changes.
With the advent of GST, supply chain and distribution will see radical changes. Industry and the veterans are already thinking and have started to conceptualise alternate scenarios. For instance, the number of CFAs would gradually reduce and this layer of pharma distribution may completely vanish in five to seven years.

Let’s say, a pharma company had individual CFAs in Delhi, Gurgaon. Faridabad, Noida and Ghaziabad (called NCR region) in pre-GST era (to save on taxes), in post-GST era, would just need and have single CFA to cater to the NCR territory. Slowly this consolidation of CFAs will pick pace and may ultimately lead to elimination of CFAs altogether. Now that pharma industry will not have to face any big-ticket challenges in 2018 (hopefully!), it will start to work on drawing out strategies to improve supply-chain efficiencies in the post-GST scenario.

Already, a very radical idea, though in its infancy, is being contemplated – which is 13 CFAs, with Rs 13,000 crores in sales, 33 lakh sq ft warehouse space, and nearly 3,000 people, are planning to join hands and launch a new holding company, which will not only consolidate this business, but also enter into wholesale distribution (stockist, a level below). If it materialises, it would be significant, indeed!

Distribution consolidation

The second area which may witness a great churn would be consolidation of the pharma distribution. Let’s have a quick comparison of ‘Pharma Distributors’ in India and the US: In the world’s largest pharma market, top three distributors control over 90 per cent of the market, and among top 10 distributors, even the smallest distributor has $1 billion size. While in India, the situation is absolutely reverse, it’s highly fragmented. In India, distributors with more than `200 crores revenue, can be counted on fingers.

Hence, the pharma distribution in India, at distributors’ level, is ripe for consolidation. It has already begun, and in all likelihood, will gain momentum in 2018. Already a PE funded pharma distribution company, Ascent Health has started
the consolidation process by acquiring distributors in Mumbai and Delhi.

Other policy challenge, though pharma industry may be well used to it, would be the continuous movement towards more price control. Only few days back, government again brought nearly 50 more drugs under price control. In 2018, there may be more such moves by the Government of India.

Earlier this year government banned large number of Fixed Dose Combinations (FDCs) on account of being irrational combinations, which was challenged by various companies in the court. As a corollary to this decision, interestingly, recently a case was filed before the Delhi High Court. The petitioner (association of dermatologist) requested the court to curb the approval and sale of a number of corticosteroids that are prescribed for treating a number of derma related ailments including skin inflammation, itching, fairness and pigmentation. The court has asked the central government as well as the Central Drug Standards Control Organization (CDSCO) to respond to the petition.

This case is a throwback to the earlier cases already going on, and which are in final stages of hearing at Supreme Court. In a way, the new case supports the government point. What it means is that even some section of the medical fraternity is questioning the indiscriminate launch of FDCs. So, it wouldn’t be surprising that excess of the past will be cleansed through more such administrative or judicial actions.

Another focus of pharma companies in the coming year, to grow faster and profitably, would be on increased R&D spend, but targeted spends
on speciality drugs, niche molecules and complex therapies such as injectables, inhalers, dermatology, controlled-release substances and biosimilars. So, we have companies working on NDDS like painless injections, or focussed exclusively on one therapeutic segments like CNS, derma, women’s health and so on. Clearly, the focus would be on niche spaces and deep presence and differentiated offerings in the chosen domain

In a nutshell

Though domestic market will continue its growth path, in 2018, reaching its peak growth rate of 13-15 per cent will still take time. There will still be few growth pressures. The key trends would be:

• Domestic market will continue to see regulatory pressures in the form of DPCO or FDC banning
• Companies would have to explore and find their niche
• As in global market, domestic companies will have to decide their niche, be it therapeutic wise, or specific aspect of R&D, to secure their future
• Consolidation of pharma distribution, especially at distributors level, will gain pace
• In the post GST scenario, supply chain efficiencies would improve, and 2018 would be the harbinger of this change

A recent article, mentioned that experts at Pantone (a ‘colour specialist’ organisation), chose ‘ultra-violet’ to be the colour of 2018. And this colour, according to Pantone Colour Institute, stands for originality, ingenuity, and visionary thinking; it’s a colour found in the cosmos, it stands for wellness movement (amethyst crystals), and finally it’s one of the most complex colours! In a sense, it truly represents what Indian pharma is all about, its challenges, or what it needs to do going forward. May be the road to bright future for pharma is paved with ultra-violet pebbles!