Some Indian drug makers have made acquisitions in the US, Europe and some emerging markets in the last few years. But until recently, the benefits from the acquisitions were not reflected enough in their earnings as the gains were offset by factors such as rupee appreciation, regulatory issues and competition abroad.
Also, though Indian companies have been targeting the largest market for off-patent drugs, the US, their products were facing price erosion due to cut-throat competition. For instance, if a product was going off patent, there would be several companies waiting to launch a similar product. There were instances when price erosion on the first day of the launch was as much as 99%. The result: Companies were not able to show good growth in revenue or profit. The rupee appreciation, which ate into profits booked in foreign currency, was in addition to this.
But in the last two quarters we have seen a change. Pricing pressure has come down and margins have stabilized in the overseas markets. The companies are doing well domestically as well. The rupee’s depreciation was another helping factor.
The returns from the pharma sector will be relative to the market. The overall market is expected to remain range-bound in the short term on the back of high inflation, high interest rates and a weak rupee. In such an environment, pharma, being a defensive and under-owned sector, is likely to outperform the broad market.
Currently, investors are significantly underweight in this sector—even though exports are looking up and the domestic market is estimated to grow at 10-12%. If the rupee continues to depreciate, it will add to the earnings growth trajectory.
Within the sector, we are quite excited about the contract research and manufacturing service (CRAMS). Globally, companies are reducing their research and development expenses and are outsourcing these activities. These big players are entering into collaborative arrangements with Indian companies. With manufacturing costs in India lower than in developed countries, this space may provide higher growth. Overall, this is expected to translate into high revenue and earnings growth for CRAMS companies. But the number of listed companies that are into this business is limited. Among others, we also like companies with a strong line of exclusive or niche products under development.
So, what could hinder the pharma sector’s growth? In India, we can always expect a growth rate of 8-12% per annum for the sector since the pharma and health care industry is rather immune to economic cycles. In the last two years, the domestic pharma market has been doing well-driven mainly by volume growth.
But being an export-oriented business model, significant rupee appreciation could impact earnings. Regulatory issues—within the country and outside—are also a cause for concern. There are differences between the government and industry over the new pharmaceutical policy. The government wants more drugs to come under price control. This will hit the profitability of companies. Given the strong opposition from industry, the government has appointed a group of ministers to give the final recommendation on the policy. We have to wait and see the outcome of this process.
Earlier, pharma company growth was less than that of companies in other sectors. Now it’s a different situation. Expectations of a slowdown in India’s gross domestic product to less than 8%, the dismal economic situation in the US, concerns over inflation, interest rates and the weakening rupee are all weighing heavily on the performance of most sectors. With overall expectations down, the relative growth exhibited by pharma companies looks attractive again.
The author is the fund manager of UTI Pharma and Healthcare