The BSE Healthcare index has appreciated by around 40% in the past year, easily beating the broad market’s rise. The outperformance reflects a good year for pharmaceutical companies, particularly those that have a sizeable exposure to the US generic market.
The question that arises is: Now what for Indian pharmaceutical companies? The pace and size of US generic drug launches is likely to taper off in 2013. The domestic market seems to offer the opportunity of a growing market, but also presents the risk of government policy sending calculations awry.
The year 2012 saw the impact on revenues from many large drugs going off patent, benefiting Indian companies that had been preparing for years for this period, especially those which succeeded in getting exclusive rights to sell the generic versions of drugs for six months.
The industry’s sales have risen by 21.8% from the year ago, the operating profit margin by 96 basis points, and net profit by 21.9%. One basis point is one-hundredth of a percentage point. That does not appear very extraordinary, and the reason becomes apparent when you look at a size-wise analysis. For the top 10 companies, sales have risen by 19.6% from the year ago, while operating profit margin (OPM) has widened by 2 percentage points, and net profit has risen 47%. That ties in with the fact that the top companies have benefited more from the US generic opportunity.
The outlook for 2013 is a bit mixed. Contribution from the US generics market will continue to be significant, but it will become a regular revenue stream now, with fewer big first-to-file (FTF) opportunities. The focus will be on companies that are able to build a steady and large revenue base of sales in the US market. Any residual FTF opportunities and significant contribution from drugs where there are fewer competitors can be contributors to outperformance.
Currency volatility may play a different game in 2013. Last year, the rupee depreciation swelled up sales in rupee terms for companies with overseas operations. But it also played havoc with other aspects of financials, such as mark-to-market gains or losses, valuation of inventory, and its effect on foreign currency-denominated liabilities. The depreciation in the rupee has taken a more benign stance, and if that continues, it may affect reported sales numbers adversely, but have a soothing effect on other fronts.
The domestic drug pricing policy was to be a game-changer, but investors do not seem to be viewing it as a major threat to valuations. It may be too soon for such a conclusion, and being a new policy, its implementation and impact on the domestic business of Indian companies needs to be watched closely.
These are some of the known factors, but a crucial game-changer in 2013 could be inorganic growth opportunities. Almost all the successful players in the US generic market have mopped up sizeable cash flows. As the US generic opportunity scales down, they may well use that money to buy assets, either to grow in scale or expand business opportunities. Sun Pharmaceutical Industries Ltd has already made some moves in that direction. More may follow suit.
Till now, most Indian pharmaceutical companies were united in their quest to make it big in the US generic market. With that in the bag, companies may now want to chart a different path to securing growth. This year may see more clarity emerge on that front.