Indian low-cost outsourcing companies poised to gain

Indian low-cost outsourcing companies poised to gain
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First Published: Tue, Mar 09 2010. 09 26 PM IST

Updated: Tue, Mar 09 2010. 09 26 PM IST
The Indian Contract Research and Manufacturing Services (CRAMS) companies are on the threshold of a significant opportunity given the expected increase in the pace of outsourcing from India.
We expect the adverse effect of global inventory destocking (undertaken by customers) to correct gradually from FY11 as the underlying demand for pharmaceutical products has remained intact despite the global slowdown.
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Most Indian CRAMS companies have recently indicated that there will be an increased trend towards outsourcing in FY11.
We expect a significant traction in the global outsourcing business, given low research and development (R&D) productivity and intense pressure on global innovators to generate growth. A large portion of this outsourcing business is likely to be sourced from Asia (mainly India and China).
Given significant entry barriers in this business, we expect existing companies to get a disproportionate share of the business.
India’s market share in the global contract manufacturing business is likely to more than double to 7% in 2007-2012, while supply revenues will grow from $800 million to $3 billion, giving rise to a significant opportunity for well-established CRAMS companies. Given growth challenges faced by global innovator companies, outsourcing is likely to grow exponentially in the coming years. We believe that India is on the threshold of a significant opportunity in the global outsourcing industry and has compelling advantages for attracting outsourcing business.
We believe that, over the next decade, existing outsourcing firms with high-cost operations in the US and Europe will gradually lose business to India due to the several advantages, which India offers. Some of the advantages are world-class quality at 30-40% lower cost; proven chemistry and process innovation skills instilled through years of fierce competition in the domestic market; India has six times the number of trained chemists as the US, available at one-tenth of the cost; India has up to 40% lower capital cost, resulting in lower initial capital expenditure on new facilities; established regulatory skills—India has the highest number of US Food and Drug Administration-approved facilities outside the US.
Investors should take a long-term view on the CRAMS opportunity as India is still evolving as a global contract manufacturing destination.
Gestation periods are likely to be longer (till Indian companies achieve critical mass) and at times will be accompanied by phases of faint visibility (due to the confidentiality attached to signing of contracts). However, we believe that the overall CRAMS opportunity is too large to ignore despite teething problems, which will be taken care of as Indian companies strengthen their pipelines.
We reiterate our BUY rating on Divi’s Laboratories Ltd (17% upside), Piramal Healthcare Ltd (19% upside). Consolidation of customer base and delayed payback from acquired companies, which were funded through leverage, are the key risks to our positive stance.
Graphics by Ahmed Raza Khan/Mint
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First Published: Tue, Mar 09 2010. 09 26 PM IST