Can Indian pharma companies beat the regulatory odds?

Categories: Blog
November 2, 2016Posted By Admin

Regulatory issues from US FDA(Food and Drug Administration) have created stir among pharma companies and have soured investor sentiment towards pharma stocks. But this is not the final and with its structural advantages India is going to play much bigger role in $1.2trillion global pharma market. Increase level of import alerts, export ban, warning letters and Form 483 observation letter over the past two years have surprisingly increased, post setting up a dedicated set up in 2012. And also interest for the response post inspection is looked into minutely.

“India is going to be a world power in pharma as it has the advantage of the lowest cost of producing goods and good technology. The FDA problems for the pharma sector in India were more of cultural in nature and that the regulatory hurdles are going to ease in future”. -Rakesh Jhunjhunwala

Stocks of Indian pharmaceutical companies have taken a knock over the last year and this is reflected in the poor run of the S&P BSE Healthcare Index. While markets are in good swing in the last one year the S&P  BSE Healthcare Index continues to underperform. This poor performance is in sharp contrast to the performance of these stocks between 2013 and 2015. While the Sensex gained 20%+, the Healthcare Index was one of the top gainers, returning more than 55 per cent then. Those were the big days for pharma stocks which have attracted lot of funds from both domestic as well as institutional investors attracted by the strong growth in their earnings, especially from overseas markets.

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The S&P BSE Healthcare Index underperformed from June 2006 to September 2011, but has outperformed since then (indexing done in Sept 2005). The flight to safety seems to have helped the healthcare sector to outperform; But If we observe the one-year time period, S&P BSE Healthcare Index continues to underperform.

Issues ballooning from the regulators

The US Food and Drug Administration (US FDA) raised the red flag during its inspections on select Indian manufacturing facilities when it found issues with current good manufacturing practices (cGMP) and processes. This impacted exports to the US and product approvals. As a result, companies such as Sun Pharma, Dr Reddy’s Labs, Lupin, Cadila Healthcare and IPCA Labs felt the heat. Recently-listed Alkem Labs also reported adverse observations from the German and Netherlands regulators. The Indian regulator has also been tightening its vigilance of late. In March 2016, the Health Ministry banned around 340 fixed dosage combination drugs (FDC). According to AIOCD-AWACS, the market research company of All India Chemists and Druggists Association, the FDC ban’s impact on the ₹98,042-crore Indian pharmaceutical market was estimated to be around ₹3,050 crore, or 3.1 per cent of the market. The observations and warning letters issued by the US drug regulator have been taken quite seriously by Indian investors — and not without reason. Exports of many companies were impacted following these strictures.

The revenue and earnings have declined as a result of increased scrutiny in manufacturing plants of pharma companies. Market capitalization of  top Indian drug makers has taken a hit.  Companies like Sun Pharma, Dr. Reddy’s Laboratories, Cipla (BOM:500087), Lupin (BOM:500257) and Wockhardt (BOM:532300), seen their share prices falling from their peaks.  Adding to the list the other companies like Ipca Laboratories and Cadila Health care also have taken hit.

A warning letter, however, does not lead to an immediate stoppage of exports, nor does it lead to the dreaded import ban. The severity of the event matters as well as the company’s reputation. Also, it is facility-specific. Companies having multiple facilities can apply for site transfer for key products. While the lead time for such transfers is 12 to 18 months, it can help de-risk revenue.

Also, many companies have managed to take the needed remedial action to get back into groove. They are also continuing to receive approvals for new drugs.

Companies that paid stronger attention to their processes and product quality have managed to weather the current phase relatively better. Especially the Contract Research and Manufacturing (CRAMS) companies were able to pass audits with flying colors. A high reliance on export revenue, their inherent nature of business which calls for tighter internal controls and risk management and client inspections held them in good stead.

Several factors continue to be in Indian pharma industry’s favor. India is the third-largest exporter of pharmaceutical products in volume terms. Its well-entrenched position in the US is a major positive. According to an IMS report, while the global pharmaceutical industry is expected to reach $1.3 trillion by 2018, the world’s largest market — the US — is expected to reach $450-480 billion. Indian companies supply almost 40 per cent of the generic and over-the-counter drugs sold in the US.

But select pharmaceutical companies are going through a tough phase due to regulatory issues. Many have also seen their revenue and earnings decline as a result of regulatory review, making investors view the entire sector with suspicion. But all is not lost yet. Focus on compliance, tighter quality control and increasing spends on R&D can turn around their fortunes in the coming years. Termed as defensive stocks, share prices of pharma companies have been always expensive due to their nature of sustainable earning growth. With the ongoing regulatory concerns the stocks became reasonably priced today and a good option for long-term investors.