JM Financial: India Pharma Sector update

State of the Indian Pharma companies
􀂄 Implied generic value is still reasonable: We analyzed six Indian companies’
growth and profitability over the last decade across brands-generic segment.
We conclude that Indian companies are still reasonably valued even though
the combined market cap has increased from c.$5bn to c.$30bn over this
period. Brand segment has delivered over 20% earnings CAGR for most
companies on the back of deeper penetration and rising affordability. We
continue to believe that Indian (along with other similar markets) continue to
offer growth potential justifying the use of c. 20x PE for some of these
companies. Excluding the implied value of this segment, we observe that the
generic segment is valued between $1-3bn. Given the current base,
developing pipelines and the medium term opportunity, we believe this is
reasonable.
􀂄 Better control of destiny: Unlike the volatile period of first half of the
decade, Indian companies have shown a certain maturity of model in the
second half. This is demonstrated through better margin control even while
they continue to make investments. Most companies have shown either stable
or improving margins driven by increasing scale in the generic segment.
Companies have also seen stable to improving return on capital employed
despite greater investment in capacity building due to pay-offs on existing
investments for generic markets.
􀂄 Plenty of growth in store for next three to four years: Indian market has
grown from `55bn to `400bn from 1995 to 2010 – 14% CAGR over a 15 year
time-frame. In the first five years, per capita drug expenditure doubled from
`65 to `125. In the slow-years for 2000-05, it increased only 50% to `185.
However, in the last five year period, it has almost doubled to `350. Over this
period, per capita income (PPP) has seen a CAGR of 7%. We think there is
scope for further growth as Indian costs are still below the other emerging
markets. Secondly, while there is growth opportunity in emerging markets,
we note that barring some exceptions, this region contributes less than 10%
to sales for Indian companies and size has been gained mainly through
acquisitions. Companies with established businesses have a big opportunity
to ramp-up in this region for the next several years.
􀂄 R&D investments in differentiated products to ensure growth even in
generic segment: Indian companies have achieved some success in
developing difficult products. This is clearly a breakthrough due to sustained
investments over last 3 years, with strategies evolving to move away from metoo
generics. Over the next 2-3 years, companies that have R&D initiatives
geared towards developing more sustainable opportunities will emerge
stronger. We still do not see much strength in basic R&D for most companies
under coverage, even though there have been some intermittent successes.
􀂄 Maintain bullish stand even though risks remain: While there are multiple
risks to business from quality issues to timing of approval due intensifying
competition and price controls, we remain bullish on pharma companies as
the longer term opportunities should offset these concerns.