Citi on India Pharam: Multiple Themes; Multiple Growth Drivers

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We remain positive on the Indian pharma & healthcare space and expect
continued outperformance over the medium to long term. With multiple growth
drivers (US generics, Emerging Markets, traction in CRAMS) playing out
simultaneously, we expect the earnings trajectory to be strong over the next
three to four years for most companies. At the same time, we are seeing good
progress on potential longer-term growth engines, such as Biosimilars and the
Japanese generics markets.


Global Generics: High Growth Phase
We expect strong growth over the next two to three years – primarily on the
back of patent expiries in the US & EU markets (cUS$60bn over CY10-15).
Most Indian firms are better placed (in terms of size, visibility, readiness of
plants & filings) to target this wave than in the past. Diversification into niche
segments (injectibles, controlled subs, oral contraceptives, oncology, sustained
release etc) & rising penetration in emerging markets (including India) would
also buoy earnings. Over the longer term (three to five years), we see Japanese
generics & Biosimilars emerging as key growth drivers as well. Most firms have
reached critical scale in key markets & growth is being driven by many more
products than before, limiting the adverse impact of approval delays/
competition in a few products.

CRAMS: Are we close to a Recovery?
Companies engaged in contract research & manufacturing have struggled over
the last two years. Destocking by large customers, slower decision making (led
by a spate of consolidation), rationalizing of R&D pipelines & drying up of
funding of the small / biotech companies were the main factors for the slow
down. We had anticipated a pick up from 2HFY11. However, recent trends
indicate that this may spill over into FY12. This along with the low FY10 base
should drive high growth for firms engaged in contract manufacturing. Contract
research may however remain subdued for some more time, as P/E / VC
funding for smaller / biotech firms have not seen any material pick-up yet.

Healthcare Delivery: Secular Growth
We expect demand to remain strong, driven by favorable demographics. Higher
occupancy, better case mix & some price hikes would improve profitability.
Besides the recent policy thrust (5 yr tax holiday for new hospitals with 100+
beds), greater granularity provided by companies on financials have helped the
street appreciate the true potential of this industry much better.

What could go wrong?
This is probably the most pertinent issue to discuss with managements, at this
point. Consensus is bullish and valuations reflect this. Execution risk is the
biggest potential negative in our view. Most stocks price in several potential
upsides & delays/setbacks could hurt. Currency (strong INR) is another risk.
While firms are hedged to an extent, economic loss is difficult to hedge away.
Other risks include sluggish recovery in contract research, pricing pressure in
EU & longer FDA approval times.