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Ear to the Ground: Verdict is Out
India is projected to be the third-largest pharma market (after the US and China) in terms of
incremental growth. It is also evident that the sub-continent, with the highest population and
robust economic growth, offers attractive return to pharma companies due to its costeffective
manufacturing capabilities and branded generics nature of the market. Historically,
the non-regulated structure of market has enabled Indian companies to build strong market
share, however, with changing market dynamics, companies have to adopt new strategic
approach to grow and compete. Therefore, to gain a deeper understanding of this
transformation, we set out to survey various markets, encompassing all zones and tiers. We
selected a sample of 27 cities, ideally representing a mix of all geographies within India, and
after meeting more than 100 distributors across cities, we gained the following insights:
Growth momentum to sustain and move into next orbit
Indian pharma market is likely to sustain current growth momentum (14-15% versus
historical run-rate of 10-12% over FY00-10) and a large number of distributors
anticipate growth trajectory to move to the next level of 18-20%. This could potentially
add USD 3 bn of incremental sales over the next four to five years. This strong growth is
inclusive of metros, tier I and II cities and smaller or tier III and IV towns. However,
one-third of this incremental growth will come from tier III-IV towns and rural markets,
which constitute 20% of the total market, and are currently growing at 25-30%, higher
than metros and tier-I cities. This is largely led by increase in income levels, higher
penetration of healthcare, and increase in health awareness among masses. Cipla, with a
strong portfolio in the acute and respiratory segment, is depicting strong growth in tier
II-IV markets, while Cadila, Lupin, Sanofi-Aventis and IPCA are also aggressively
expanding in these regions.
Chronic therapies leading growth; cosmetology new growth avenue
Chronic therapies including cardiac, diabetics and neuro-psychiatry, constitute 28% of
the total market and are growing at 18-19% versus the current industry growth of 15%
(MAT March 2011). Most distributors have observed that anti-diabetics is emerging as a
high-growth segment, followed by cardiac and CNS. Further, rising discretionary
spending and focus on personal care is driving growth in the cosmetology segment. This
segment’s growth potential is large, given lower penetration, and it entails higher
margins due to better pricing of products. Other super specialties such as oncology,
pediatrics and nephrology are also picking up in selective markets.
The competition in chronic therapies is increasing rapidly, leading to higher investments
by players to retain market share. Consequently, specialty focused promotion is
emerging as a strong and effective approach to build brand loyalty. As per our survey,
most companies have carved new divisions for key specialties, while others have created
dedicated field force or special tasks force (STFs) to promote high-value brands within
segments. Most distributors view this as highly effective strategy to enhance market
share and also results in higher field force productivity. Sun Pharma has pioneered the
specialty focus model, resulting in higher market share in the chronic segment.
Expansion by MNCs could intensify competition for Indian counterparts
Multinational pharma companies have become aggressive and have initiated meaningful
investments in the domestic market. These investments, although at nascent stage, will
eventually set the base for the next leg of growth. Most leading players have set bold
aspirations for their Indian businesses and are adopting a more localised business model,
including pan-India penetration, branded generics launches, and well-spread out
distribution network. While recent branded generics launches are priced economically,
our survey indicates that sales have not ramped up in most markets for these products.
Moreover, in-licensing of off-patented/patented molecules could incrementally drive
higher revenues in the medium term. We believe that with aggressive expansion plans
and deep pockets, MNCs could potentially emerge as strong competitors, compelling
Indian companies to hike investments, while price wars could potentially hurt their
profitability in the long term.
Higher attrition in field force poses risk to current growth
The cost of hiring competent field force is soaring and retention is posing a key
challenge. Most markets are seeing more than 30% field force attrition. We have
identified four key reasons behind high attrition: (a) increase in demand for medical
representatives to increase doctor focus, coverage and number of divisions; (b) limited
supply of talent pool with companies competing for high quality people; (c) setting up
challenging field force targets with a mandate to aggressively capture market share; and
(d) shift to other sectors like IT and financial services which offer higher incentives and
growth. We perceive higher attrition as a potential risk for companies following the old
incentive structure and inefficient policies to retain field force, which could dent their
growth and profitability in the near term. Cadila, Cipla, IPCA and GSK are few players
facing higher attrition, while Sun Pharma, Lupin and Torrent have been ranked by most
distributors as companies possessing highly effective and stable field force.
Decline in success rate of new product introductions
Most large and mid-size companies, to actively expand coverage across molecules or
therapies, are aggressively launching new products. New product introductions
contribute 4-5% of overall market growth. However, as per our survey, 70-80% of these
products are failures. Most of these failures are in established segments, where more
than 10-15 players currently exist. Also, there is a growing resistance among retailers
and distributors to provide shelf space for new products before prescription generation.
Hence, we observe companies that are more proactive and launch products ahead of the
market are more successful in building brands, which potentially contributes to higher
business growth. Most distributors suggest that new launches by Sun Pharma, Sanofi-
Aventis and Lupin have pent-up demand in the first week of launch. Also, companies
with differentiated R&D pipeline like Sun Pharma and Dr. Reddy’s clearly have an edge
over others.
Differentiating ‘class from mass’: End driver of survey
Through our distributor survey we tried to differentiate highly effective companies from
others (‘class from mass’) on the basis of parameters such as: (a) portfolio concentration
(chronic versus acute); (b) growth relative to the market; (c) field force stability and
productivity; (d) field force penetration; (e) success of new product launches; and (f)
ability to build brands. The survey questionnaire was designed to gauge top 30
companies (as per market share) on the basis of these key parameters.
We conclude that, Sun Pharma and Lupin are ranked by 94% and 74% of coverage
distributors, respectively, as preferred players in the large–cap space, while IPCA and
Torrent are ranked by 86% and 70% of coverage distributors, respectively, as leading
players in the mid-cap space. MNCs are adopting a more localised approach to build
market presence and are building infrastructure for the next leg of growth. Interestingly
Sanofi-Aventis, among MNC pharma, is ahead of peers and is aggressively coming up in
tier III–IV cities. Moreover, we also identified some key emerging small-mid size players,
such as Macleods, Aristo, Eris and Mankind, who are scaling up and capturing
incrementally higher market share.
Differentiating ‘Class from Mass’
A strong and growing domestic market has opened floodgates of opportunities for Indian as
well as MNC players, who are targeting these with multi-pronged approach. While some
companies have been frontrunners in identifying future opportunities, others have lost
momentum. To differentiate the former from the latter, we have contemplated various
parameters which could be critical for growth. Further, we believe that historical execution is
a realistic measure to differentiate players, but it may not be indicative of future growth and
performance. Hence, these five key parameters (or critical success factors) could gauge the
strength of a company’s domestic business and act as an effective tool to differentiate good
from the bad (or winners from losers). These include:
a) Portfolio concentration or business mix (acute versus chronic)
b) Ability to build brands
c) Success of new product launches
d) Field force penetration or coverage
e) Field force stability and productivity
On the basis of above mentioned parameters and through our analysis from the survey, we
have identified few highly effective companies which have strong execution and are growing
ahead of market.
Sun and Lupin emerge as favored plays in large cap; Torrent/IPCA score in mid cap
Sun pharma and Lupin were ranked by most distributors as outperformers among large caps,
while Torrent and IPCA scored in mid caps. Among MNCs, Aventis scored over other players
such as GSK and Pfizer. Players such as Cipla, Ranbaxy and Cadila are facing some pressures
in terms of growth and stability but are likely to turnaround, in our view.
Sun pharma has emerged as the undisputed choice among distributors primarily because of
its ability to identify therapeutic gap areas and launch products ahead of competition,
resulting in better mind share and market share. Second, the company has focus on medical
colleges and has innovatively built its doctors franchise by engaging them at an early stage.
Lupin scores over peers due to its focus on key opinion leaders (KOLs). The company has
actively build a wider portfolio by entering into newer therapeutic areas and is growing ahead
of peers in chronic segments such as CVS, CNS, and respiratory. Moreover, its aggressive
and highly effective field force helps it sustain growth in a highly competitive market.
Cipla, despite deep penetration and high field force productivity, has seen slow growth in
domestic market. This is largely due to instability in the field force which has further
impacted its ability to build big brands. However, we believe that Cipla can surprise the
market positively due to its higher focus on tier II and IV markets, where the company has
started witnessing high growth traction, and addressing of structural issues with reference to
its mature and generic-generic portfolio in domestic market.
Other companies like Cadila, Dr. Reddy’s, and Ranbaxy are also gearing up which is
evident from the fact that they have ramped up their field force by 22%, 94%, and 72%,
respectively, over the past two years.
In the mid-cap space, Torrent is ahead of comparable peers on account of higher focus on
the chronic segment, better field force stability, and ability to build brands. However, it lags
in terms of launching new products. Moreover, IPCA is also gaining strong momentum in all
markets and has increased divisions (12 from earlier seven) to expand into newer therapies
and tier II to IV towns. We highlight that Torrent and IPCA have expanded field force
aggressively (by 64% and 58%, respectively) which has impacted their field force
productivity (Fig. 3).
In the MNC space, Sanofi-Aventis has a clear advantage over other MNCs because of high
focus on the chronic segment, strong brand building abilities, competent sales force, and
aggressive approach in metros as well as tier II to IV towns.
Future Growth Drivers
As the domestic pharma market grows in size and diversity, there are several opportunities
that will scale up to their full potential. Some of these include biologics and vaccines,
consumer healthcare, patented products and hospital segment, which are at an early stage of
lifecycle, but are likely to scale up with upgradation of therapies, increased penetration of
multi-specialty hospitals and changes in patients preference. According to industry sources,
these opportunities will collectively grow to USD 25 bn by 2020 from the current USD 5 bn.
Rising acceptability of new therapies
As the domestic pharma market grows in size and diversity, we believe the acceptability of
modern medicine (including biologics and vaccines) and new therapies will increase due to
aggressive market creation by players and greater propensity of self medication. Investment
in enhancing patient awareness and education will impact diagnosis and treatment levels. In
addition patients will show greater propensity to self medicate. The consumer healthcare
segment has the potential to grow at over 14% annually, provided players make large OTC
brands easily available to consumers, differentiate their products, and establish an emotional
connection with patients. Finally, the acceptance of biologics and vaccines will rise. The
biologics market is expected to reach USD 3 bn by 2020 from the current USD 300 mn.
Launch of patented products
Although patented products’ contribution to the domestic market is negligible (USD 200 mn;
<1% of total market) and there have been very few launches since 2005 in India, the recent
successes of Januvia and Galvus indicates that patented products can drive tremendous
growth in a few therapeutic areas, provided they are priced adequately. Rising affordability
and increased healthcare insurance penetration will be the primary growth drivers for the
patented products segment. The overall contribution of patented products is likely to remain
below 5% (USD 1.7 bn by 2020), however, revenue will be concentrated to few brands and
hence would be attractive for MNC players who proactively launch and build brands.
Hospital segment to gain importance
The hospital segment is one of the fast growing segments and has been a key growth driver
for the domestic industry. While the retail segment is mainstay of the pharma market
(contributes 85-90% of overall sales), the hospital segment is gaining importance driven by
dramatic rise in infrastructure and advent of corporate hospitals. In the developed world,
hospitals account for more than 25% of the pharmaceutical market, while in India they
account for less than 10%, but are increasing at rapid pace. Over time, the proportion of
pharmaceutical sales to hospitals is likely to increase with strong capacity addition (37%
increase in FY10) in the healthcare segment. The hospital market contribution to domestic
market to likely to grow from USD 1.7 bn to USD 14 bn by 2020 (22% CAGR; 26% market
share). We highlight that our survey indicates strong focus by MNCs in hospital segment.
Valuations: Rich, But Not Stretched
Earning CAGR of 23% likely over FY10-13E
We expect our pharma universe to post 17% revenue CAGR over FY11-13E, driven by
25% and 21% growth in Sun Pharma and Cadila, respectively. The drivers of this growth
are multiple, in our view, including strong traction in the domestic market, USD 135 bn
worth opportunity from patent cliff in the US market, and double digit growth in various
emerging markets. We expect operating margins to expand by 220 bps to 21.8% over
FY11-13E, led by outperformance from Ranbaxy (400 bps expansion) and Sun Pharma
(300 bps margin expansion) during the same period. We expect strong revenue growth
and operating margin expansion to drive 23% earning CAGR over FY11-13E.
Pharma Index’s relative performance to broad market has moderated
The BSE Healthcare Index has underperformed the broad market (Sensex) over the past
four months, after a strong outperformance over the past three years. This is further
evident from the fact that the relative premium to the broader market, which had
expanded towards the beginning of the year (43-45% relative to market), has corrected
more than 14-15% from its peak since January 2011. We believe this is largely because:
(a) sector valuation multiples (one year forward) have expanded from their five year
historical average of 19x to 23x; and (b) the sector is fairly owned across institutional
investors who have been booking profits. However, post correction, over the past four
months, the sector is trading near to its five year average multiple (18-19x).
Valuations rich, but not stretched; prefer stock-specific approach
Although valuations of the pharma sector have moved up, they are not in stretched
territory. While we remain positive on the sector (as fundamentals remain strong), we
prefer to be more stock specific. Moreover, variations in stock performance within the
sector also highlight the importance of company-focused approach.
Premium valuations to sustain
Our universe currently trades at 22x FY12E and 18.5x FY13E EPS. Current sector
valuations are closer to their five year average PE. Historically, the pharma universe has
traded at a 10-15% premium to the broader market on account of consistent earnings
growth, healthy balance sheet, and defensive nature of the market. Currently, the
Pharma Index is trading at 24-25% premium to the Sensex (past one year average
premium is 25-26%), slightly higher than the long-term average premium of 10-15%.
We expect premium valuations to sustain with emergence of the innovator-generic
partnership model, strong earnings growth (23% earning CAGR), robust financial ratios
(Universe RoCE of 28% and low leverage of 0.2 x) and higher positive free cash flow.
Lupin and Cadila likely to catch up peers’ multiple
We expect our large-cap universe to continue to trade at 19x one year forward PE (inline
with five-year average). However, Lupin and Cadila, which have historically traded at
five year mean multiple of 13-14 (mid-cap valuations), are seeing visible narrowing
down of the multiple gap with large peers as these companies have gradually moved into
the big league and we expect this gap (still trading at 10-15% discount to comparable
peers) to further narrow.
Top picks
We conclude, on the basis of our distributor survey, that Sun Pharma, Lupin, Cipla, and
Torrent have a strong franchise in the domestic market and robust growth outlook.
However, after considering incremental upsides from international markets, companyspecific
issues and current valuations, we expect Lupin, Dr Reddy’s, Cadila, and
Torrent to be outperformers over the next 12-18 months.
Key Risks
High field force attrition could dent growth and profitability
A well spread out and competent field force (with good communication skills and product
knowledge) is critical for establishing and sustaining market share in a fiercely
competitive market like India. Players like Sun pharma, Lupin and most MNCs have
pioneered various models to establish quality field force. This entails rigorous investment
in hiring, training, and retaining people, which creates upfront costs recovered over twothree
years. For example, it takes one year for a company to recover upfront costs (or
sunk costs) for each new medical representative and it takes another two-three years for
a medical representative to reach company level productivity. Moreover, it takes sixeight
months for a new sales representative to establish relations with physicians and
practitioners. Hence, loss of a trained field person not only results in loss of sales, but
also loss of initial investment. As per the survey, most companies are facing high
attrition across tiers or geographies which could potentially risk growth in near term.
Almost ~ 75-80% of distributors confirmed 15-30% (and above) field force attrition
across markets surveyed
We have identified three key reasons behind higher attrition: (a) increase in demand for
medical representatives and limited supply of talent pool with companies competing for
high quality people; (b) setting up challenging field force targets with mandate to
aggressively capture market share; and (c) shift to other sectors like IT and financial
services for better incentives and growth.
Sun pharma, Lupin, and Torrent have been ranked by distributors as companies
possessing highly effective and stable field force, while Cadila, IPCA, GSK, and Cipla are
companies facing higher attrition.
Rise in fixed costs and higher competition to impact domestic margins
While attrition is posing potential risk to growth, increase in cost of hiring is likely to
impact profitability. Most companies are hiring non-science graduates for ramping up
field force which could result in high training expenses. Moreover, to retain the field
force, companies such as Unichem, IPCA, and Torrent, among others, are revising
inventive structures, resulting in higher employee costs. Other factors such as expansion
into Tier-II to Tier IV towns as well as increase in competition from MNCs and new
players will also exert pressure on margins.
Rural penetration requires higher investment
Managing penetration in smaller markets offers several challenges to companies such as
higher distribution costs due to poor infrastructure, increase in working capital led by
high inventories to initially fill channel and longer credit period. As per the survey,
average credit period in smaller towns is between one to two months versus less than
fifteen days in metros and tier-I cities. Moreover, it takes longer to break even
investments due to lower productivity of medical representatives. The payback period
ranges from one and half to two years versus less than one year for urban markets.
Apart from higher cost of investment, attrition, lack of talent pool, malpractices and
higher competition from local players are other challenges for companies to grow and
expand in these markets.
Emerging competition from MNCs and new players could lead to price war
The domestic market is being targeted by both MNCs and Indian companies. This is
further brought out by our survey where most distributors are seeing aggressive
expansion by MNCs. As seen in chart 33, these high investments have started to yield
traction for MNC players like Aventis, AstraZeneca, and MSD. Further, new players such
as Macleods, Mankind, Aristo etc. are rapidly expanding market share, giving stiff
competition to Indian counterparts. We believe this emerging competition could lead to
higher investments by existing players, while price wars could potentially hurt their
profitability in the near term.
Decline in success rate of new product introductions
New product introductions contribute 4-5% of overall market growth. Most large and
mid-size companies, to actively expand coverage across molecules or therapies, are
aggressively launching new products. However, as per our survey, 70-80% of these
products are failures. Most of these failures are in established segments, where more
than 10-15 players currently exist. Also, there is a growing resistance among retailers
and distributors to provide shelf space for new products before prescription generation.
Hence, we observe companies that are more proactive and launch products ahead of the
market are more successful in building brands, which potentially contributes to higher
business growth. Most distributors suggest that new launches by Sun Pharma, Sanofi-
Aventis and Lupin have pent-up demand in the first week of launch. Also, companies
with differentiated R&D pipeline like Sun Pharma and Dr. Reddy’s clearly have an edge
over others.
Potential expansion of controlled pricing list to impact profitability
Domestic drug prices are lowest in the world, however, time and again the government
has deliberated expansion of the drugs list under pricing control. Currently, 74 drugs
(15% of total market) are under controlled pricing and government is contemplating to
expand this list to include up to 356 drugs which could cover potentially 50-60% of the
total market. Most of the existing products under price control are anti-infective, pain
killers and vitamins, among others, which primarily belong to the acute therapy
segment. However, the proposal, if implemented, will extend the list to include some
basic anti-diabetics and cardiovascular/other specialty class drugs, which are increasing
prevalence and affecting the masses.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Ear to the Ground: Verdict is Out
India is projected to be the third-largest pharma market (after the US and China) in terms of
incremental growth. It is also evident that the sub-continent, with the highest population and
robust economic growth, offers attractive return to pharma companies due to its costeffective
manufacturing capabilities and branded generics nature of the market. Historically,
the non-regulated structure of market has enabled Indian companies to build strong market
share, however, with changing market dynamics, companies have to adopt new strategic
approach to grow and compete. Therefore, to gain a deeper understanding of this
transformation, we set out to survey various markets, encompassing all zones and tiers. We
selected a sample of 27 cities, ideally representing a mix of all geographies within India, and
after meeting more than 100 distributors across cities, we gained the following insights:
Growth momentum to sustain and move into next orbit
Indian pharma market is likely to sustain current growth momentum (14-15% versus
historical run-rate of 10-12% over FY00-10) and a large number of distributors
anticipate growth trajectory to move to the next level of 18-20%. This could potentially
add USD 3 bn of incremental sales over the next four to five years. This strong growth is
inclusive of metros, tier I and II cities and smaller or tier III and IV towns. However,
one-third of this incremental growth will come from tier III-IV towns and rural markets,
which constitute 20% of the total market, and are currently growing at 25-30%, higher
than metros and tier-I cities. This is largely led by increase in income levels, higher
penetration of healthcare, and increase in health awareness among masses. Cipla, with a
strong portfolio in the acute and respiratory segment, is depicting strong growth in tier
II-IV markets, while Cadila, Lupin, Sanofi-Aventis and IPCA are also aggressively
expanding in these regions.
Chronic therapies leading growth; cosmetology new growth avenue
Chronic therapies including cardiac, diabetics and neuro-psychiatry, constitute 28% of
the total market and are growing at 18-19% versus the current industry growth of 15%
(MAT March 2011). Most distributors have observed that anti-diabetics is emerging as a
high-growth segment, followed by cardiac and CNS. Further, rising discretionary
spending and focus on personal care is driving growth in the cosmetology segment. This
segment’s growth potential is large, given lower penetration, and it entails higher
margins due to better pricing of products. Other super specialties such as oncology,
pediatrics and nephrology are also picking up in selective markets.
The competition in chronic therapies is increasing rapidly, leading to higher investments
by players to retain market share. Consequently, specialty focused promotion is
emerging as a strong and effective approach to build brand loyalty. As per our survey,
most companies have carved new divisions for key specialties, while others have created
dedicated field force or special tasks force (STFs) to promote high-value brands within
segments. Most distributors view this as highly effective strategy to enhance market
share and also results in higher field force productivity. Sun Pharma has pioneered the
specialty focus model, resulting in higher market share in the chronic segment.
Expansion by MNCs could intensify competition for Indian counterparts
Multinational pharma companies have become aggressive and have initiated meaningful
investments in the domestic market. These investments, although at nascent stage, will
eventually set the base for the next leg of growth. Most leading players have set bold
aspirations for their Indian businesses and are adopting a more localised business model,
including pan-India penetration, branded generics launches, and well-spread out
distribution network. While recent branded generics launches are priced economically,
our survey indicates that sales have not ramped up in most markets for these products.
Moreover, in-licensing of off-patented/patented molecules could incrementally drive
higher revenues in the medium term. We believe that with aggressive expansion plans
and deep pockets, MNCs could potentially emerge as strong competitors, compelling
Indian companies to hike investments, while price wars could potentially hurt their
profitability in the long term.
Higher attrition in field force poses risk to current growth
The cost of hiring competent field force is soaring and retention is posing a key
challenge. Most markets are seeing more than 30% field force attrition. We have
identified four key reasons behind high attrition: (a) increase in demand for medical
representatives to increase doctor focus, coverage and number of divisions; (b) limited
supply of talent pool with companies competing for high quality people; (c) setting up
challenging field force targets with a mandate to aggressively capture market share; and
(d) shift to other sectors like IT and financial services which offer higher incentives and
growth. We perceive higher attrition as a potential risk for companies following the old
incentive structure and inefficient policies to retain field force, which could dent their
growth and profitability in the near term. Cadila, Cipla, IPCA and GSK are few players
facing higher attrition, while Sun Pharma, Lupin and Torrent have been ranked by most
distributors as companies possessing highly effective and stable field force.
Decline in success rate of new product introductions
Most large and mid-size companies, to actively expand coverage across molecules or
therapies, are aggressively launching new products. New product introductions
contribute 4-5% of overall market growth. However, as per our survey, 70-80% of these
products are failures. Most of these failures are in established segments, where more
than 10-15 players currently exist. Also, there is a growing resistance among retailers
and distributors to provide shelf space for new products before prescription generation.
Hence, we observe companies that are more proactive and launch products ahead of the
market are more successful in building brands, which potentially contributes to higher
business growth. Most distributors suggest that new launches by Sun Pharma, Sanofi-
Aventis and Lupin have pent-up demand in the first week of launch. Also, companies
with differentiated R&D pipeline like Sun Pharma and Dr. Reddy’s clearly have an edge
over others.
Differentiating ‘class from mass’: End driver of survey
Through our distributor survey we tried to differentiate highly effective companies from
others (‘class from mass’) on the basis of parameters such as: (a) portfolio concentration
(chronic versus acute); (b) growth relative to the market; (c) field force stability and
productivity; (d) field force penetration; (e) success of new product launches; and (f)
ability to build brands. The survey questionnaire was designed to gauge top 30
companies (as per market share) on the basis of these key parameters.
We conclude that, Sun Pharma and Lupin are ranked by 94% and 74% of coverage
distributors, respectively, as preferred players in the large–cap space, while IPCA and
Torrent are ranked by 86% and 70% of coverage distributors, respectively, as leading
players in the mid-cap space. MNCs are adopting a more localised approach to build
market presence and are building infrastructure for the next leg of growth. Interestingly
Sanofi-Aventis, among MNC pharma, is ahead of peers and is aggressively coming up in
tier III–IV cities. Moreover, we also identified some key emerging small-mid size players,
such as Macleods, Aristo, Eris and Mankind, who are scaling up and capturing
incrementally higher market share.
Differentiating ‘Class from Mass’
A strong and growing domestic market has opened floodgates of opportunities for Indian as
well as MNC players, who are targeting these with multi-pronged approach. While some
companies have been frontrunners in identifying future opportunities, others have lost
momentum. To differentiate the former from the latter, we have contemplated various
parameters which could be critical for growth. Further, we believe that historical execution is
a realistic measure to differentiate players, but it may not be indicative of future growth and
performance. Hence, these five key parameters (or critical success factors) could gauge the
strength of a company’s domestic business and act as an effective tool to differentiate good
from the bad (or winners from losers). These include:
a) Portfolio concentration or business mix (acute versus chronic)
b) Ability to build brands
c) Success of new product launches
d) Field force penetration or coverage
e) Field force stability and productivity
On the basis of above mentioned parameters and through our analysis from the survey, we
have identified few highly effective companies which have strong execution and are growing
ahead of market.
Sun and Lupin emerge as favored plays in large cap; Torrent/IPCA score in mid cap
Sun pharma and Lupin were ranked by most distributors as outperformers among large caps,
while Torrent and IPCA scored in mid caps. Among MNCs, Aventis scored over other players
such as GSK and Pfizer. Players such as Cipla, Ranbaxy and Cadila are facing some pressures
in terms of growth and stability but are likely to turnaround, in our view.
Sun pharma has emerged as the undisputed choice among distributors primarily because of
its ability to identify therapeutic gap areas and launch products ahead of competition,
resulting in better mind share and market share. Second, the company has focus on medical
colleges and has innovatively built its doctors franchise by engaging them at an early stage.
Lupin scores over peers due to its focus on key opinion leaders (KOLs). The company has
actively build a wider portfolio by entering into newer therapeutic areas and is growing ahead
of peers in chronic segments such as CVS, CNS, and respiratory. Moreover, its aggressive
and highly effective field force helps it sustain growth in a highly competitive market.
Cipla, despite deep penetration and high field force productivity, has seen slow growth in
domestic market. This is largely due to instability in the field force which has further
impacted its ability to build big brands. However, we believe that Cipla can surprise the
market positively due to its higher focus on tier II and IV markets, where the company has
started witnessing high growth traction, and addressing of structural issues with reference to
its mature and generic-generic portfolio in domestic market.
Other companies like Cadila, Dr. Reddy’s, and Ranbaxy are also gearing up which is
evident from the fact that they have ramped up their field force by 22%, 94%, and 72%,
respectively, over the past two years.
In the mid-cap space, Torrent is ahead of comparable peers on account of higher focus on
the chronic segment, better field force stability, and ability to build brands. However, it lags
in terms of launching new products. Moreover, IPCA is also gaining strong momentum in all
markets and has increased divisions (12 from earlier seven) to expand into newer therapies
and tier II to IV towns. We highlight that Torrent and IPCA have expanded field force
aggressively (by 64% and 58%, respectively) which has impacted their field force
productivity (Fig. 3).
In the MNC space, Sanofi-Aventis has a clear advantage over other MNCs because of high
focus on the chronic segment, strong brand building abilities, competent sales force, and
aggressive approach in metros as well as tier II to IV towns.
Future Growth Drivers
As the domestic pharma market grows in size and diversity, there are several opportunities
that will scale up to their full potential. Some of these include biologics and vaccines,
consumer healthcare, patented products and hospital segment, which are at an early stage of
lifecycle, but are likely to scale up with upgradation of therapies, increased penetration of
multi-specialty hospitals and changes in patients preference. According to industry sources,
these opportunities will collectively grow to USD 25 bn by 2020 from the current USD 5 bn.
Rising acceptability of new therapies
As the domestic pharma market grows in size and diversity, we believe the acceptability of
modern medicine (including biologics and vaccines) and new therapies will increase due to
aggressive market creation by players and greater propensity of self medication. Investment
in enhancing patient awareness and education will impact diagnosis and treatment levels. In
addition patients will show greater propensity to self medicate. The consumer healthcare
segment has the potential to grow at over 14% annually, provided players make large OTC
brands easily available to consumers, differentiate their products, and establish an emotional
connection with patients. Finally, the acceptance of biologics and vaccines will rise. The
biologics market is expected to reach USD 3 bn by 2020 from the current USD 300 mn.
Launch of patented products
Although patented products’ contribution to the domestic market is negligible (USD 200 mn;
<1% of total market) and there have been very few launches since 2005 in India, the recent
successes of Januvia and Galvus indicates that patented products can drive tremendous
growth in a few therapeutic areas, provided they are priced adequately. Rising affordability
and increased healthcare insurance penetration will be the primary growth drivers for the
patented products segment. The overall contribution of patented products is likely to remain
below 5% (USD 1.7 bn by 2020), however, revenue will be concentrated to few brands and
hence would be attractive for MNC players who proactively launch and build brands.
Hospital segment to gain importance
The hospital segment is one of the fast growing segments and has been a key growth driver
for the domestic industry. While the retail segment is mainstay of the pharma market
(contributes 85-90% of overall sales), the hospital segment is gaining importance driven by
dramatic rise in infrastructure and advent of corporate hospitals. In the developed world,
hospitals account for more than 25% of the pharmaceutical market, while in India they
account for less than 10%, but are increasing at rapid pace. Over time, the proportion of
pharmaceutical sales to hospitals is likely to increase with strong capacity addition (37%
increase in FY10) in the healthcare segment. The hospital market contribution to domestic
market to likely to grow from USD 1.7 bn to USD 14 bn by 2020 (22% CAGR; 26% market
share). We highlight that our survey indicates strong focus by MNCs in hospital segment.
Valuations: Rich, But Not Stretched
Earning CAGR of 23% likely over FY10-13E
We expect our pharma universe to post 17% revenue CAGR over FY11-13E, driven by
25% and 21% growth in Sun Pharma and Cadila, respectively. The drivers of this growth
are multiple, in our view, including strong traction in the domestic market, USD 135 bn
worth opportunity from patent cliff in the US market, and double digit growth in various
emerging markets. We expect operating margins to expand by 220 bps to 21.8% over
FY11-13E, led by outperformance from Ranbaxy (400 bps expansion) and Sun Pharma
(300 bps margin expansion) during the same period. We expect strong revenue growth
and operating margin expansion to drive 23% earning CAGR over FY11-13E.
Pharma Index’s relative performance to broad market has moderated
The BSE Healthcare Index has underperformed the broad market (Sensex) over the past
four months, after a strong outperformance over the past three years. This is further
evident from the fact that the relative premium to the broader market, which had
expanded towards the beginning of the year (43-45% relative to market), has corrected
more than 14-15% from its peak since January 2011. We believe this is largely because:
(a) sector valuation multiples (one year forward) have expanded from their five year
historical average of 19x to 23x; and (b) the sector is fairly owned across institutional
investors who have been booking profits. However, post correction, over the past four
months, the sector is trading near to its five year average multiple (18-19x).
Valuations rich, but not stretched; prefer stock-specific approach
Although valuations of the pharma sector have moved up, they are not in stretched
territory. While we remain positive on the sector (as fundamentals remain strong), we
prefer to be more stock specific. Moreover, variations in stock performance within the
sector also highlight the importance of company-focused approach.
Premium valuations to sustain
Our universe currently trades at 22x FY12E and 18.5x FY13E EPS. Current sector
valuations are closer to their five year average PE. Historically, the pharma universe has
traded at a 10-15% premium to the broader market on account of consistent earnings
growth, healthy balance sheet, and defensive nature of the market. Currently, the
Pharma Index is trading at 24-25% premium to the Sensex (past one year average
premium is 25-26%), slightly higher than the long-term average premium of 10-15%.
We expect premium valuations to sustain with emergence of the innovator-generic
partnership model, strong earnings growth (23% earning CAGR), robust financial ratios
(Universe RoCE of 28% and low leverage of 0.2 x) and higher positive free cash flow.
Lupin and Cadila likely to catch up peers’ multiple
We expect our large-cap universe to continue to trade at 19x one year forward PE (inline
with five-year average). However, Lupin and Cadila, which have historically traded at
five year mean multiple of 13-14 (mid-cap valuations), are seeing visible narrowing
down of the multiple gap with large peers as these companies have gradually moved into
the big league and we expect this gap (still trading at 10-15% discount to comparable
peers) to further narrow.
Top picks
We conclude, on the basis of our distributor survey, that Sun Pharma, Lupin, Cipla, and
Torrent have a strong franchise in the domestic market and robust growth outlook.
However, after considering incremental upsides from international markets, companyspecific
issues and current valuations, we expect Lupin, Dr Reddy’s, Cadila, and
Torrent to be outperformers over the next 12-18 months.
Key Risks
High field force attrition could dent growth and profitability
A well spread out and competent field force (with good communication skills and product
knowledge) is critical for establishing and sustaining market share in a fiercely
competitive market like India. Players like Sun pharma, Lupin and most MNCs have
pioneered various models to establish quality field force. This entails rigorous investment
in hiring, training, and retaining people, which creates upfront costs recovered over twothree
years. For example, it takes one year for a company to recover upfront costs (or
sunk costs) for each new medical representative and it takes another two-three years for
a medical representative to reach company level productivity. Moreover, it takes sixeight
months for a new sales representative to establish relations with physicians and
practitioners. Hence, loss of a trained field person not only results in loss of sales, but
also loss of initial investment. As per the survey, most companies are facing high
attrition across tiers or geographies which could potentially risk growth in near term.
Almost ~ 75-80% of distributors confirmed 15-30% (and above) field force attrition
across markets surveyed
We have identified three key reasons behind higher attrition: (a) increase in demand for
medical representatives and limited supply of talent pool with companies competing for
high quality people; (b) setting up challenging field force targets with mandate to
aggressively capture market share; and (c) shift to other sectors like IT and financial
services for better incentives and growth.
Sun pharma, Lupin, and Torrent have been ranked by distributors as companies
possessing highly effective and stable field force, while Cadila, IPCA, GSK, and Cipla are
companies facing higher attrition.
Rise in fixed costs and higher competition to impact domestic margins
While attrition is posing potential risk to growth, increase in cost of hiring is likely to
impact profitability. Most companies are hiring non-science graduates for ramping up
field force which could result in high training expenses. Moreover, to retain the field
force, companies such as Unichem, IPCA, and Torrent, among others, are revising
inventive structures, resulting in higher employee costs. Other factors such as expansion
into Tier-II to Tier IV towns as well as increase in competition from MNCs and new
players will also exert pressure on margins.
Rural penetration requires higher investment
Managing penetration in smaller markets offers several challenges to companies such as
higher distribution costs due to poor infrastructure, increase in working capital led by
high inventories to initially fill channel and longer credit period. As per the survey,
average credit period in smaller towns is between one to two months versus less than
fifteen days in metros and tier-I cities. Moreover, it takes longer to break even
investments due to lower productivity of medical representatives. The payback period
ranges from one and half to two years versus less than one year for urban markets.
Apart from higher cost of investment, attrition, lack of talent pool, malpractices and
higher competition from local players are other challenges for companies to grow and
expand in these markets.
Emerging competition from MNCs and new players could lead to price war
The domestic market is being targeted by both MNCs and Indian companies. This is
further brought out by our survey where most distributors are seeing aggressive
expansion by MNCs. As seen in chart 33, these high investments have started to yield
traction for MNC players like Aventis, AstraZeneca, and MSD. Further, new players such
as Macleods, Mankind, Aristo etc. are rapidly expanding market share, giving stiff
competition to Indian counterparts. We believe this emerging competition could lead to
higher investments by existing players, while price wars could potentially hurt their
profitability in the near term.
Decline in success rate of new product introductions
New product introductions contribute 4-5% of overall market growth. Most large and
mid-size companies, to actively expand coverage across molecules or therapies, are
aggressively launching new products. However, as per our survey, 70-80% of these
products are failures. Most of these failures are in established segments, where more
than 10-15 players currently exist. Also, there is a growing resistance among retailers
and distributors to provide shelf space for new products before prescription generation.
Hence, we observe companies that are more proactive and launch products ahead of the
market are more successful in building brands, which potentially contributes to higher
business growth. Most distributors suggest that new launches by Sun Pharma, Sanofi-
Aventis and Lupin have pent-up demand in the first week of launch. Also, companies
with differentiated R&D pipeline like Sun Pharma and Dr. Reddy’s clearly have an edge
over others.
Potential expansion of controlled pricing list to impact profitability
Domestic drug prices are lowest in the world, however, time and again the government
has deliberated expansion of the drugs list under pricing control. Currently, 74 drugs
(15% of total market) are under controlled pricing and government is contemplating to
expand this list to include up to 356 drugs which could cover potentially 50-60% of the
total market. Most of the existing products under price control are anti-infective, pain
killers and vitamins, among others, which primarily belong to the acute therapy
segment. However, the proposal, if implemented, will extend the list to include some
basic anti-diabetics and cardiovascular/other specialty class drugs, which are increasing
prevalence and affecting the masses.
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