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Investment summary
We initiate coverage on the Indian pharma sector with a DETERIORATING outlook. We see three challenges
for the Indian pharmas: 1) domestic formulations: an undifferentiated expansion strategy by most
companies is leading to margin pressure, and this may be the start of the much talked about
consolidation; 2) US: impending patent cliff, rising regulatory risks and increasing competition even for
Para IV opportunities; and 3) succession issues particularly for small Indian companies. These challenges
come at a time when earnings growth is likely to slow while the sector trades at a near all-time high
premium to the broader market.
We see limited scope for earnings surprises – acquisitions and a favourable currency movement are
probably the only two areas that could surprise positively. We believe companies with focus on specialty
products, R&D-backed products and tighter cost control will emerge winners. We initiate coverage on six
pharma companies, with BUYs on Sun Pharma and Dr Reddy’s, REDUCE on Ranbaxy, and HOLDs on Cadila
Healthcare, Cipla and Lupin.
An undifferentiated expansion strategy is putting margins under pressure
Majority of the top 15 Indian pharma companies have very undifferentiated expansion strategies, which
revolve around adding field force and increasing revenue mix from products related to the chronic segment
versus the acute segment. Very few companies have spoken about improving field-force productivity. We
believe field-force productivity will not peak soon, given the sector revenue is driven by the pull factor
rather than the push factor and given the market today is not wide enough to absorb the push factor
(generated by field-force addition). We believe the lack of differentiation is creating margin pressure. The
scenario is particularly challenging for the smaller Indian companies whose product concentration is high
and field force has been relatively less stable. Furthermore, the privately held companies have been
demonstrating very robust growth (3-4x ahead of the market), putting further pressure on listed peers. We
strongly believe the current growth trend in the domestic market is unsustainable and that this could lead
to the much talked about consolidation in the Indian market, post which we believe efficiency may return to
the system
US: Impending patent cliff, rising regulatory risks, Para IV opportunities not as lucrative as previously
Over 2011-15, drugs worth USD96b will lose patent protection, compared to USD74b over 2005-10. Out of
the USD96b, about 60% of the drugs will go off-patent over 2011-12. The impending patent cliff is likely to
see slower number of launches in the US starting 2013. Given that the third wave of Indian generics has
entered the US market with their set of filings, market dynamics are likely to become more competitive in
the near future. Regulatory risks in the form of warning letters/import alerts have been on the rise, while
introduction of authorised generics by the innovators even for products as small as USD100m has meant
greater price erosions and lower market share during exclusive periods, thus not making Para IV as
lucrative an opportunity as It was previously.
Earnings growth slowing, nonetheless the sector trades at near all-time high premium to the market
We believe these challenges will lead to slower earnings growth for the sector. For our coverage universe,
we project core earnings growth of 17% over FY11-14, versus 25% achieved over FY08-11. Including nonrecurring
opportunities, we estimate FY11-14 earnings CAGR of 11.1%, versus Bloomberg consensus
forecast of 13.5%. We anticipate earnings cuts by the Street.
Limited scope of earnings surprise, but inorganic growth and forex movement may surprise positively
We see limited scope for earnings surprises, though acquisitions and a favourable currency movement could
surprise positively. Indian companies have been less acquisitive than their global peers such as Teva (TEVA
US, Not rated), Watson (WPI US, Not rated) and Mylan (MYL US, Not rated), and certain portfolio gaps can
be bridged through acquisitions. We believe Indian companies are relatively much more mature to handle
acquisitions and the deals can be concluded without significant equity dilution given their stronger balance
sheets.
A favourable forex movement would be another positive factor, but at this point we have limited
understanding of where the currencies will head from current levels. Assuming currency stays at current
levels (INR43/USD, INR76/GBP, INR67/EUR and INR63/JPY), we estimate earnings growth over FY11-14E
would jump 3ppt to 20% versus our current estimate of 17% growth.
BUY Sun Pharma and Dr Reddy’s, REDUCE Ranbaxy, HOLD Cadila, Cipla and Lupin
We believe Sun Pharma is best placed to overcome the challenges in the sector and is our top pick for its
focused business approach (US + India presence), strong execution history and a solid balance sheet to fund
acquisitions without equity dilution.
Our BUY rating for Dr Reddy’s is mainly based on its strong US pipeline. We acknowledge the risks
associated with the exposure to Russia, but the company seems better prepared to handle the structural
changes in Russia than it was with BetaPharm (Germany). India and APIs could surprise positively as there
are no major expectations from these areas.
We initiative coverage on Ranbaxy with a REDUCE rating, as we believe valuations adequately price in the
recovery of the core business. In our view, the market is too focused on generic Lipitor launch and US
FDA/DoJ resolution and is ignoring the slow progress of the core business. We believe Ranbaxy will lack the
triggers once Lipitor is launched and the US FDA/DoJ issues are resolved.
We have HOLD ratings for Cadila, Cipla and Lupin. For Cadila, the US FDA’s warning letter on its sterile
facility, a key growth driver for the company, puts a question mark on its US growth prospects in the long
run. We are not sure if the warning letter will have any indirect impact on the non-sterile approvals too,
which means FY13 growth from the US market is also unclear.
Cipla’s share price has corrected significantly compared to its peers. While current valuations look
reasonable, re-rating is unlikely any time soon unless clarity emerges on a key intangible issue – leadership.
Lupin has seen a sharp P/E expansion in the past two years, driven by large filings in the US (niche products
such as oral contraceptives) and planned ramp-up of the US branded generic business. With the latter
showing signs of moderation, all eyes will probably be on execution in oral contraceptives (OCs). We believe
the market dynamics for OCs may have become more competitive and that the delay in product approvals
for over a year may have withered some competitive advantage for Lupin. We assume slower ramp-up in
OCs with sales of USD100m in FY14, which is 20-50% below the company’s indication. Our FY13-14 estimate
is 10% below consensus.
Valuations and top ideas
An undifferentiated expansion strategy is putting margins under pressure
Majority of the top 15 Indian pharma companies have very undifferentiated expansion strategies, which
revolve around adding field force and increasing revenue mix from products related to the chronic segment
versus the acute segment. Very few companies have spoken about improving field-force productivity. We
believe field-force productivity will not peak soon, given the sector revenue is driven by the pull factor
rather than the push factor and given the market today is not wide enough to absorb the push factor
(generated by field-force addition). We believe the lack of differentiation is creating margin pressure. The
scenario is particularly challenging for the smaller Indian companies whose product concentration is high
and field force has been relatively less stable. Furthermore, the privately held companies have been
demonstrating very robust growth (3-4x ahead of the market), putting further pressure on their listed
peers. We strongly believe the current growth trend in the domestic market is unsustainable and that this
could lead to the much talked about consolidation in the Indian market, post which we believe efficiency
may return to the system.
US: Impending patent cliff, rising regulatory risks, Para IV opportunities not as lucrative as previously
Over 2011-15, drugs worth USD96b will lose patent protection, compared to USD74b over 2005-10. Out of
the USD96b, about 60% of the drugs will go off-patent over 2011-12. The impending patent cliff is likely to
see slower number of launches in the US starting 2013. Given that the third wave of Indian generics has
entered the US market with their set of filings, market dynamics are likely to become more competitive in
the near future. Regulatory risks in the form of warning letters/import alerts have been on the rise, while
introduction of authorised generics by the innovators even for products as small as USD100m has meant
greater price erosions and lower market share during exclusive periods, thus making Para IV not as
lucrative an opportunity as it was previously.
Earnings growth slowing, nonetheless the sector trades at near all-time high premium to the market
We believe these challenges will lead to slower earnings growth for the sector. For our coverage universe,
we project core earnings growth of 17% over FY11-14, versus 25% achieved over FY08-FY11. Including nonrecurring
opportunities, we estimate FY11-14 earnings CAGR of 11.1%, versus Bloomberg consensus
forecast of 13.5%. We anticipate earnings cuts by the Street.
Limited scope of earnings surprise, but inorganic growth and forex movement may surprise positively
We see limited scope for earnings surprises, though acquisitions and a favourable currency movement could
surprise positively. Indian companies have been less acquisitive than their global peers such as Teva (TEVA
US, Not rated), Watson (WPI US, Not rated) and Mylan (MYL US, Not rated), and certain portfolio gaps can
be bridged through acquisitions. We believe Indian companies are relatively much more mature to handle
acquisitions and the deals can be concluded without significant equity dilution given their stronger balance
sheets.
A favourable forex movement would be another positive factor, but at this point we have limited
understanding of where the currencies will head from current levels. Assuming that currency stays at
current levels (INR49/USD, INR76/GBP, INR67/EUR and INR63/JPY), earnings growth over FY11-14 would
jump 3ppt to 20%, vs. our estimate of 17% growth.
BUY Sun Pharma and Dr Reddy’s; REDUCE Ranbaxy, HOLD Cadila, Cipla and Lupin
We believe Sun Pharma is best placed to overcome the challenges in the sector and is our top pick for its
focused business approach (US + India presence), strong execution history and a solid balance sheet to fund
acquisition without equity dilution.
Our BUY rating for Dr Reddy’s is mainly based on its strong US pipeline. We acknowledge the risks
associated with the exposure to Russia, but the company seems better prepared to handle the structural
changes in Russia than it was with BetaPharm (Germany). India and APIs could surprise positively as there
are no major expectations from these areas.
We initiative coverage on Ranbaxy with a REDUCE rating, as we believe valuations adequately price in the
recovery of the core business. In our view, the market is too focused on generic Lipitor launch and US
FDA/DoJ resolution and is ignoring the slow progress of the core business. We believe Ranbaxy will lack the
triggers once Lipitor is launched and the US FDA/DoJ issues are resolved.
We have HOLD ratings for Cadila, Cipla and Lupin. For Cadila, the US FDA’s warning letter on its sterile
facility, a key growth driver for the company, puts a question mark on its US growth prospects in the long
run. We are not sure if the warning letter will have any indirect impact on the non-sterile approvals too,
which means FY13 growth from the US market is also unclear.
Cipla’s share price has corrected significantly compared to its peers. While current valuations look
reasonable, re-rating is unlikely any time soon unless clarity emerges on a key intangible issue – leadership.
Lupin has seen a sharp P/E expansion in the past two years, driven by large filings in the US (niche products
such as oral contraceptives) and planned ramp-up of the US branded generic business. With the latter
showing signs of moderation, all eyes will probably be on execution in oral contraceptives (OCs). We believe
the market dynamics for OCs may have become more competitive and that the delay in product approvals
for over a year may have withered some competitive advantage for Lupin. We assume slower ramp-up in
OCs with sales of USD100m in FY14, which is 20-50% below the company’s indication. Our FY13-14 estimate
is 10% below consensus.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Investment summary
We initiate coverage on the Indian pharma sector with a DETERIORATING outlook. We see three challenges
for the Indian pharmas: 1) domestic formulations: an undifferentiated expansion strategy by most
companies is leading to margin pressure, and this may be the start of the much talked about
consolidation; 2) US: impending patent cliff, rising regulatory risks and increasing competition even for
Para IV opportunities; and 3) succession issues particularly for small Indian companies. These challenges
come at a time when earnings growth is likely to slow while the sector trades at a near all-time high
premium to the broader market.
We see limited scope for earnings surprises – acquisitions and a favourable currency movement are
probably the only two areas that could surprise positively. We believe companies with focus on specialty
products, R&D-backed products and tighter cost control will emerge winners. We initiate coverage on six
pharma companies, with BUYs on Sun Pharma and Dr Reddy’s, REDUCE on Ranbaxy, and HOLDs on Cadila
Healthcare, Cipla and Lupin.
An undifferentiated expansion strategy is putting margins under pressure
Majority of the top 15 Indian pharma companies have very undifferentiated expansion strategies, which
revolve around adding field force and increasing revenue mix from products related to the chronic segment
versus the acute segment. Very few companies have spoken about improving field-force productivity. We
believe field-force productivity will not peak soon, given the sector revenue is driven by the pull factor
rather than the push factor and given the market today is not wide enough to absorb the push factor
(generated by field-force addition). We believe the lack of differentiation is creating margin pressure. The
scenario is particularly challenging for the smaller Indian companies whose product concentration is high
and field force has been relatively less stable. Furthermore, the privately held companies have been
demonstrating very robust growth (3-4x ahead of the market), putting further pressure on listed peers. We
strongly believe the current growth trend in the domestic market is unsustainable and that this could lead
to the much talked about consolidation in the Indian market, post which we believe efficiency may return to
the system
US: Impending patent cliff, rising regulatory risks, Para IV opportunities not as lucrative as previously
Over 2011-15, drugs worth USD96b will lose patent protection, compared to USD74b over 2005-10. Out of
the USD96b, about 60% of the drugs will go off-patent over 2011-12. The impending patent cliff is likely to
see slower number of launches in the US starting 2013. Given that the third wave of Indian generics has
entered the US market with their set of filings, market dynamics are likely to become more competitive in
the near future. Regulatory risks in the form of warning letters/import alerts have been on the rise, while
introduction of authorised generics by the innovators even for products as small as USD100m has meant
greater price erosions and lower market share during exclusive periods, thus not making Para IV as
lucrative an opportunity as It was previously.
Earnings growth slowing, nonetheless the sector trades at near all-time high premium to the market
We believe these challenges will lead to slower earnings growth for the sector. For our coverage universe,
we project core earnings growth of 17% over FY11-14, versus 25% achieved over FY08-11. Including nonrecurring
opportunities, we estimate FY11-14 earnings CAGR of 11.1%, versus Bloomberg consensus
forecast of 13.5%. We anticipate earnings cuts by the Street.
Limited scope of earnings surprise, but inorganic growth and forex movement may surprise positively
We see limited scope for earnings surprises, though acquisitions and a favourable currency movement could
surprise positively. Indian companies have been less acquisitive than their global peers such as Teva (TEVA
US, Not rated), Watson (WPI US, Not rated) and Mylan (MYL US, Not rated), and certain portfolio gaps can
be bridged through acquisitions. We believe Indian companies are relatively much more mature to handle
acquisitions and the deals can be concluded without significant equity dilution given their stronger balance
sheets.
A favourable forex movement would be another positive factor, but at this point we have limited
understanding of where the currencies will head from current levels. Assuming currency stays at current
levels (INR43/USD, INR76/GBP, INR67/EUR and INR63/JPY), we estimate earnings growth over FY11-14E
would jump 3ppt to 20% versus our current estimate of 17% growth.
BUY Sun Pharma and Dr Reddy’s, REDUCE Ranbaxy, HOLD Cadila, Cipla and Lupin
We believe Sun Pharma is best placed to overcome the challenges in the sector and is our top pick for its
focused business approach (US + India presence), strong execution history and a solid balance sheet to fund
acquisitions without equity dilution.
Our BUY rating for Dr Reddy’s is mainly based on its strong US pipeline. We acknowledge the risks
associated with the exposure to Russia, but the company seems better prepared to handle the structural
changes in Russia than it was with BetaPharm (Germany). India and APIs could surprise positively as there
are no major expectations from these areas.
We initiative coverage on Ranbaxy with a REDUCE rating, as we believe valuations adequately price in the
recovery of the core business. In our view, the market is too focused on generic Lipitor launch and US
FDA/DoJ resolution and is ignoring the slow progress of the core business. We believe Ranbaxy will lack the
triggers once Lipitor is launched and the US FDA/DoJ issues are resolved.
We have HOLD ratings for Cadila, Cipla and Lupin. For Cadila, the US FDA’s warning letter on its sterile
facility, a key growth driver for the company, puts a question mark on its US growth prospects in the long
run. We are not sure if the warning letter will have any indirect impact on the non-sterile approvals too,
which means FY13 growth from the US market is also unclear.
Cipla’s share price has corrected significantly compared to its peers. While current valuations look
reasonable, re-rating is unlikely any time soon unless clarity emerges on a key intangible issue – leadership.
Lupin has seen a sharp P/E expansion in the past two years, driven by large filings in the US (niche products
such as oral contraceptives) and planned ramp-up of the US branded generic business. With the latter
showing signs of moderation, all eyes will probably be on execution in oral contraceptives (OCs). We believe
the market dynamics for OCs may have become more competitive and that the delay in product approvals
for over a year may have withered some competitive advantage for Lupin. We assume slower ramp-up in
OCs with sales of USD100m in FY14, which is 20-50% below the company’s indication. Our FY13-14 estimate
is 10% below consensus.
Valuations and top ideas
An undifferentiated expansion strategy is putting margins under pressure
Majority of the top 15 Indian pharma companies have very undifferentiated expansion strategies, which
revolve around adding field force and increasing revenue mix from products related to the chronic segment
versus the acute segment. Very few companies have spoken about improving field-force productivity. We
believe field-force productivity will not peak soon, given the sector revenue is driven by the pull factor
rather than the push factor and given the market today is not wide enough to absorb the push factor
(generated by field-force addition). We believe the lack of differentiation is creating margin pressure. The
scenario is particularly challenging for the smaller Indian companies whose product concentration is high
and field force has been relatively less stable. Furthermore, the privately held companies have been
demonstrating very robust growth (3-4x ahead of the market), putting further pressure on their listed
peers. We strongly believe the current growth trend in the domestic market is unsustainable and that this
could lead to the much talked about consolidation in the Indian market, post which we believe efficiency
may return to the system.
US: Impending patent cliff, rising regulatory risks, Para IV opportunities not as lucrative as previously
Over 2011-15, drugs worth USD96b will lose patent protection, compared to USD74b over 2005-10. Out of
the USD96b, about 60% of the drugs will go off-patent over 2011-12. The impending patent cliff is likely to
see slower number of launches in the US starting 2013. Given that the third wave of Indian generics has
entered the US market with their set of filings, market dynamics are likely to become more competitive in
the near future. Regulatory risks in the form of warning letters/import alerts have been on the rise, while
introduction of authorised generics by the innovators even for products as small as USD100m has meant
greater price erosions and lower market share during exclusive periods, thus making Para IV not as
lucrative an opportunity as it was previously.
Earnings growth slowing, nonetheless the sector trades at near all-time high premium to the market
We believe these challenges will lead to slower earnings growth for the sector. For our coverage universe,
we project core earnings growth of 17% over FY11-14, versus 25% achieved over FY08-FY11. Including nonrecurring
opportunities, we estimate FY11-14 earnings CAGR of 11.1%, versus Bloomberg consensus
forecast of 13.5%. We anticipate earnings cuts by the Street.
Limited scope of earnings surprise, but inorganic growth and forex movement may surprise positively
We see limited scope for earnings surprises, though acquisitions and a favourable currency movement could
surprise positively. Indian companies have been less acquisitive than their global peers such as Teva (TEVA
US, Not rated), Watson (WPI US, Not rated) and Mylan (MYL US, Not rated), and certain portfolio gaps can
be bridged through acquisitions. We believe Indian companies are relatively much more mature to handle
acquisitions and the deals can be concluded without significant equity dilution given their stronger balance
sheets.
A favourable forex movement would be another positive factor, but at this point we have limited
understanding of where the currencies will head from current levels. Assuming that currency stays at
current levels (INR49/USD, INR76/GBP, INR67/EUR and INR63/JPY), earnings growth over FY11-14 would
jump 3ppt to 20%, vs. our estimate of 17% growth.
BUY Sun Pharma and Dr Reddy’s; REDUCE Ranbaxy, HOLD Cadila, Cipla and Lupin
We believe Sun Pharma is best placed to overcome the challenges in the sector and is our top pick for its
focused business approach (US + India presence), strong execution history and a solid balance sheet to fund
acquisition without equity dilution.
Our BUY rating for Dr Reddy’s is mainly based on its strong US pipeline. We acknowledge the risks
associated with the exposure to Russia, but the company seems better prepared to handle the structural
changes in Russia than it was with BetaPharm (Germany). India and APIs could surprise positively as there
are no major expectations from these areas.
We initiative coverage on Ranbaxy with a REDUCE rating, as we believe valuations adequately price in the
recovery of the core business. In our view, the market is too focused on generic Lipitor launch and US
FDA/DoJ resolution and is ignoring the slow progress of the core business. We believe Ranbaxy will lack the
triggers once Lipitor is launched and the US FDA/DoJ issues are resolved.
We have HOLD ratings for Cadila, Cipla and Lupin. For Cadila, the US FDA’s warning letter on its sterile
facility, a key growth driver for the company, puts a question mark on its US growth prospects in the long
run. We are not sure if the warning letter will have any indirect impact on the non-sterile approvals too,
which means FY13 growth from the US market is also unclear.
Cipla’s share price has corrected significantly compared to its peers. While current valuations look
reasonable, re-rating is unlikely any time soon unless clarity emerges on a key intangible issue – leadership.
Lupin has seen a sharp P/E expansion in the past two years, driven by large filings in the US (niche products
such as oral contraceptives) and planned ramp-up of the US branded generic business. With the latter
showing signs of moderation, all eyes will probably be on execution in oral contraceptives (OCs). We believe
the market dynamics for OCs may have become more competitive and that the delay in product approvals
for over a year may have withered some competitive advantage for Lupin. We assume slower ramp-up in
OCs with sales of USD100m in FY14, which is 20-50% below the company’s indication. Our FY13-14 estimate
is 10% below consensus.
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