The New Pharma Pricing Policy (NPPP) proposed by the Department of
Pharmaceutical in October 2011 was opposed by various NGOs and Health ministry
as it is believed that the pricing based on Top 3 brands would not actually reduce the
prices to the affordable level for masses. Following the same, the Government
formed a Group of Ministers (GOM) on the pharma pricing policy, headed by Mr.
Sharad Pawar, to work on an alternative policy. We believe that the new policy may
be more detrimental to the industry than the one which was proposed earlier as
pricing cuts will be steeper. Apart from impacting profitability, the new policy can
significantly de-rate the valuation of leading Indian Pharma companies.
GOM in action following instructions from the Supreme Court; final outcome
and implementation timelines still uncertain: The GOM on pharma pricing has
swung into action based on the order from the Supreme Court to decide on
pricing policy for essential drugs as listed in National List of Essential Medicines
(NLEM) 2011. The GOM met on Thursday but could not arrive at any decision as
it has called for more data to take a call on market-based pricing formula.
However, the GOM is expecting to meet on September 27 and take a final
decision within next few days.
The new policy can be marginally better on coverage of drugs but harsher in
terms of pricing compared to NPPP 2011: According to some of the media
reports, the GOM came to a consensus that the regulation should be limited to
348 medicines and their 614 dosages and combination drugs will not be
included in the price control. This will be beneficial to the industry as it would
reduce the price control to 60% of the market as per some industry sources (v/s
75% including combination drugs). However, the pricing formula, though market
based, will be much harsher in its impact on top companies. As per various
proposals, Weighted Average Price (WAP) of all the brands having volume
market share of more than 5% or 1% should be considered for price ceiling.
Domestic business is of high importance to most of the leading Indian
companies: We note that the domestic formulation business is one of the most
profitable business segments for most of the leading pharma companies from
India and the new policy is likely to reduce the profitability, return rations and
free cash flow generated by the companies from the domestic business. This, in
turn, will impact the global growth ambitions of the pharma companies leading
to damage to the valuation of these companies. Further, all the leading Pharma
companies are trading at a relatively higher valuation leaving little room for
margin of safety.
Pharma pricing policy – The risk is significantly higher than it appears
The NPPP proposed by Department of Pharmaceutical in October 2011 was opposed
by various NGOs and Health ministry as it believed that the pricing based on Top 3
brands would not actually reduce the prices to the affordable level for masses.
Following the same, the Government formed a GOM on the pharma pricing policy
headed by Mr. Sharad Pawar to work on an alternative policy. We believe that the
new policy is likely to be more detrimental to the industry than the one which was
proposed earlier as pricing cuts will be steeper. Apart from impacting profitability,
the new policy can significantly de-rate the valuation of leading Indian Pharma
companies.
Background of Drug Price control in India
Price control on drugs was first introduced in 1963. This was followed by Drugs
Prices Control Order (DPCO), 1966 and 1970, 1978, 1979 and 1987. All these were
formed to control the prices of bulk drugs and essential drugs. The current DPCO
was introduced in 1995 which controlled the prices of drugs based on cost of
production with allowance given for post-manufacturing expenses. The pricing policy
of 1995 was on products where market share of dominant producers are beyond a
particular level. Accordingly, a list of 74 bulk drugs was identified and these drugs as
well as the formulations based on these drugs (currently about 1577 in number)
were brought under the price control regime.
A new pharmaceutical policy was introduced in 2002, which further liberalized the
span of control over pricing. The turnover limit for price control was raised from
Rs40m to Rs250m. All drugs under the unit price up to Rs2 were excluded from the
ambit of price control. The 2002 Drug Policy was challenged in the Karnataka High
Court and a stay was issued on the implementation of policy. This order was
challenged by the Government in the Supreme Court which vacated the stay. In the
light of the order of the Supreme Court, it was decided to formulate a fresh
Pharmaceutical Pricing Policy and accordingly the 2002 Drug Policy was never
implemented and the 1995 Drug Policy continued to be applicable which continues
even today. In accordance with the guidelines given by the Supreme Court, the
Ministry of Health revised the list of medicines in the NLEM earlier notified in 1996.
The revised list was notified as NLEM 2003. In 2011, the Ministry of Health revised
the NLEM and notified new NLEM 2011. The Government has enunciated the NPPP
2011 which seeks to replace the Drug Policy 1994 and will consider the pricing of
Essential Drugs as laid down in NLEM 2011. NPPP proposed a cap on the prices of
348 essential medicines and their formulations based on the weighted average price
of Top 3 brands. These drugs currently account for around 60% of the domestic
pharma market.
Except for the last proposed DPCO in 2006, all the previous DPCOs have resulted in
reducing bulk drugs under price control. Till 1987, prices of 347 drugs were
controlled. In 1987, price control on drugs was reduced to be applicable to 142 drugs
and then in the last revision in 1995 it came down to 74 drugs. This was further
proposed to be reduced to just 30 drugs in 2002 but the Supreme Court also wanted
life-saving drugs to be under price control. As a result, a NLEM 2003 was constituted
which had 354 drugs.
A brief about NPPP 2011
Government had proposed the NPPP 2011. In November 2004, the government set
up a Task Force under the Chairmanship of Principal Advisor, Planning Commission,
Dr. Pronab Sen, to look into the issue of price control. The Pronab Sen Committee
submitted its recommendations in September 2005. The NPPP was primarily based
on the Pronab Sen Commission recommendations.
The policy was significantly different from the existing policy. The new policy
proposed to replace the existing pricing policy of 1995. Drugs brought under price
control are determined based on essentiality for which NLEM 2011 has been
considered. In the past, the criteria for selection of drugs under price control were
based on sales and market share to prevent monopoly in the market. Another major
difference was in the pricing formula which was based on market-based pricing
rather than cost-based pricing as per the existing policy. The NPPP acknowledged
that the market is competitive enough to keep margins and profitability of
pharmaceutical companies in check. The departure from a cost-plus method would
have been a big relief for the industry as the negative impact of price control would
have been relatively less. Further, the NPPP proposed price revision for drugs based
on change in WPI versus existing practice of annual assessment of costs. The existing
DPCO 1995 was expected to remain in existence for two more years from the date
the new pricing policy is adopted. Only 34 out of the 74 drugs in the current DPCO
list are part of NLEM. The remaining drugs have therefore moved out of price control
post expiry of the two-year period.
As per the NPPP, almost 60% of the India Pharma market would come under price
control. However, the policy was shot down by various NGOs and health ministry as
they felt that the policy did not bring down the prices of drugs at the affordable level
to masses.
GOM in action following instructions from the Supreme Court – Final
outcome and implementation timelines still uncertain
The GOM on pharma pricing headed by Mr. Sharad Pawar has swung into action
based on the orders from the Supreme Court to decide on pricing policy for essential
drugs as listed in NLEM 2011. The GOM met on Thursday but could not arrive at any
decision as it has called for more data to take a call on market-based pricing formula.
However, the GOM is expecting to meet on September 27 and take a final decision
within next few days.
We believe that, despite the rapid activities taking place in the ministry to formulate
the new policy, the final outcome (cost based/market based) and timelines remain
uncertain as post the GOM proposes the new policy, the opinions of various stake
holders will be invited which may delay the implementation. The new policy can be
marginally better on coverage of drugs but harsher in terms of pricing compared to
NPPP 2011.
According to some of the media reports, the GOM came to consensus that the
regulation should be limited to 348 medicines and their 614 dosages and the
combination drugs should not be included in the price control. This will be beneficial
to the industry as it would reduce the price control to 60% of the market as per
some industry sources (v/s 75% including combination drugs). However, the pricing
formula, though market based, will be much harsher in its impact on top companies.
As per various proposals, WAP of all the brands having volume market share of more
than 5% or 1% should be considered for price ceiling.
As per NPPP 2011, which decides ceiling price based on Top 3 brands, 32% of the
348 drugs would have seen the price of top brand falling by more than 20% as
indicated in the table below. However, the below analysis does not quantify the
impact on industry as it does not take into account the size of the molecule.
Exhibit 1: Pricing impact on highest priced brands as per NPPP 2011
Decrease in the price of highest priced brands % of molecules under NLEM
0-5% 52%
5-10% 7%
10-15% 5%
15-20% 4%
> 20% 32%
Source: DOP
Possible Pricing Formula
Out of the six options suggested to the GoM by different stakeholders, three have
been shortlisted - one was suggested by the Prime Minister's Economic Advisory
Committee (PMEAC). As per the PMEAC suggested pricing:
If a drug is widely purchased by the government through tender process, the
MRP should be linked to the tender price.
For the remaining drugs, the retail price could be fixed at: (a) 1.25 times the 50th
percentile (median price) of a particular drug or (b) the price which 80% of the
consumers are paying, whichever is less.
The second option includes taking a WAP of all brands, which have a market share of
more than 5% and the third option entails the use of WAP for all the drugs which
have a market-share of more than 1%. To decide on at least one of these three
options, the GoM has asked for more data analysis. They want to see how drugs
have been priced in other emerging countries with similar platforms as India.
We believe that significant reduction in prices may lead to quality issues as
companies may focus more stringently on minimizing costs rather than focusing on
quality.
Following table indicates the possible changes that may appear in the new policy v/s
NPPP 2011. The table has been prepared by taking into account the outcome of last
meeting of GoM and opinion of various stake-holders.
Domestic business is of high importance to most of the leading
Indian companies; if the pricing impact is severe based on new
policy, it will have unwarranted repercussions for the companies
We note that the domestic formulation business is one of the most profitable
business segments for most of the leading pharma companies from India and the
new policy is likely to reduce the profitability, return rations and free cash flow
generated by the companies from the domestic business. This, in turn, will impact
the global growth ambitions of the pharma companies leading to damage to the
valuation of these companies.
We are not sure about how severe the impact of this policy will be on the
profitability of leading companies, but, it will certainly be a sizable impact which
cannot be ignored. The impact on profitability of leading Indian companies will
depend on various parameters like percentage of profits derived from domestic
formulation business which in most cases are higher than the percentage of revenue
derived from domestic formulation business, percentage of domestic revenue
covered by the 348 drugs and its formulations and pricing premium the company
commands in those drug formulations.
We believe that, the domestic formulation business is high RoCE and high cash-flow
generating business for most of these companies due to branded nature of the
market and low capital employed. The rapid strides made by most of these
companies in the international market have been funded through the domestic
formulation business. In fact, for many companies, the international operations are
not still profitable. It is the domestic formulation business which subsidized the
international operations for many of the companies in the initial years.
Any severe impact of the new policy will have multiple negative repercussions on the
business of these companies as mentioned below:
Overall profitability of the companies may go down significantly which will lead
to lower RoCE and RoEs
The top-line growth in both, the domestic business and international business,
will be impacted. The growth in domestic business will come down as prices gets
impacted and growth in international business will come down as the
companies will be left with lower free cashflows to invest in international
business.
For investors, the above two factors may lead to substantial de-rating of the
stocks in the short term and even in the longer term.
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