Don’t overdose on MNC pharma stocks ::Business Line

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Meaningful revenues from new products may take time to flow in. Intensifying competition and policy challenges add to MNCs’ woes. Given the rich valuations for select MNC stocks, the underperformance may aggravate in the near future.Multinationals may be the worst affected in the event of an adverse pricing policy to cap drug prices.

Investors, buffeted by the wild swings in stock markets in the last five years, have sought refuge in stocks of ‘defensive’ pharma companies.

After all, drug sales aren’t particularly affected by an economic slowdown. Select multinationals in the sector have enjoyed particular fancy, with price-earnings multiples as high as 24 times, a whopping 33 per cent premium to the market.

But it may be time for investors to rethink their bets on these stocks. MNCs in the Indian pharma space seem to be losing strength, with slower growth, intensifying competition and new policy challenges.

CHANGE IN STRATEGY

Pharma MNCs in India have undergone a significant makeover in the last few years from just being marketing arms for their parents’ patented drugs to tailoring their products to the local market.

A vibrant domestic market has led multinationals to re-think their India strategy to look beyond their parent’s products and launch new generic drugs. Multinationals currently constitute more than a fourth of the domestic market.

EXPANDING REACH

The last few years have seen MNCs aggressively expand their presence in the Indian market by adding to their sales force and rolling out new products.

For instance, Sanofi Aventis, through its ‘Prayas’ initiative, reaches out to doctors and patients in the semi-urban and rural areas. It has expanded its field force in the last three years and targets reaching out to over one lakh doctors in the rural areas through this programme.

Similarly, GlaxoSmithkline Pharma, through its ‘reach’ initiative, has expanded presence in the rural markets. It has increased its field force by over 80 per cent in the last four years.

The company currently has a field force of over 3,300 medical representatives, who market the company’s brands with doctors. Glaxo is also aggressively ramping up its branded generics drugs segment. The company launched five new products in 2012.

Even as MNCs are expanding presence in the domestic market it has not been an easy ride as growth challenges remain unabated.

In 2012, drug sales data compiled by pharma research firm AIOCD AWACS show, home-grown drug makers grew sales at 15 per cent, while multinationals clocked a more modest 12.4 per cent growth.

This is lower than the 17 per cent growth achieved in the previous year. The slowdown is expected to persist due to a variety of reasons.

NEW PRODUCT LAUNCHES

Though MNCs have been focussing on new generic drug launches to drive growth, meaningful revenues from new products may take time to flow in. And product launches may no longer fetch substantial premiums.

Thanks to the competition, MNCs are under pressure to settle for lower prices for their new launches too. For instance, of the 16.9 per cent sales growth for GlaxoSmithkline Pharma in 2012, volume growth constituted 11.9 per cent, price increases contributed 3.5 per cent and new versions of existing products accounted for the balance 1.5 per cent. The new products are yet to start paying off for the company.

COST PRESSURE

While MNCs are yet to realise meaningful upside from new launches, costs have increased, given the higher employee costs due to field force additions and lower margins on new launches.

Operating profit margins have been under pressure. For instance, the aggregate revenues of 10 pharma MNCs witnessed a slow 7.8 per cent rise in 2012, compared with 29.4 per cent growth in the previous year.

Their aggregate operating margins declined from 19 per cent for the period ended December 2010 to 17.4 per cent by December 2012. Profits declined 2.6 per cent during this period, compared with 23.9 per cent increase in the previous year.

However, chronic drug makers such as Sanofi Aventis, for instance, have managed to improve margins and profits in the last two years.

CHALLENGE TO PATENTS

Indian courts questioning patent protection for some products manufactured by MNC pharma majors, especially when suspected of ever-greening, also poses a threat to realisations and prospects.

The recent landmark ruling by the country’s apex court rejecting the patent plea by Novartis for its anti-cancer drug Glivec reflects the clear will of regulatory and legal authorities to make life-saving drugs affordable to people.

Extension of the judgement to pending patent litigation from MNCs — Bayer, Merck and Bristol-Myers Squibb — may only add to the woes of multinationals.

Compulsory licence, allowing other companies to sell a generic equivalent of pricey innovative drugs, may further risk revenues and profits of multinationals.

Last year, the Intellectual Property Appellate Board rejected Bayer’s plea to stay the compulsory licence granted to Natco pharma to sell generic copies of the former’s anti-cancer drug brand Nexavar. The order permitted Natco Pharma to sell its generic version at Rs 8,800 for a month’s dosage of 120 tablets, implying a 97 per cent discount to Bayer’s price of Rs 2.8 lakh.

APPROVAL DELAYS

The recent tightening of new product approvals by the Indian drug regulator and clampdown on irrational combination drugs may have a bearing on the revenue and profits of MNCs too. Approval delays and slower new launches may temper growth for multinationals.

The pending policy measure to curb drug prices is yet another growth dampener. The new drug pricing policy notified in December 2012 proposes to cap the prices of essential drugs at the weighted average price of brands with share of over one per cent in the market.

Multinationals may be the worst affected in the event of an adverse pricing policy to cap drug prices. Given their high dependence on domestic market, a stringent policy may inhibit growth for MNCs.

Also, multinationals who adopt a premium pricing strategy may be highly vulnerable to price cuts in the event of an adverse regulation. For instance, Glaxo’s largest selling anti-biotic brand Augmentin (Amoxycillin and Clavulanic acid) figures among the revised essential drug list. A strip of eight Glaxo augmentin tablets (500mg Amoxycillin and 125mg Clavulanic acid) costs three times more than the lowest priced brand in this category.

This will mean steeper price cuts for Glaxo, if the proposed policy is implemented in its current form.

MOST MNC STOCKS HAVE UNDERPERFORMED THE BENCHMARK BSE HEATHCARE ON A ONE-YEAR BASIS.

THIS HAS BEEN ACCOMPANIED BY SLACKENING REVENUE AND PROFIT GROWTH IN THE LAST ONE YEAR.

BUT, GIVEN THE RICH VALUATIONS FOR SELECT MNC STOCKS, THE UNDERPERFORMANCE MAY AGGRAVATE IN THE NEAR FUTURE.

FOR INSTANCE, GLAXO’S VALUATION DOES NOT SEEM TO FACTOR THE GROWTH CONCERNS COMPLETELY.

THE COMPANY’S REVENUE GROWTH SLIPPED TO 10.7 PER CENT IN 2012 FROM 12.5 PER CENT IN THE PREVIOUS YEAR.

SIMILARLY, ITS OPERATING MARGINS DECLINED BY OVER 8 PERCENTAGE POINTS IN THE LAST TWO YEARS — FROM 33.7 PER CENT IN 2010 TO 25.5 PER CENT IN 2012. THE ADJUSTED PROFIT DECLINED BY OVER 2 PER CENT IN 2012, COMPARED WITH THE PREVIOUS YEAR.

DESPITE THE SLACKENING PERFORMANCE, THE STOCK CURRENTLY TRADES AT 23.9 TIMES ITS FY14 EARNINGS, AT HIGHER END OF ITS HISTORICAL TRADING BAND.

WHILE INVESTORS MAY FIND A FEW ATTRACTIVE PICKS IN THE MNC PHARMA SPACE, THE SEGMENT AS A WHOLE MAY NOT DESERVE A LARGE SLICE OF THE PORTFOLIO.

IT MAY HELP TO WAIT UNTIL FURTHER CLARITY EMERGES OVER DRUG PRICING POLICY AND GROWTH STABILITY BEFORE TAKING FRESH EXPOSURE IN MULTINATIONAL PHARMA STOCKS.

DID YOU KNOW?

MULTINATIONALS USE THEIR R&D CAPABILITIES AS THE SELLING POINT TO PROMOTE THEIR BRANDS WITH DOCTORS. BUT SMALLER COMPANIES USE PRICE AS THE USP TO SELL THEIR BRANDS. NOT JUST THAT, SOME COMPANIES ALSO INCENTIVISE CHEMISTS TO ENCOURAGE SUBSTITUTION OF COSTLIER BRANDS WITH THEIR LOW COST BRANDS BY GIVING THEM FREE STRIPS OF MEDICINES (BONUS UNITS).