J.P. Morgan - Indian Pharmaceuticals

Indian Pharmaceuticals Domestic growth to see slow and steady recovery but pre-FY14 growth levels unlikely in a hurry

Industry growth in FY14 was impacted by several one-off factors, but players expect recovery in the domestic market in FY15. Our channel checks, conversations with industry association and commentary from players indicated steady recovery post the 1QFY15. While we expect growth to improve from the ~6% in FY14, in our view, the lack of new product introductions and muted price hike in non-DPCO drugs is likely to cap growth at ~8-10% vs. average growth of ~14% before FY14. The key upside risk to our assumption is clarity in approval for new product introductions, while downside risk is increasing the coverage of price control beyond NLEM drugs.

· Domestic industry growth to recover through FY15…: Industry growth is likely to recover for ~6% level in FY14, as the one-off factors like rollout of NLEM, trade destocking, product ban impact are behind the industry and industry growth should improve steadily through the year. The government announced the Drug (Price Control) Order (DPCO) 2013 in mid-May with implementation deadline of end-Jun. The disruption related to rollout of DPCO and subsequent destocking severely impacted industry growth from Jun onwards. Therefore, the low base post July, normalization in distribution and impact from price increase taken from Apr-onwards should help improve growth to 8-10% in FY15, in our view.

· …but limited to 8-10% rather than low-mid teens. While we expect an improvement of growth, the likelihood of achieving 10+% growth witnessed before FY14 remains limited in the current operating environment. The key reasons for a cap in growth trends are a) limited price hikes in non-DPCO drugs given increasing competition in the domestic market; b) the net impact from price hike in DPCO drugs could be lower than the announced price increase as the players are likely to transfer some of the pricing benefit to the trade channel to offset the trade margin reduction; c) changing regulation hurting new drug approvals and product introductions in the market.

· What is required for higher industry growth? The key driver for improvement in growth rate beyond the 8-10% expectation would be ramp up in new product introductions rather than just new brand launches as the later merely shifts prescriptions from existing brands and usually increase price erosion in the category. A key impediment to new product introductions is slowing new drug approvals by regulatory authorities. Further, the product pipeline of companies is also seeing impact for lack of approvals for clinical trials over the last year. As per DRRD 20F filings, new products launched in the preceding 24 months accounted for 6-8% of growth historically and we believe this has declined to low-single digit over the last year. The introduction of new drugs is a key driver for profitable growth for the sector in the domestic market in the medium term, which depends on clarity in the approval process and timeline. (Please see our note “Domestic growth implications from changing regulations on clinical trials and new drug approvals” published on 3rd Mar 2014).

· Scope for price control moving beyond NLEM? Media reports (ET) indicated that the National Pharmaceutical Pricing Authority (NPAA) is considering benchmarking prices of the most expensive brands to the average price of the respective categories in therapies like cancer, HIV, CVS, diabetes, malaria and TB. The article also indicated that the new policy will also stipulate the new medicine prices to not exceed the most expensive brand in the respective category. In our view, such a change in policy will hurt industry growth and more importantly, this would dis-incentivize companies from introducing new product in these critical segments.

Table 1: Indian Pharma companies – Contribution to Revenue and Focus Therapy Areas

	India as % of revenue	Focus areas
SUNP	26.0	CVS, Anti-Diabetic, Neuro Psychiatry, GI
LPC	22.3	CVS, Anti-Biotics + Cephs and Anti-Diabetic
DRRD	12.0	Cardiology, GI, Antineoplastics
GNP	25.3	Dermatology, Cardiology and Gynecology

Source: Company reports.

Figure 1: Industry growth in the last year impacted by one-off, but recovery likely from current levels

Source: AIOCD data (PILMAN and Media reports -ET, BS, Express Pharma, Mint).

Figure 2: Quarterly Domestic Revenue YoY Growth for Indian Companies reported so far

Source: Company reports

Figure 3: Domestic Formulation YoY Growth Trend

Source: Company reports and J.P. Morgan estimates. Note: SUNP growth for FY13 -FY14 impacted by one-off adjustments. Adjusted for the extra sales recorded in the Q4FY12 and the change in treatment of expected sales returns and treatment of discounts, the underlying sales growth of domestic formulation business is 19%.

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