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Emerging markets matter. Over the past decade, non-US/EU markets
have contributed 24% of incremental sales for Indian companies: as much
as the domestic market. We believe they will become even more important,
especially once tailwinds in the US start to dwindle. For Indian firms to
maintain ~20% YoY growth trajectories and to justify their 18-20x forward
P/E multiples, success in emerging markets will be critical, in our view.
■
The different shades of pink. Of the 20 emerging generics’ markets we
surveyed in our 5th March 2010 note Pharma (Far) Marts, we analysed
Russia, Brazil, Japan and South Africa further: these are promising, and
relevant to Indian firms’ prospects. We talked to local experts, companies,
and analysed data. Conclusions: 1) They are not all equally rosy (Russia the
most followed by Brazil); 2) Indian firms have several strategic strengths; but
3) challenges abound. Most are professionalising management for this multipronged
growth, but are at different stages of this evolution.
■
We still like Dr. Reddy’s and Lupin. While Cipla and Ranbaxy have a
higher current proportion of profits and sales coming from emerging markets,
(EM) we are cautious on their growth prospects. We find Dr. Reddy’s to be
the best positioned: success in Russia is on solid foundations and should
continue. Lupin’s management model – a professional CEO and empowered
local management – allows it to scale across markets. Glenmark’s mediumterm
prospects remain strong, but near-term growth may be tepid for a while.
Sun is in early stages in EMs – a professional CEO is an important step.
New growth horizons
Why emerging markets matter
Over the past decade, as the Indian industry has diversified into formulation exports, non-
US/EU markets have contributed to a quarter of incremental sales: as much as the
domestic market. We believe they will become even more important, especially when
several strategic tailwinds in the US start to dwindle: the 2011-14 patent cliff, increasing
genericisation, and as Indian firms’ portfolios mature. For the Indian companies to
maintain their ~20% YoY sales growth trajectories and the stocks to justify their 18-20x
forward P/E multiples, success in Emerging Markets will be critical, in our view.
These are fast growing markets, expected to drive up to two-thirds of incremental global
sales until 2015. The best among these have some common characteristics, such as:
1) fast-growing economies driving strong income growth especially at low levels where
healthcare is discretionary; 2) Branding, which protects pricing; and 3) high out-of-pocket
payments. Yet there are significant differences, and many companies have struggled in
these markets despite low manufacturing costs and branding experience.
Of the 20 such markets we surveyed in our 5th March 2010 note Pharma (Far) Marts, in
this report we take analysis to a deeper level for countries that: 1) we find attractive; and
2) Indian companies have a meaningful presence in. We shortlisted four: Brazil, Russia,
Japan and South Africa. These comprise ~60% of Emerging Market sales for Indian firms.
Good prospects, but growth not easy
Indian companies are strategically well positioned to compete in these markets, given their
large and proven portfolio of products and personnel, familiarity with branded generics’
markets and low manufacturing costs. All of Russia, Brazil, and South Africa do not have a
comparable manufacturing set-up, and Japanese costs are materially higher. Further,
managing a branded generic business is radically different from managing a portfolio of
innovative products – a critical advantage over big pharma. The latter’s exposure to
emerging markets is still small, and to generics, in particular, is insignificant. While they
have the ammunition to acquire, organic competition is what matters for Indian companies,
and there is ample room for new brands to be established in fast growing markets.
Yet, despite the strategic positives, growth is not a foregone conclusion. There are critical
characteristics of each market which significantly impact attractiveness: we rate Russia the
highest followed by Brazil. We provide in-depth analyses of each of the markets.
Identifying the early winners
We encountered some common traits that help identify beneficiaries: 1) Own the front end;
2) Focus, and patience; 3) Build over buy: while local partnerships are important, given
universal demand for such assets, a large buy is likely to become a burden; and 4) a
professionalised management structure with operational freedom to line managers.
While Cipla and Ranbaxy have a higher current proportion of profits and sales coming
from emerging markets, we are cautious on their growth prospects. We find Dr. Reddy’s to
be the best positioned: it is much more focused and cautious post the Betapharm fiasco,
and yet quite ambitious, targeting US$1 bn in sales in three years (FY10: US$450 mn). Its
patience and brand focus should help sustain its success in Russia. Lupin’s proven
management model – a professional CEO and empowered local management – allows it
to scale across markets. Growth in Japan may be weaker than the government’s target,
but margin expansion can drive strong profit growth. Sun’s transition to professional
management is important step for it to replicate its successes in India and the US.
Glenmark’s medium-term prospects remain strong, and it is establishing the right
management model, but near-term growth may be tepid for a while.
Why emerging markets matter
Over the past decade, as the Indian industry has diversified into formulation exports, non-
US/EU markets have contributed to a quarter of incremental sales: as much as the
domestic market. We believe they will become even more important, especially when
several strategic tailwinds in the US start to dwindle: the 2011-14 patent cliff, increasing
genericisation, and as Indian firms’ portfolios mature. For the Indian companies to
maintain their ~20% YoY sales growth trajectories and the stocks to justify their 18-20x
forward P/E multiples, success in emerging markets will be critical, in our view.
These are fast growing markets, expected to drive up to two-thirds of incremental global
sales until 2015. The best among these have some common characteristics, such as:
1) fast-growing economies driving strong income growth especially at low levels where
healthcare is discretionary; 2) Branding, which protects pricing; and 3) high out-of-pocket
payments. Yet there are significant differences, and many companies have struggled in
these markets despite low manufacturing costs and branding experience.
Of the 20 such markets we surveyed in our 5th March 2010 note Pharma (Far) Marts, in
this report we take analysis to a deeper level for countries that: 1) we find attractive; and
2) Indian companies have a meaningful presence in. We shortlisted four: Brazil, Russia,
Japan and South Africa. These comprise ~60% of Emerging Market sales for Indian firms.
It’s three-pronged growth, not two
The nature of the Indian pharmaceutical sector has changed substantially in the last ten
years: in FY01 most of the exports were of API (Active Pharmaceutical Ingredients), and
formulation exports were only 17% of total sales (Figure 10). By FY10, however, API sales
had dropped to 18% (from 35%), and formulation exports reached 54% of sales (Figure
11). Thus, in our sample set of 10 large listed Indian companies, while Indian formulation
sales had a 14% CAGR, API sales expanded 11%, non US/EU formulation exports 35%
and US/EU exports had a 38% CAGR.
The 20% revenue CAGR for the industry was largely export-driven (Figure 12). Market
perception and news flow make it seem as if only the US market matters – while it is
indeed important, we note that the share of incremental revenues from “Other” markets
has been as high as that from the domestic market (Figure 13). We expect them to play an
even more critical role, especially as their market shares are still small.
US growth still strong; but tailwinds to dwindle
Growth in the US is by no means over. Pending ANDAs (Abbreviated New Drug
Application) for most Indian companies number many times their current product offerings
(Figure 14) and we are now moving into a historically high period of patent expiries (Figure
15).
That said, the market share of Indian companies in the US is already a significant 10%
(Figure 16), and US generic market growth is already slowing, as penetration is in the mid-
70s and post the expected surge in the next two years, may stagnate (Figure 17). For
longer-term investors, and in particular for the companies to sustain the current high
valuation multiples, there need to be growth avenues beyond the 2012 patent expiries.
“What after the US?” is an oft-asked and a very pertinent one.
Attractiveness of key emerging markets
This is especially so as these markets are expected to be the fastest growing among all
generic markets until 2015 (Figure 18), and two thirds of incremental revenues is expected
from them
Identifying and investigating the important markets
In our 5th March 2010 note Pharma (Far) Marts we had provided a view on about 20 large
emerging generic markets. In this report we focus on four of these: Russia, Brazil, Japan
and South Africa. These were shortlisted on the basis of market potential as well as
current relevance for Indian companies. Any country that did not match both of these
parameters was left out: for example, Turkey is a promising market, but no Indian
company has a meaningful presence there. Similarly, while Romania is material for
Ranbaxy, we aren’t too excited by its growth prospects.
The four markets that we cover in this report contribute to ~61% of the “other” revenues
(Figure 21). Of these, we find Russia to be the most promising, followed by Brazil, Japan
and then South Africa.
Growth drivers in three of these markets (Russia, Brazil and South Africa) are similar to
the ones we flagged for India (see our 5th March 2010 note Digging into the Pyramid),
though not obviously the same – for example, literacy rates and urbanisation are already
quite high (Figure 22). The Japanese market is a standout – it is a developed market, and
the driver for generic market growth is just improving genericisation. Per-capita levels are
significantly higher than those in India for each of the emerging markets too (Figure 23),
but the potential for catch-up to developed world standards is still significant.
■ Rising incomes, especially at lower income levels: Over and above the normal
correlation of healthcare expenditure with GDP (Figure 24), these markets have a high
share of out-of-pocket expenses in healthcare (Figure 25), so rising incomes are an
important driver. These are, for good measure, linked to overall economic growth.
Further, most governments are now focusing on the lower income strata. For example,
similar to the National Rural Employment Guarantee (NREGA) scheme in India, we
have the “Zero Hunger” initiative in Brazil that the new president Dilma Rousseff has
promised to expand. In South Africa, only about 14-15% of the 50 mn population has
access to medical insurance, and yet the market is one of the largest for generics – as
this base expands, the market can see significant growth. In China, rising deposit
rates and minimum wages are expected to rise. At lower income levels, healthcare is a
discretionary spend, so market growth should remain strong.
■ Improving healthcare infrastructure: another constraint on pharmaceutical
consumption in the Emerging markets has been lack of medical infrastructure –
availability of hospitals for treatment (Figure 26) and of doctors to write prescriptions
(Figure 27). There seems to be a concerted effort in most economies to close these
gaps. The metrics for Russia seem comparable to those in developed countries, but
years of disrepair may have rendered quite a bit of this infrastructure unusable: as per
World Bank statistics, bed density in Russia has been falling steadily over the years.
Good prospects but growth not
easy
Indian companies are strategically well positioned to compete in these markets, given their
large and proven portfolio of products and personnel, familiarity with branded generics’
markets and low manufacturing costs. All of Russia, Brazil, and South Africa do not have a
comparable manufacturing set-up, and Japanese costs are materially higher. Further,
managing a branded generic business is radically different from managing a portfolio of
innovative products – a critical advantage over big pharma. The latter’s exposure to
emerging markets is still small, and to generics, in particular, is insignificant. While they
have the ammunition to acquire, organic competition is what matters for Indian companies,
and there is ample room for new brands to be established in fast growing markets.
Yet, despite the strategic positives, growth is not a foregone conclusion. There are critical
characteristics of each market which significantly impact attractiveness: we rate Russia the
highest and South Africa the lowest. We provide in-depth analyses of each of the markets.
All good markets, but some better and some worse
Each of the four markets we analyse in greater depth in subsequent sections is attractive,
but for simplification from an investment perspective, we have attempted to rank them.
Over and above the execution issues, attractiveness of a particular market depends on
several parameters, such as: 1) legislative/regulatory risk; 2) strength of local competition;
3) margins; and 4) the tendency of incumbents to influence policy-making so as to make it
difficult for alien competition. On the whole, however, macro risks can largely be
outweighed by the strength of execution.
We ranked the four markets along several metrics: size, growth, average margins,
strength of the channel (stronger counter-party means tougher business),
regulatory/legislative risk, strength of competition and barriers to entry. Relative values are
all against the Indian market, which is used as the baseline. This is summarised in Figure
30. Of the markets, Russia is the most attractive, and South Africa the least.
Strengths of Indian companies help their chances
Indian companies are strategically well positioned to compete in these markets, given their
low manufacturing costs, large and proven portfolio of products, and familiarity with
branded generics markets given intense competition on home terrain.
■ Large portfolio and chemistry skills: The companies have tremendous flexibility in
choosing the right products and reacting to changing dynamics in the markets, given:
1) The large multi-therapy product portfolios of Indian companies (recall that the larger
ones sell 500-plus products and sometimes launch 50-plus products in a year in the
domestic market); 2) Availability of skilled chemists and engineers used to churning
out multiple molecules and complex chemistry; and 3) Significant good manufacturing
practice (GMP)-compliant manufacturing capacity.
■ Experience of branded generics’ markets: These markets are not generic
(i.e. unbranded) markets as in the US or UK, where product capabilities,
manufacturing costs, legal skills and an efficient supply chain are all that matter.
Similarly, promoting branded generics to doctors is very different from promoting a
patent-protected product: portfolio management, product lifecycle management and
supply chain complexity are very different for branded generics (more on this below).
■ Low costs: Availability of a supply chain within India in a few industry clusters is a
unique advantage over local competitors in these markets: Russia imports much of its
formulations; Brazil and South Africa have to import much of their API; and Japanese
manufacturing costs are so high that gross margins are 30-40% despite generic drug
prices being relatively high: Indian companies make 50%-plus margins on prices less
than one-tenth of Japanese prices.
That said, so long as margins in these markets remain high, the cost advantage is
likely to remain limited to providing higher margins to Indian companies – and it won’t
help their market share. Further, with efficient sourcing arrangements (especially from
India), larger competitors can offset this slightly.
Competition: Still a level playing field, execution key
There are four types of competition for Indian companies: 1) The local incumbents; 2) The
big pharma companies now targeting these markets; 3) Other global generics’ companies;
and 4) Other Indian companies:
■ Local incumbents: In all four of the markets we analysed, the local companies are
unlikely to be able to compete with Indian firms on cost or even on diversity of product
portfolios, or global scale. Once Indian firms have learnt to navigate the local market
(not an easy task, as discussed below), these companies do not pose a big threat.
■ Big Pharma: There is very little in common between marketing innovative products
and marketing branded generics. For innovative products there is no alternative, the
products are significantly profitable, the portfolio is driven by research focus, the sales
force is well-trained and details only a handful of products. For branded generics, on
the other hand, there are multiple other copies selling in the market, profitability is not
as high, portfolio needs to be market-focused, and a typical medical representative
may be promoting 15-20 if not 100 products. Supply chain complexity similarly can be
meaningful. Thus, this is not a business which would come naturally to big pharma.
Further, their exposure outside the developed economies is still small Figure 28), and
emerging markets aren’t really a “do or die” option for them yet. In particular, even
where the split of revenues for emerging markets is available, we find that generics
are a very small part of the overall business (Figure 29).
Further, to really add to competition there is no alternative but to grow organically in
these markets. Acquisitions can only speed up the lessons, but at the same time any
hiccups post such acquisitions can also create difficulties in the broader organisation
accepting the new generics business model.
■ Global generics’ companies: Teva, courtesy of several acquisitions, has built up a
formidable presence in many of these markets, and expects to experience a 23%
CAGR over 2009-15. It is investing aggressively in many of these markets, and has
the management bandwidth and generics market experience to do well.
■ Other Indian companies: Most companies we talked to stated that other than for
tenders, most of the competition at the molecule/product level is with local companies
or big pharma. This is not surprising, as only a handful of companies are investing in
emerging markets and the effective market share of Indian firms in these markets in
total is less than 5%. We believe this state of affairs can continue.
On the whole, we believe the playing field remains even for Indian companies so long as
the approach is prudent. These are evolving and growing markets, and there is room for
enough brands to be built. Just throwing capital in may get some companies size, but that
would just be about putting on a different name tag – it won’t really change the market
dynamics. The learning curve will remain for every new entrant, and it seems from our
discussions that the mistakes made by new entrants are mostly similar – be they Indian,
global generic or big pharma companies.
‘I can produce cheaply and I can brand’ not enough
Yet, despite the strategic positives, growth in these markets is not a foregone conclusion.
Success for various Indian companies, and indeed for most non-local companies in these
markets, has been sporadic, and by no means easy. Based on conversations with market
experts, discussions with companies and our analysis, some of the reasons are as follows:
■
One size does not fit all: There is a natural propensity to replicate successful
strategies from India as all these markets appear to be similar at first glance. However,
market drivers differ significantly and each requires a different approach. Geographical
spread, cultural acceptance of generics, competition, pricing and channel behaviour, to
name a few, vary across markets. Also, these markets are still evolving and the
strategies that will succeed longer-term are not as clear-cut as one would expect,
e.g. whether a field force is needed in Japan to promote to doctors.
■
Access to the channel typically challenging: Channels are effectively consolidated
(though apparently fragmented) in most markets and even where they are not, it is not
easy to establish relationships quickly. One need only envisage the difficulty of a new
entrant into India to understand how complex and time consuming the steps can be.
New entrants sometimes find it hard to get distributors to pay attention to their products
and end up establishing prolonged payment periods, e.g. Russia. Local
partners/acquisitions are critical to understand local nuances but at the same time,
choosing a wrong partner is a very costly mistake. The sour experience of some
entrants into Brazil in particular has been driven by the wrong choice of partner.
■
Pricing models very different: Indian companies are quite used to the maximum
retail price (MRP)-based models in India, and are now aware of the reverse auctiontype
pricing dynamics in the US. But they have little experience of a “high list price, and
then give heavy discounts” type of model, for example, seen in Brazil. This is similar to
the unbranded generics’ market in India, but more extreme: average discounts run at
65-70%. Japan, on the other hand, has regulated prices, and biannual cuts.
Understanding these nuances becomes critical for success.
■
Competitors and their strengths: The influence of incumbents on policy is a risk any
new entrant will face. This is true especially for markets where local competition is
significant. Further, channel relationships with big pharma in Japan are also believed to
be slowing down generics’ adoption. In this regard, Russia is an attractive market –
only about 30% of the value of drugs sold in Russia is made locally.
All good markets, but some better and some worse
Each of the four markets that we analyse in greater depth in subsequent sections is
attractive, but for simplification from an investment perspective, we have attempted to rank
them. Over and above the execution issues, attractiveness of a particular market depends
on several parameters, such as: 1) Legislative/regulatory risk; 2) Strength of local
competition; 3) Margins; and 4) Tendency of incumbents to influence policy-making so as
to make it difficult for alien competition. On the whole, however, macro risks can largely be
outweighed by the strength of execution.
We ranked the four markets along several metrics: size, growth, average margins,
strength of the channel (stronger counter-party means tougher business),
regulatory/legislative risk, strength of competition and barriers to entry. Relative values are
all against the Indian market, which is used as the base line. This is summarised in Figure
30. Of the markets, Russia is the most attractive, and South Africa the least.
Identifying the early winners
We encountered some common traits that help identify beneficiaries: 1) Own the front end;
2) Focus, and patience; 3) Build over buy: while local partnerships are important, given
universal demand for such assets, a large buy is likely to become a burden; and 4) a
professionalised management structure with operational freedom to line managers.
While Cipla and Ranbaxy have a higher current proportion of profits and sales coming
from emerging markets, we are cautious on their growth prospects. We find Dr. Reddy’s to
be the best positioned: it is much more focused and cautious post the Betapharm fiasco,
and yet quite ambitious, targeting US$1 bn in sales in three years (FY10: US$450 mn). Its
patience and brand focus should help sustain its success in Russia. Lupin’s proven
management model – a professional CEO and empowered local management – allows it
to scale across markets. Growth in Japan may be weaker than the government’s target,
but margin expansion can drive strong profit growth. Sun’s transition to professional
management is important step for it to replicate its successes in India and the US.
Glenmark’s medium-term prospects remain strong, and it is establishing the right
management model, but near-term growth may be tepid for a while.
Identifying the winning traits
Given the diversity of the end-markets, the competitive environment there and approaches
taken by various companies, it is difficult and perhaps unwise to arrive at general
conclusions. However, our review of these businesses does suggest some common traits
that help winnow out the winners:
■
Clear strategy on whether to own the front-end: Given the strengths of India as a
manufacturing base, it is likely that over the next decade more manufacturing will
happen in India. The question though is whether Indian companies will own the brands
and the front-end in various markets. This, in our view, is the most difficult and yet the
most critical decision. Companies like Cipla decided very early to focus on their core
competency of product development and manufacturing, and sought partners that they
would supply to. Some, such as Dr. Reddy’s, have decided to focus on their own direct
presence in some markets (e.g., Russia), and partner with GSK for most of the rest.
We prefer the approach of owning the brands – the migration of manufacturing to India
will be slow, as low manufacturing costs are not yet a differentiator in these markets,
and may not be for quite a while. Instead, to benefit from growth, companies must
establish their own presence in key markets.
■
Start small and have patience: While owning the front-end is important, it takes time
to understand the market and build brands – replicating their scale in India, which was
built over decades, is likely to take time despite the strategic advantages that Indian
firms possess. Companies that have shown patience and focus have done well; at the
same time, the industry has already seen enough examples of companies in a hurry
losing out. Attempting short-cuts like playing on price, spreading out wide
geographically or entering with a large portfolio of products with no differentiation
seems to reduce impact and creates a negative image in some of these markets.
■
Funding & build versus buy: With Big pharma also in the race, Indian companies are
up against a lot of capital that can go iterative on learning. Large acquisitions are likely
to be costly given almost universal demand for such assets – that by itself can become
a burden. Acquisitions by competitors need not hurt growth prospects for Indian
companies, as it effectively only means a different name-tag on existing competition.
■
The right management model: Each of these markets has very different dynamics, and
one size does not fit all. Companies thus need to adapt their approach, and for that,
decision making needs to be close to the ground. An empowered local management
team is thus critical for success. While many of the companies have professionalised as
they have scaled up, decision-making remains too centralised in most.
Some may feel that it is too early to rank Indian companies on their performance so far in
the Emerging Markets, as their presence is small strategies (and even markets) are still
evolving. Some trends are however very clear, which provide some predictive power.
Dr. Reddy’s: brand focus; bite what you can chew
Post the Betapharm fiasco Dr. Reddy’s has scaled down its expectations on the pace of
growth, though certainly not its eventual ambitions: it targets US$1 bn in sales from its
branded generics businesses, versus the US$450 mn in FY10. In the “width versus depth”
choice it seems to be consistently choosing depth these days and is focusing on a few key
markets. For the rest, the company has partnered with GSK: the alliance includes Brazil,
and is expected to drive sales of ~$150mn by FY15 from next to nothing in FY11.
Its intention of hiring a new CEO, we believe, is a step in the right direction to effectively
manage a truly multinational organisation. We believe the company is also selectively
looking for acquisition targets now, though its attention is focused on the markets it is
already in and understands well.
It has been very successful in Russia with its focus on brand building: over 15 years of
presence it has built a ~US$200 mn business (FY11E sales) on a portfolio of 15 products.
It was ranked 12th in Russia and has grown much faster than the market (26% versus 16%
for the market) over the past four years. Its focus on OTC (15% of its sales versus 50% for
the market) should hold it in good stead.
After entering South Africa in 2004 via a local partner, the company has now bought back
the partner’s stake. While this is a small market for it now (~1% of sales), it can add
meaningfully to growth in the coming years.
The company is actively looking for a strategic alliance in Japan and may set up a small
JV with capital infusion of US$2-3 mn. This is expected to only become meaningful after
FY15.
Lupin: management model works; Good Execution
Lupin was the second among large Indian companies to professionalise (after Ranbaxy,
which soon reversed the step), and the first to remain under a professional CEO for a long
time. This has yielded results – the company has multiple growth engines that are not
correlated, and run mostly independently. It has also managed its acquisitions well – in
both Japan and in South Africa (as in other acquisitions) old management continued, and
has delivered.
Its strategy of establishing a small presence first, learning about the market and then
growing has helped the company avoid the pitfalls of hurried expansion and then having to
write off businesses. It has also been savvy enough not to pursue expansions in certain
markets that it initially found exciting (e.g., Saudi Arabia). It is evaluating targets in Brazil,
which it believes can be a good market for its oral contraceptive portfolio.
In Japan, Lupin has already increased Kyowa’s gross margins from 33% to 42% by
improving productivity at the Japanese factory and improving local sourcing of material. It
aims to increase this to 55-60% (with most of this 15-20% improvement flowing down to
EBITDA margins) by supplying API and formulations from India. The company is setting
up a line at its Goa Facility with the help of Kyowa engineers which it expects to be
approved by the Japanese regulator.
Lupin has been the fastest growing generic company in South Africa (26.5% growth in
MAT (Moving Annual Total) June-10; 3% of Lupin’s FY11 sales) and is now in the Top-20
generic companies.
Sun Pharma: early steps
While Sun has so far focused on India and the US, which fit its earlier management model,
the company has prudently started to re-orient itself for multi-pronged growth. The new
CEO believes that the journey to US$5 bn in sales would be very different from the journey
so far to reach US$1 bn. There are a number of positive lessons and strengths in Sun –
for example, its product and customer focus, and ability to outsmart competition. But to
scale these strengths across multiple markets, the company needed to change its
management model – the hiring of Kal Sundaram as a CEO is thus a big positive.
In a typical Sun approach, it measures the attractiveness of markets based on not just
market growth and profitability, but also its own capabilities, which it acknowledges are not
even across markets.
Sun has already invested in manufacturing in Mexico and Brazil, and already has a
number of filings in South Africa. The company sees the opportunity in Russia, and
realises it must be there, but finds it an unpredictable market. It is also evaluating Japan
and China, though it realises that the latter is likely to be a very challenging market.
Ranbaxy: best exposure, but spread out too thin?
Ranbaxy has been the pioneer among Indian companies in most emerging markets, and
has the highest proportion of sales and profits from these: various Emerging markets
contribute ~32% of sales (CIS: 6%, Africa: 9%, Latin America: 5% and others 12%).
Unfortunately though, it seems the continuous transition in senior management has led to
the company losing its way in most of these markets, and with the exception of South
Africa, the company’s performance has been poor of late. Being the first entrant, it made
its fair share of mistakes and had to encounter stiff resistance from local incumbents – this
usually leads to a company learning its lessons, adapting and cementing its leadership
position. It seems the lessons learnt were lost due to transitions and lack of management
focus. In Brazil and in Russia, growth over the past three to four years has lagged market
growth.
We continue to believe that Ranbaxy’s presence in so many markets distracts senior
management attention: this is despite it being the first company to build professional
management, oriented towards multi-pronged growth. It hampers focus and delays
correction of mistakes: things like choosing product portfolio (e.g., transitioning away from
the Similarés market in Brazil), hiring the right people, empowering local management
(one common refrain across markets seems to be Ranbaxy’s reliance on putting its own
people in charge of local operations), choosing the right pricing strategy, etc.
While Ranbaxy may seem to be best positioned among all Indian companies in the key
Japanese market due to Daiichi-Sankyo being a large presence, we are apprehensive
about the value accruing to Ranbaxy, as its role will primarily be of a contract
manufacturer. Further, as discussed in greater detail in the section on Japan, success of
the “hybrids” (i.e., innovator companies getting into generics) is by no means a given.
Glenmark: good medium term; but tepid near term
Glenmark has taken its core dermatology and respiratory products to the CIS, Latin
America, Africa and Asia-Pacific. Growth has been healthy so far, despite the glitch in
FY09: the FY07-11E CAGR is 21% from these markets. This is, however, not exciting
growth in these fast-growing markets, especially given Glenmark’s low base. Some of its
early strategies do not seem to be outright successes – e.g., the decision to enter Russia
via the smaller cities using price as a strategy worked initially, but the company ended up
getting positioned as a low-end player. Similarly, in Brazil, Glenmark acquired Klinger in
2004 for US$5.2 mn – supposedly not a very reputed company, with sales mostly in the
tender business. The overhang of that apparently is still an issue in the channel.
We expect the company to do well over the medium term: management is astute and
agile, and has been building the organisation for a multi-country operation with sufficient
operational freedom for line managers. Its focus on the core dermatology and respiratory
portfolio ensures that attention is not thinly spread. However, we see the need for some
re-strategising in these markets, which could potentially slow down growth temporarily.
Cipla: is not owning the front-end the right strategy?
Like Ranbaxy, Cipla caught onto the potential of these markets very early. However,
contrary to Ranbaxy’s approach, the company chose to focus on its core strengths –
product development and manufacturing – and sought partners in these markets.
However, these markets still have high margins, so the incumbents haven’t yet felt the
pressure to actively seek outsourcing partners. The only market where Cipla has excelled
therefore, has been South Africa, where Cipla-Medpro sole-sources its products from
Cipla and jointly works on its portfolios with it. This has been a big success, and we are
surprised Cipla has not used this model in other markets. This is likely to be due to a
somewhat top-down management model
Russia: less risky than it seems
The Russian market has experienced a 19% CAGR over the past four years, and is now
US$18 bn in size. About 30% of the market is generic, including 4% that is unbranded
generic, and dominated by local players. The target market for Indian companies is thus
US$3.5-4 bn. Strong market growth is expected to continue, and together with high out-ofpocket
spending, healthy margins, and much better acceptance of imports and Indian
companies, make it a very attractive growth proposition. The approach in Russia needs to
be shaped by the fact that some factors driving growth are very different from those in
other BRICS countries. Russia’s population is falling, and is also ageing the fastest –
funding is thus an important issue. Further, a tendency towards self-medication makes
OTC drugs a large 50% of the overall market. Lastly, attractive pricing, weak local
manufacturing and high sales force productivity drive strong margins.
The regulatory risks that worry the market are, in our view, unlikely to derail these
prospects: 1) Greater localisation is likely to be a multi-year theme, and not imminent;
2) Expanding the tender-based government funded scheme to 33% of the population may
run into funding constraints and is not as negative as it seems; and 3) Extension of the
vital and essential drugs (VED) list price cuts to a broader portfolio, though possible
(especially as 2011 is a pre-election year, and pensioners make a high percentage of the
electorate), is not likely.
Russia has largely been a happy hunting ground for Indian companies. Dr. Reddy’s is by
far the largest Indian company in Russia, with a strong franchise in its therapy areas, and
good channel reputation. As it expands its OTC footprint (a recent tie-up with Cipla helps),
the company should maintain its above-market growth. Torrent has also been successful,
but its conservative stance has meant it remains small. Market feedback on Glenmark
suggests its entry through smaller cities may not have been very successful.
Different drivers, but still large and growing
The Russian market has had a 19% CAGR (in local currency; 16% in US dollar) over the
past four years, and is now a large US$18 bn. This momentum is expected to continue,
with Pharmexpert forecasting 15% growth in 2011 (Figure 34). Price cuts introduced in
April 2010 through the VED catalysed strong 12% YoY volume growth in 2010 (three
quarters of total growth). The YoY increase in ASP despite VED-led cuts is due to hikes
taken before VED implementation in April 2010.
As per Pharmexpert only ~30% of the market is generic, of which about 4% is unbranded
generics, dominated by Russian companies. The addressable market for Indian
companies entering Russia would be close to US$3.5-4 bn, if they target all sub-segments
of the market, i.e., hospitals and OTC as well. Much of the growth in the private market is
generics driven.
■ Government initiatives: do lower prices and higher demand imply a larger
market? No discussion on the Russian market, especially from the funding
perspective, is complete without focusing on reforms instituted by the government.
These present opportunities as well as risks.
Russia’s high import dependence (>70% by value is imported, see Figure 45 below)
makes prices extremely vulnerable to currency movements – in 2008, rouble
depreciation drove up to 200% increases in the prices of some drugs (e.g. anti-viral
drugs). Thereafter, the government drew up a VED list which enforced methods of
calculating prices, drug registration by manufacturers before April 2010 and the
approval of wholesale (8-15%) and retail mark-ups (20-25%). While prices of VED
drugs fell 9% YoY in 3Q10, leading to average prices declining 3% YoY for the market
(Figure 41), the overall market still grew 11% due to 14% volume growth (Figure 42).
Figure 42: Market volumes grow when prices fall Figure 43: Value share of VED in private
What is perhaps more interesting is how the market behaved during implementation of
the VED. Since the April 2010 date was well known, many manufacturers increased
prices in the run-up to the date, and then took the price cuts. In our discussions with
companies and industry experts, we noted a unanimous view that the VED impact has
not been high on the industry as the list is very basic, and because of the way it has
been implemented. In general policymaking, many market experts have flagged the
gaps between regulations and on-the-ground impact due to implementation problems.
However, there is a risk, well understood by investors, of the VED list being expanded
beyond the current ~30% of the market value (Figure 43). But, some experts we
talked to suggested that by convincing doctors to prescribe brand names and not
INNs companies can offset some of this risk.
■ High acceptance of generics and imported drugs: Perception of quality of branded
generics is good among both doctors and patients – this allows companies to sell at
relatively low discount to innovator brands. Large multinational companies do not
usually launch their patented portfolios because: 1) high out-of-pocket funding (nearly
75%, Figure 39) implies the ability to pay is low, and at high prices there is not much of
a market; and 2) innovator companies remain wary of registration data becoming
available to generic competitors: they believe it is difficult to dispute such challenges in
the courts. Further, doctors are willing to prescribe branded generics according to
patient affordability. Thus, generics comprise ~30% of the market (Figure 35). While
locals dominate in terms of volumes (65%), their value share is a mere 30%.
Acceptance of international players (including Indians) is high.
Productivity high due to sales concentration: Sales and growth in Russia are still
concentrated in the 18 major cities with population larger than 1 mn. Moscow and St
Petersburg lead in growth not only because of the growth drivers mentioned above,
but also because of: 1) healthcare infrastructure development; 2) income
concentration and increasing migration; and 3) a skew in central government budgets
towards these cities.
Thus, with an average sales force strength of 350-400 (versus 3,000-plus for at-par
coverage in India), companies can generate much higher revenues. FY10 sales force
productivity for DRL for example was US$440,000/medical rep, 4-5x of India. Even for
a vast country as Russia, such a sales force is sufficient to cater to the market with a
product basket serving three to four therapeutic areas.
■ A consolidated channel: The top-10 distributors account for 70% of the market, and
top-10 pharmacies about 30%. Channel consolidation is increasing as distributors,
having run out of scope for more wholesale distribution points (having 50 branches
which cover a 300,000 population each suffices), are now investing heavily in
pharmacy chains, e.g., SIA International’s acquisition of a large share of stock of
Apteki 36.6 chain, and Finnish distributor Oriola-KD’s buyout of the remaining 25%
interest of the company managing the Staryj Lekar drugstore chain. Pharmacy chains
generate only 35-40% of their sales through drugs, the rest coming from products like
shampoos. Their rapid growth is expected to help reduce price disparity between
geographies as they have centralised structures. For now, though, fragmentation in
pharmacy chains still exits, with the top-10 players having a combined market share of
~30%.
Channel margins are usually 8-15% for wholesalers and ~20-25% for retailers: these
mark-ups vary between geographies. Easier to reach pharmacies, say in Moscow,
may have 20% mark-ups, whereas those in remote towns may even get 35%.
Brazil: attractive but tough
The Brazilian pharmaceutical market is ~US$26 bn in size, though the effective market for
Indian companies, which focus primarily on branded generics, is a smaller US$3-3.5 bn.
The market is growing rapidly (by 22% in local currency and 32% in US dollars in 2009),
due to rising incomes, especially among the poor, and a healthy acceptance of generics.
Government programmes like “Zero Hunger” drove the acceleration after 2005, and the
planned expansion in the programme is expected to maintain the momentum.
The market is also very profitable despite high channel consolidation and intense
competition. Discounts of 65-70% to the channel therefore are common. Companies
therefore tend to set high list prices, and then offer discounts – the net result is the
manufacturer prices several multiples of that in the US or in India. Further, an urbancentric
market keeps sales productivity high.
While competition is intense (four large local incumbents and most international players
making a beeline for the market), Indian companies do have a material cost advantage.
However, most seem to have struggled with the local market complexities, in particular
with the pricing model. It seems even Sanofi has struggled with Medway. Torrent is the
largest Indian company in Brazil, and is easily the most successful. Its focus on particular
therapy areas and geography has helped it respond well to local market needs. For
several others, an attempt to play on price (introducing products at 50% of the
incumbent’s) has led to doctors thinking of them as low quality. In general, it seems hiring
empowered local management is an important ingredient for success.
Several growth drivers in place
According to industry experts, including government expenditure of ~ US$8 bn, Brazil’s
pharmaceutical market size is estimated to be ~ US$26 bn. Much of government spending
is via tenders, which are supplied mostly by local companies. Thus, ~ US$18 bn is an
effective market for foreign companies. IMS estimates that generics constitute ~49% of
sales: likely an understated number, as like in India, we believe the rural market (where
“Similarés” dominates) is not adequately covered. Moreover, with the exception of
Ranbaxy, Indian companies are mostly in the branded generics segment, which is a much
smaller 14% of the market, but growing the fastest (Figure 52). A high 80% of these
“private” market sales is paid out of pocket, making them very attractive in a growing
economy.
Competition intense; focused strategies succeeding
■ Large incumbents, many newcomers: Whereas there are about 230 pharmaceutical
companies in Brazil, 75% of the sales come from the top 20. For generics, the top
four, i.e. Medley, EMS, Ache and EuroFarma completely dominate the market (~80%
share). This by itself does not make the market unattractive, but occasionally local
regulations can get inimical to importers. Further, given the large and growing market
and high manufacturer margins, most large generics as well as multi-national
companies with generics aspirations are increasing their attention to the market. A
simple “my costs are lower, and I can brand” approach is unlikely to succeed.
■ Similarés market transitioning to branded generics: there are three types of drugs
in Brazil – the patent-protected innovator drugs, the patent-expired generics drugs,
and the Similarés market (see Figure 52above for the split of market). The Similarés
are copies of innovator products that existed before the Generic Law of 1999 and
before Brazil became a signatory to TRIPS (Trade Related Intellectual Property
Rights) under the WTO. These received approval only on safety and absolute
effectiveness, but are now required to prove bioequivalence by 2014, or be phased
out.
There was (and, perhaps, still is) some hope that as the Similarés are phased
out/become more regulated – the branded generics market will benefit. The Similarés
comprise about 70% of the generics market, and have well established brands,
making them important from a scale perspective. However, market experts believe
they should be able to transition to the branded generics model. Earlier, they
dominated the rural markets (some believe for this reason their size is understated),
but over the past five years have been coming to the larger cities too.
■ Lack of manufacturing strength: There is very little API integration in the larger
generics companies – most of API is imported from India/China. Thus, they hold a
significant cost disadvantage to their Indian competitors.
Japan: expectations too high
Genericisation in Japan is a low 20% by volume, about a quarter that in the US, but the
value share is 6-7%, about half that of the US due to significantly higher generic pricing.
Regulatory steps have driven a steady but by no means rapid increase in genericisation:
the US$3.8 bn market has a 7-8% CAGR. The government’s 30% target by FY12 has
generated much newsprint, but is unlikely to be met anytime soon. Generics are generally
viewed as lower quality drugs: doctors are less willing to prescribe them and pharmacies
and patients don’t see economic reasons to substitute them. We expect steady growth in
the market driven by regular policy pushes, expiring patents and a consolidating channel.
Pricing is regulated, and insurance (government plus ~1,500 private insurers) covers most
of the spending. Despite the ageing population (~43% are above 50 years old), the plans
seem to be well funded – at ~8% of GDP Japan’s healthcare expenses are the lowest in
the developed world. There seems to be no funding crisis for healthcare that can trigger a
drastic change – likely a reason that generic prices are high and genericisation low.
Competition is primarily local, and most foreign entrants need to and are partnering with
local players. Most generics’ companies are small, family-owned, and heavily leveraged.
Consolidation though expected, is not imminent. Japanese generic companies have
mediocre EBITDA margins despite the high prices – their lack of manufacturing integration
is the most important decision. It is also not clear if the companies will eventually need the
350-400 sales forces they maintain. For companies importing material from low cost
locations like India, margins can be substantially higher: 2-3x the ~15% current industry
average. Lupin can target such margins once supplies start from India.
A significant opportunity, but expectations too high
Genericisation in Japan is a low 20% (versus ~75% in the US): even this volume share is
mostly due to vitamins and OTC products. Value share though is not as insignificant due
to significantly better pricing: the 6-7% (versus ~12% in the US) translates into a generics
market size of ~US$3.8 bn. Generic market growth increased from a 7.5% CAGR (2003-
08) to ~10% in 2010, driving the volume share of generics from 17% to 20% (Figure 58).
The government’s 30% target by FY12 generated much newsprint, but this target is
unlikely to be met soon. The system views generics as lower quality drugs: doctors are
unwilling to prescribe, pharmacies are reluctant to substitute and even patients are
hesitant to accept generics.
Profitability can be very high with integration
■ Channel consolidation likely to help genericisation: In the pharmacy channel (60%
of total prescriptions, Figure 67), while pharmacies are fragmented but getting
consolidated, the top-four wholesalers already dominate the market. The 55,000
pharmacies tended to be near the point of care for patients (hospital, clinic), but this is
changing, as more pharmacies are appearing in shopping areas. The top-four publicly
traded companies have around 10% of the market. Both pharmacies and wholesalers
in the current system would prefer selling innovative products even after patent expiry
as their mark-up is a fixed percentage of the selling price (~15% for wholesalers) – the
more expensive the drug, the more money they make. So much so that most pureplay
generic companies sell through Hanshas (dealers) which are smaller than
distributors, and usually affiliated to one hospital or community.
However, as the pharmacy chains expand, they are likely to better respond to the
various government incentives for pharmacies for increasing generics dispensing, and
could influence wholesalers to source more generics.
■ High generic prices: There are biannual price cuts in Japan which lead to low prices
for innovator products as well. Assuming that the ~6.5% average cut we saw in April
2010 was the regular decline in the price of a brand over its lifetime, prices would fall
~50% over 20 years. So, assuming starting price points are similar, by the time a
brand goes off-patent, it could be down 35-40%. For example, Aricept (branded form)
is priced 50% lower in Japan compared to the US. However, given the low discount,
the generic price is much higher than that seen in the US
Barriers to entry are high; local partnerships needed
■ Soft barriers to entry: While there is no “nationalistic” sentiment while prescribing
medicines, regulations are so stringent that getting approvals to ship finished products
into Japan slows down new entrants. Lupin is implementing a separate line for Japan
shipments using Kyowa’s help in its Goa facility due to different regulatory
requirements. Further, establishing relationships with the channel is not easy,
especially as the Hansha through which most of generic drugs are supplied are small
and fragmented. Not surprisingly, the top-three players in the industry are domestic.
■ Competition mostly from locals: There are types of competitors – the pure generics
companies like Sawai and Towa, and the hybrids – companies that have so far been
selling innovative products, but believe their relationships with the doctors and the
channel can help them succeed even in generics. The more astute among these
hybrids are setting up parallel organisations for the generics market (e.g. Daiichi-
Sankyo), but many believe their innovative products and generics can flourish under
the same umbrella. Our research indicates that the first type of competitor is likely to
be more successful, though both types don’t have much of a pipeline to speak of.
More pure generics’ companies are small, family-owned, and seem to have a lot of
debt on their balance sheet. The last is not really a situation of panic, especially given
the low interest rates in Japan. There has been some consolidation in the industry.
While more is expected, it is not imminent.
Foreign entrants are still positioning themselves in the market, usually via local
partners (Figure 71). Such partnerships/acquisitions allow them to get product
registrations, get local manufacturing capacity, and valuable channel relationships.
The recent Sanofi-Nichi-Iko deal is one such example where a big pharma company
and a big domestic player have come together in Japan.
Among Indian companies, only Lupin and Cadila have a meaningful presence. Lupin
generates 11% of its sales from Japan and has experienced a 17% CAGR since its
acquisition of Kyowa in October 2007. It has also managed to increase Kyowa’s gross
margins from 33% to 42%, and with sourcing from India (not started yet), hopes to reach
55-60% gross margins. It is now setting up a line for Japan in its Goa factory with the help
of Kyowa engineers.
South Africa: small but attractive
The South African pharmaceutical market is ~US$3.5 bn in size, and growing at 10-12%
annually. The private generic market, that Indian companies can target, is about US$850-
900 mn in size. The government tender Anti-Retroviral (ARV, or anti-HIV) market is also
large, but very low margin, and not as attractive (e.g. prices fell 53% in the recent tender).
That said, the market is very profitable – large local incumbents like Adcock and Aspen
generate 25-30% EBIT margins despite having very low manufacturing integration.
Despite price controls (SEP starting 2003 and now reference pricing), generic prices are
healthy, with the discount to innovator prices being only 40%. SEP actually allowed for
significant price increases over the past four years. Thus, despite high channel margins
(e.g. 50% mark-ups to wholesalers) and several consolidated counter-parties (pharmacies,
doctors), manufacturers get to generate high profits. The market has higher barriers to
entry, but with persistence and a local partner, market shares can increase, and generate
significant profits.
Small market with low generic penetration
The South African pharmaceutical market was ~US$3.5 bn in June 2010 (MAT), having a
10-12% CAGR. Only 18% of this market is government funded – the rest (Figure 74; 82%)
is private, and largely (70%, Figure 76) out of pocket.
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■
Emerging markets matter. Over the past decade, non-US/EU markets
have contributed 24% of incremental sales for Indian companies: as much
as the domestic market. We believe they will become even more important,
especially once tailwinds in the US start to dwindle. For Indian firms to
maintain ~20% YoY growth trajectories and to justify their 18-20x forward
P/E multiples, success in emerging markets will be critical, in our view.
■
The different shades of pink. Of the 20 emerging generics’ markets we
surveyed in our 5th March 2010 note Pharma (Far) Marts, we analysed
Russia, Brazil, Japan and South Africa further: these are promising, and
relevant to Indian firms’ prospects. We talked to local experts, companies,
and analysed data. Conclusions: 1) They are not all equally rosy (Russia the
most followed by Brazil); 2) Indian firms have several strategic strengths; but
3) challenges abound. Most are professionalising management for this multipronged
growth, but are at different stages of this evolution.
■
We still like Dr. Reddy’s and Lupin. While Cipla and Ranbaxy have a
higher current proportion of profits and sales coming from emerging markets,
(EM) we are cautious on their growth prospects. We find Dr. Reddy’s to be
the best positioned: success in Russia is on solid foundations and should
continue. Lupin’s management model – a professional CEO and empowered
local management – allows it to scale across markets. Glenmark’s mediumterm
prospects remain strong, but near-term growth may be tepid for a while.
Sun is in early stages in EMs – a professional CEO is an important step.
New growth horizons
Why emerging markets matter
Over the past decade, as the Indian industry has diversified into formulation exports, non-
US/EU markets have contributed to a quarter of incremental sales: as much as the
domestic market. We believe they will become even more important, especially when
several strategic tailwinds in the US start to dwindle: the 2011-14 patent cliff, increasing
genericisation, and as Indian firms’ portfolios mature. For the Indian companies to
maintain their ~20% YoY sales growth trajectories and the stocks to justify their 18-20x
forward P/E multiples, success in Emerging Markets will be critical, in our view.
These are fast growing markets, expected to drive up to two-thirds of incremental global
sales until 2015. The best among these have some common characteristics, such as:
1) fast-growing economies driving strong income growth especially at low levels where
healthcare is discretionary; 2) Branding, which protects pricing; and 3) high out-of-pocket
payments. Yet there are significant differences, and many companies have struggled in
these markets despite low manufacturing costs and branding experience.
Of the 20 such markets we surveyed in our 5th March 2010 note Pharma (Far) Marts, in
this report we take analysis to a deeper level for countries that: 1) we find attractive; and
2) Indian companies have a meaningful presence in. We shortlisted four: Brazil, Russia,
Japan and South Africa. These comprise ~60% of Emerging Market sales for Indian firms.
Good prospects, but growth not easy
Indian companies are strategically well positioned to compete in these markets, given their
large and proven portfolio of products and personnel, familiarity with branded generics’
markets and low manufacturing costs. All of Russia, Brazil, and South Africa do not have a
comparable manufacturing set-up, and Japanese costs are materially higher. Further,
managing a branded generic business is radically different from managing a portfolio of
innovative products – a critical advantage over big pharma. The latter’s exposure to
emerging markets is still small, and to generics, in particular, is insignificant. While they
have the ammunition to acquire, organic competition is what matters for Indian companies,
and there is ample room for new brands to be established in fast growing markets.
Yet, despite the strategic positives, growth is not a foregone conclusion. There are critical
characteristics of each market which significantly impact attractiveness: we rate Russia the
highest followed by Brazil. We provide in-depth analyses of each of the markets.
Identifying the early winners
We encountered some common traits that help identify beneficiaries: 1) Own the front end;
2) Focus, and patience; 3) Build over buy: while local partnerships are important, given
universal demand for such assets, a large buy is likely to become a burden; and 4) a
professionalised management structure with operational freedom to line managers.
While Cipla and Ranbaxy have a higher current proportion of profits and sales coming
from emerging markets, we are cautious on their growth prospects. We find Dr. Reddy’s to
be the best positioned: it is much more focused and cautious post the Betapharm fiasco,
and yet quite ambitious, targeting US$1 bn in sales in three years (FY10: US$450 mn). Its
patience and brand focus should help sustain its success in Russia. Lupin’s proven
management model – a professional CEO and empowered local management – allows it
to scale across markets. Growth in Japan may be weaker than the government’s target,
but margin expansion can drive strong profit growth. Sun’s transition to professional
management is important step for it to replicate its successes in India and the US.
Glenmark’s medium-term prospects remain strong, and it is establishing the right
management model, but near-term growth may be tepid for a while.
Why emerging markets matter
Over the past decade, as the Indian industry has diversified into formulation exports, non-
US/EU markets have contributed to a quarter of incremental sales: as much as the
domestic market. We believe they will become even more important, especially when
several strategic tailwinds in the US start to dwindle: the 2011-14 patent cliff, increasing
genericisation, and as Indian firms’ portfolios mature. For the Indian companies to
maintain their ~20% YoY sales growth trajectories and the stocks to justify their 18-20x
forward P/E multiples, success in emerging markets will be critical, in our view.
These are fast growing markets, expected to drive up to two-thirds of incremental global
sales until 2015. The best among these have some common characteristics, such as:
1) fast-growing economies driving strong income growth especially at low levels where
healthcare is discretionary; 2) Branding, which protects pricing; and 3) high out-of-pocket
payments. Yet there are significant differences, and many companies have struggled in
these markets despite low manufacturing costs and branding experience.
Of the 20 such markets we surveyed in our 5th March 2010 note Pharma (Far) Marts, in
this report we take analysis to a deeper level for countries that: 1) we find attractive; and
2) Indian companies have a meaningful presence in. We shortlisted four: Brazil, Russia,
Japan and South Africa. These comprise ~60% of Emerging Market sales for Indian firms.
It’s three-pronged growth, not two
The nature of the Indian pharmaceutical sector has changed substantially in the last ten
years: in FY01 most of the exports were of API (Active Pharmaceutical Ingredients), and
formulation exports were only 17% of total sales (Figure 10). By FY10, however, API sales
had dropped to 18% (from 35%), and formulation exports reached 54% of sales (Figure
11). Thus, in our sample set of 10 large listed Indian companies, while Indian formulation
sales had a 14% CAGR, API sales expanded 11%, non US/EU formulation exports 35%
and US/EU exports had a 38% CAGR.
The 20% revenue CAGR for the industry was largely export-driven (Figure 12). Market
perception and news flow make it seem as if only the US market matters – while it is
indeed important, we note that the share of incremental revenues from “Other” markets
has been as high as that from the domestic market (Figure 13). We expect them to play an
even more critical role, especially as their market shares are still small.
US growth still strong; but tailwinds to dwindle
Growth in the US is by no means over. Pending ANDAs (Abbreviated New Drug
Application) for most Indian companies number many times their current product offerings
(Figure 14) and we are now moving into a historically high period of patent expiries (Figure
15).
That said, the market share of Indian companies in the US is already a significant 10%
(Figure 16), and US generic market growth is already slowing, as penetration is in the mid-
70s and post the expected surge in the next two years, may stagnate (Figure 17). For
longer-term investors, and in particular for the companies to sustain the current high
valuation multiples, there need to be growth avenues beyond the 2012 patent expiries.
“What after the US?” is an oft-asked and a very pertinent one.
Attractiveness of key emerging markets
This is especially so as these markets are expected to be the fastest growing among all
generic markets until 2015 (Figure 18), and two thirds of incremental revenues is expected
from them
Identifying and investigating the important markets
In our 5th March 2010 note Pharma (Far) Marts we had provided a view on about 20 large
emerging generic markets. In this report we focus on four of these: Russia, Brazil, Japan
and South Africa. These were shortlisted on the basis of market potential as well as
current relevance for Indian companies. Any country that did not match both of these
parameters was left out: for example, Turkey is a promising market, but no Indian
company has a meaningful presence there. Similarly, while Romania is material for
Ranbaxy, we aren’t too excited by its growth prospects.
The four markets that we cover in this report contribute to ~61% of the “other” revenues
(Figure 21). Of these, we find Russia to be the most promising, followed by Brazil, Japan
and then South Africa.
Growth drivers in three of these markets (Russia, Brazil and South Africa) are similar to
the ones we flagged for India (see our 5th March 2010 note Digging into the Pyramid),
though not obviously the same – for example, literacy rates and urbanisation are already
quite high (Figure 22). The Japanese market is a standout – it is a developed market, and
the driver for generic market growth is just improving genericisation. Per-capita levels are
significantly higher than those in India for each of the emerging markets too (Figure 23),
but the potential for catch-up to developed world standards is still significant.
■ Rising incomes, especially at lower income levels: Over and above the normal
correlation of healthcare expenditure with GDP (Figure 24), these markets have a high
share of out-of-pocket expenses in healthcare (Figure 25), so rising incomes are an
important driver. These are, for good measure, linked to overall economic growth.
Further, most governments are now focusing on the lower income strata. For example,
similar to the National Rural Employment Guarantee (NREGA) scheme in India, we
have the “Zero Hunger” initiative in Brazil that the new president Dilma Rousseff has
promised to expand. In South Africa, only about 14-15% of the 50 mn population has
access to medical insurance, and yet the market is one of the largest for generics – as
this base expands, the market can see significant growth. In China, rising deposit
rates and minimum wages are expected to rise. At lower income levels, healthcare is a
discretionary spend, so market growth should remain strong.
■ Improving healthcare infrastructure: another constraint on pharmaceutical
consumption in the Emerging markets has been lack of medical infrastructure –
availability of hospitals for treatment (Figure 26) and of doctors to write prescriptions
(Figure 27). There seems to be a concerted effort in most economies to close these
gaps. The metrics for Russia seem comparable to those in developed countries, but
years of disrepair may have rendered quite a bit of this infrastructure unusable: as per
World Bank statistics, bed density in Russia has been falling steadily over the years.
Good prospects but growth not
easy
Indian companies are strategically well positioned to compete in these markets, given their
large and proven portfolio of products and personnel, familiarity with branded generics’
markets and low manufacturing costs. All of Russia, Brazil, and South Africa do not have a
comparable manufacturing set-up, and Japanese costs are materially higher. Further,
managing a branded generic business is radically different from managing a portfolio of
innovative products – a critical advantage over big pharma. The latter’s exposure to
emerging markets is still small, and to generics, in particular, is insignificant. While they
have the ammunition to acquire, organic competition is what matters for Indian companies,
and there is ample room for new brands to be established in fast growing markets.
Yet, despite the strategic positives, growth is not a foregone conclusion. There are critical
characteristics of each market which significantly impact attractiveness: we rate Russia the
highest and South Africa the lowest. We provide in-depth analyses of each of the markets.
All good markets, but some better and some worse
Each of the four markets we analyse in greater depth in subsequent sections is attractive,
but for simplification from an investment perspective, we have attempted to rank them.
Over and above the execution issues, attractiveness of a particular market depends on
several parameters, such as: 1) legislative/regulatory risk; 2) strength of local competition;
3) margins; and 4) the tendency of incumbents to influence policy-making so as to make it
difficult for alien competition. On the whole, however, macro risks can largely be
outweighed by the strength of execution.
We ranked the four markets along several metrics: size, growth, average margins,
strength of the channel (stronger counter-party means tougher business),
regulatory/legislative risk, strength of competition and barriers to entry. Relative values are
all against the Indian market, which is used as the baseline. This is summarised in Figure
30. Of the markets, Russia is the most attractive, and South Africa the least.
Strengths of Indian companies help their chances
Indian companies are strategically well positioned to compete in these markets, given their
low manufacturing costs, large and proven portfolio of products, and familiarity with
branded generics markets given intense competition on home terrain.
■ Large portfolio and chemistry skills: The companies have tremendous flexibility in
choosing the right products and reacting to changing dynamics in the markets, given:
1) The large multi-therapy product portfolios of Indian companies (recall that the larger
ones sell 500-plus products and sometimes launch 50-plus products in a year in the
domestic market); 2) Availability of skilled chemists and engineers used to churning
out multiple molecules and complex chemistry; and 3) Significant good manufacturing
practice (GMP)-compliant manufacturing capacity.
■ Experience of branded generics’ markets: These markets are not generic
(i.e. unbranded) markets as in the US or UK, where product capabilities,
manufacturing costs, legal skills and an efficient supply chain are all that matter.
Similarly, promoting branded generics to doctors is very different from promoting a
patent-protected product: portfolio management, product lifecycle management and
supply chain complexity are very different for branded generics (more on this below).
■ Low costs: Availability of a supply chain within India in a few industry clusters is a
unique advantage over local competitors in these markets: Russia imports much of its
formulations; Brazil and South Africa have to import much of their API; and Japanese
manufacturing costs are so high that gross margins are 30-40% despite generic drug
prices being relatively high: Indian companies make 50%-plus margins on prices less
than one-tenth of Japanese prices.
That said, so long as margins in these markets remain high, the cost advantage is
likely to remain limited to providing higher margins to Indian companies – and it won’t
help their market share. Further, with efficient sourcing arrangements (especially from
India), larger competitors can offset this slightly.
Competition: Still a level playing field, execution key
There are four types of competition for Indian companies: 1) The local incumbents; 2) The
big pharma companies now targeting these markets; 3) Other global generics’ companies;
and 4) Other Indian companies:
■ Local incumbents: In all four of the markets we analysed, the local companies are
unlikely to be able to compete with Indian firms on cost or even on diversity of product
portfolios, or global scale. Once Indian firms have learnt to navigate the local market
(not an easy task, as discussed below), these companies do not pose a big threat.
■ Big Pharma: There is very little in common between marketing innovative products
and marketing branded generics. For innovative products there is no alternative, the
products are significantly profitable, the portfolio is driven by research focus, the sales
force is well-trained and details only a handful of products. For branded generics, on
the other hand, there are multiple other copies selling in the market, profitability is not
as high, portfolio needs to be market-focused, and a typical medical representative
may be promoting 15-20 if not 100 products. Supply chain complexity similarly can be
meaningful. Thus, this is not a business which would come naturally to big pharma.
Further, their exposure outside the developed economies is still small Figure 28), and
emerging markets aren’t really a “do or die” option for them yet. In particular, even
where the split of revenues for emerging markets is available, we find that generics
are a very small part of the overall business (Figure 29).
Further, to really add to competition there is no alternative but to grow organically in
these markets. Acquisitions can only speed up the lessons, but at the same time any
hiccups post such acquisitions can also create difficulties in the broader organisation
accepting the new generics business model.
■ Global generics’ companies: Teva, courtesy of several acquisitions, has built up a
formidable presence in many of these markets, and expects to experience a 23%
CAGR over 2009-15. It is investing aggressively in many of these markets, and has
the management bandwidth and generics market experience to do well.
■ Other Indian companies: Most companies we talked to stated that other than for
tenders, most of the competition at the molecule/product level is with local companies
or big pharma. This is not surprising, as only a handful of companies are investing in
emerging markets and the effective market share of Indian firms in these markets in
total is less than 5%. We believe this state of affairs can continue.
On the whole, we believe the playing field remains even for Indian companies so long as
the approach is prudent. These are evolving and growing markets, and there is room for
enough brands to be built. Just throwing capital in may get some companies size, but that
would just be about putting on a different name tag – it won’t really change the market
dynamics. The learning curve will remain for every new entrant, and it seems from our
discussions that the mistakes made by new entrants are mostly similar – be they Indian,
global generic or big pharma companies.
‘I can produce cheaply and I can brand’ not enough
Yet, despite the strategic positives, growth in these markets is not a foregone conclusion.
Success for various Indian companies, and indeed for most non-local companies in these
markets, has been sporadic, and by no means easy. Based on conversations with market
experts, discussions with companies and our analysis, some of the reasons are as follows:
■
One size does not fit all: There is a natural propensity to replicate successful
strategies from India as all these markets appear to be similar at first glance. However,
market drivers differ significantly and each requires a different approach. Geographical
spread, cultural acceptance of generics, competition, pricing and channel behaviour, to
name a few, vary across markets. Also, these markets are still evolving and the
strategies that will succeed longer-term are not as clear-cut as one would expect,
e.g. whether a field force is needed in Japan to promote to doctors.
■
Access to the channel typically challenging: Channels are effectively consolidated
(though apparently fragmented) in most markets and even where they are not, it is not
easy to establish relationships quickly. One need only envisage the difficulty of a new
entrant into India to understand how complex and time consuming the steps can be.
New entrants sometimes find it hard to get distributors to pay attention to their products
and end up establishing prolonged payment periods, e.g. Russia. Local
partners/acquisitions are critical to understand local nuances but at the same time,
choosing a wrong partner is a very costly mistake. The sour experience of some
entrants into Brazil in particular has been driven by the wrong choice of partner.
■
Pricing models very different: Indian companies are quite used to the maximum
retail price (MRP)-based models in India, and are now aware of the reverse auctiontype
pricing dynamics in the US. But they have little experience of a “high list price, and
then give heavy discounts” type of model, for example, seen in Brazil. This is similar to
the unbranded generics’ market in India, but more extreme: average discounts run at
65-70%. Japan, on the other hand, has regulated prices, and biannual cuts.
Understanding these nuances becomes critical for success.
■
Competitors and their strengths: The influence of incumbents on policy is a risk any
new entrant will face. This is true especially for markets where local competition is
significant. Further, channel relationships with big pharma in Japan are also believed to
be slowing down generics’ adoption. In this regard, Russia is an attractive market –
only about 30% of the value of drugs sold in Russia is made locally.
All good markets, but some better and some worse
Each of the four markets that we analyse in greater depth in subsequent sections is
attractive, but for simplification from an investment perspective, we have attempted to rank
them. Over and above the execution issues, attractiveness of a particular market depends
on several parameters, such as: 1) Legislative/regulatory risk; 2) Strength of local
competition; 3) Margins; and 4) Tendency of incumbents to influence policy-making so as
to make it difficult for alien competition. On the whole, however, macro risks can largely be
outweighed by the strength of execution.
We ranked the four markets along several metrics: size, growth, average margins,
strength of the channel (stronger counter-party means tougher business),
regulatory/legislative risk, strength of competition and barriers to entry. Relative values are
all against the Indian market, which is used as the base line. This is summarised in Figure
30. Of the markets, Russia is the most attractive, and South Africa the least.
Identifying the early winners
We encountered some common traits that help identify beneficiaries: 1) Own the front end;
2) Focus, and patience; 3) Build over buy: while local partnerships are important, given
universal demand for such assets, a large buy is likely to become a burden; and 4) a
professionalised management structure with operational freedom to line managers.
While Cipla and Ranbaxy have a higher current proportion of profits and sales coming
from emerging markets, we are cautious on their growth prospects. We find Dr. Reddy’s to
be the best positioned: it is much more focused and cautious post the Betapharm fiasco,
and yet quite ambitious, targeting US$1 bn in sales in three years (FY10: US$450 mn). Its
patience and brand focus should help sustain its success in Russia. Lupin’s proven
management model – a professional CEO and empowered local management – allows it
to scale across markets. Growth in Japan may be weaker than the government’s target,
but margin expansion can drive strong profit growth. Sun’s transition to professional
management is important step for it to replicate its successes in India and the US.
Glenmark’s medium-term prospects remain strong, and it is establishing the right
management model, but near-term growth may be tepid for a while.
Identifying the winning traits
Given the diversity of the end-markets, the competitive environment there and approaches
taken by various companies, it is difficult and perhaps unwise to arrive at general
conclusions. However, our review of these businesses does suggest some common traits
that help winnow out the winners:
■
Clear strategy on whether to own the front-end: Given the strengths of India as a
manufacturing base, it is likely that over the next decade more manufacturing will
happen in India. The question though is whether Indian companies will own the brands
and the front-end in various markets. This, in our view, is the most difficult and yet the
most critical decision. Companies like Cipla decided very early to focus on their core
competency of product development and manufacturing, and sought partners that they
would supply to. Some, such as Dr. Reddy’s, have decided to focus on their own direct
presence in some markets (e.g., Russia), and partner with GSK for most of the rest.
We prefer the approach of owning the brands – the migration of manufacturing to India
will be slow, as low manufacturing costs are not yet a differentiator in these markets,
and may not be for quite a while. Instead, to benefit from growth, companies must
establish their own presence in key markets.
■
Start small and have patience: While owning the front-end is important, it takes time
to understand the market and build brands – replicating their scale in India, which was
built over decades, is likely to take time despite the strategic advantages that Indian
firms possess. Companies that have shown patience and focus have done well; at the
same time, the industry has already seen enough examples of companies in a hurry
losing out. Attempting short-cuts like playing on price, spreading out wide
geographically or entering with a large portfolio of products with no differentiation
seems to reduce impact and creates a negative image in some of these markets.
■
Funding & build versus buy: With Big pharma also in the race, Indian companies are
up against a lot of capital that can go iterative on learning. Large acquisitions are likely
to be costly given almost universal demand for such assets – that by itself can become
a burden. Acquisitions by competitors need not hurt growth prospects for Indian
companies, as it effectively only means a different name-tag on existing competition.
■
The right management model: Each of these markets has very different dynamics, and
one size does not fit all. Companies thus need to adapt their approach, and for that,
decision making needs to be close to the ground. An empowered local management
team is thus critical for success. While many of the companies have professionalised as
they have scaled up, decision-making remains too centralised in most.
Some may feel that it is too early to rank Indian companies on their performance so far in
the Emerging Markets, as their presence is small strategies (and even markets) are still
evolving. Some trends are however very clear, which provide some predictive power.
Dr. Reddy’s: brand focus; bite what you can chew
Post the Betapharm fiasco Dr. Reddy’s has scaled down its expectations on the pace of
growth, though certainly not its eventual ambitions: it targets US$1 bn in sales from its
branded generics businesses, versus the US$450 mn in FY10. In the “width versus depth”
choice it seems to be consistently choosing depth these days and is focusing on a few key
markets. For the rest, the company has partnered with GSK: the alliance includes Brazil,
and is expected to drive sales of ~$150mn by FY15 from next to nothing in FY11.
Its intention of hiring a new CEO, we believe, is a step in the right direction to effectively
manage a truly multinational organisation. We believe the company is also selectively
looking for acquisition targets now, though its attention is focused on the markets it is
already in and understands well.
It has been very successful in Russia with its focus on brand building: over 15 years of
presence it has built a ~US$200 mn business (FY11E sales) on a portfolio of 15 products.
It was ranked 12th in Russia and has grown much faster than the market (26% versus 16%
for the market) over the past four years. Its focus on OTC (15% of its sales versus 50% for
the market) should hold it in good stead.
After entering South Africa in 2004 via a local partner, the company has now bought back
the partner’s stake. While this is a small market for it now (~1% of sales), it can add
meaningfully to growth in the coming years.
The company is actively looking for a strategic alliance in Japan and may set up a small
JV with capital infusion of US$2-3 mn. This is expected to only become meaningful after
FY15.
Lupin: management model works; Good Execution
Lupin was the second among large Indian companies to professionalise (after Ranbaxy,
which soon reversed the step), and the first to remain under a professional CEO for a long
time. This has yielded results – the company has multiple growth engines that are not
correlated, and run mostly independently. It has also managed its acquisitions well – in
both Japan and in South Africa (as in other acquisitions) old management continued, and
has delivered.
Its strategy of establishing a small presence first, learning about the market and then
growing has helped the company avoid the pitfalls of hurried expansion and then having to
write off businesses. It has also been savvy enough not to pursue expansions in certain
markets that it initially found exciting (e.g., Saudi Arabia). It is evaluating targets in Brazil,
which it believes can be a good market for its oral contraceptive portfolio.
In Japan, Lupin has already increased Kyowa’s gross margins from 33% to 42% by
improving productivity at the Japanese factory and improving local sourcing of material. It
aims to increase this to 55-60% (with most of this 15-20% improvement flowing down to
EBITDA margins) by supplying API and formulations from India. The company is setting
up a line at its Goa Facility with the help of Kyowa engineers which it expects to be
approved by the Japanese regulator.
Lupin has been the fastest growing generic company in South Africa (26.5% growth in
MAT (Moving Annual Total) June-10; 3% of Lupin’s FY11 sales) and is now in the Top-20
generic companies.
Sun Pharma: early steps
While Sun has so far focused on India and the US, which fit its earlier management model,
the company has prudently started to re-orient itself for multi-pronged growth. The new
CEO believes that the journey to US$5 bn in sales would be very different from the journey
so far to reach US$1 bn. There are a number of positive lessons and strengths in Sun –
for example, its product and customer focus, and ability to outsmart competition. But to
scale these strengths across multiple markets, the company needed to change its
management model – the hiring of Kal Sundaram as a CEO is thus a big positive.
In a typical Sun approach, it measures the attractiveness of markets based on not just
market growth and profitability, but also its own capabilities, which it acknowledges are not
even across markets.
Sun has already invested in manufacturing in Mexico and Brazil, and already has a
number of filings in South Africa. The company sees the opportunity in Russia, and
realises it must be there, but finds it an unpredictable market. It is also evaluating Japan
and China, though it realises that the latter is likely to be a very challenging market.
Ranbaxy: best exposure, but spread out too thin?
Ranbaxy has been the pioneer among Indian companies in most emerging markets, and
has the highest proportion of sales and profits from these: various Emerging markets
contribute ~32% of sales (CIS: 6%, Africa: 9%, Latin America: 5% and others 12%).
Unfortunately though, it seems the continuous transition in senior management has led to
the company losing its way in most of these markets, and with the exception of South
Africa, the company’s performance has been poor of late. Being the first entrant, it made
its fair share of mistakes and had to encounter stiff resistance from local incumbents – this
usually leads to a company learning its lessons, adapting and cementing its leadership
position. It seems the lessons learnt were lost due to transitions and lack of management
focus. In Brazil and in Russia, growth over the past three to four years has lagged market
growth.
We continue to believe that Ranbaxy’s presence in so many markets distracts senior
management attention: this is despite it being the first company to build professional
management, oriented towards multi-pronged growth. It hampers focus and delays
correction of mistakes: things like choosing product portfolio (e.g., transitioning away from
the Similarés market in Brazil), hiring the right people, empowering local management
(one common refrain across markets seems to be Ranbaxy’s reliance on putting its own
people in charge of local operations), choosing the right pricing strategy, etc.
While Ranbaxy may seem to be best positioned among all Indian companies in the key
Japanese market due to Daiichi-Sankyo being a large presence, we are apprehensive
about the value accruing to Ranbaxy, as its role will primarily be of a contract
manufacturer. Further, as discussed in greater detail in the section on Japan, success of
the “hybrids” (i.e., innovator companies getting into generics) is by no means a given.
Glenmark: good medium term; but tepid near term
Glenmark has taken its core dermatology and respiratory products to the CIS, Latin
America, Africa and Asia-Pacific. Growth has been healthy so far, despite the glitch in
FY09: the FY07-11E CAGR is 21% from these markets. This is, however, not exciting
growth in these fast-growing markets, especially given Glenmark’s low base. Some of its
early strategies do not seem to be outright successes – e.g., the decision to enter Russia
via the smaller cities using price as a strategy worked initially, but the company ended up
getting positioned as a low-end player. Similarly, in Brazil, Glenmark acquired Klinger in
2004 for US$5.2 mn – supposedly not a very reputed company, with sales mostly in the
tender business. The overhang of that apparently is still an issue in the channel.
We expect the company to do well over the medium term: management is astute and
agile, and has been building the organisation for a multi-country operation with sufficient
operational freedom for line managers. Its focus on the core dermatology and respiratory
portfolio ensures that attention is not thinly spread. However, we see the need for some
re-strategising in these markets, which could potentially slow down growth temporarily.
Cipla: is not owning the front-end the right strategy?
Like Ranbaxy, Cipla caught onto the potential of these markets very early. However,
contrary to Ranbaxy’s approach, the company chose to focus on its core strengths –
product development and manufacturing – and sought partners in these markets.
However, these markets still have high margins, so the incumbents haven’t yet felt the
pressure to actively seek outsourcing partners. The only market where Cipla has excelled
therefore, has been South Africa, where Cipla-Medpro sole-sources its products from
Cipla and jointly works on its portfolios with it. This has been a big success, and we are
surprised Cipla has not used this model in other markets. This is likely to be due to a
somewhat top-down management model
Russia: less risky than it seems
The Russian market has experienced a 19% CAGR over the past four years, and is now
US$18 bn in size. About 30% of the market is generic, including 4% that is unbranded
generic, and dominated by local players. The target market for Indian companies is thus
US$3.5-4 bn. Strong market growth is expected to continue, and together with high out-ofpocket
spending, healthy margins, and much better acceptance of imports and Indian
companies, make it a very attractive growth proposition. The approach in Russia needs to
be shaped by the fact that some factors driving growth are very different from those in
other BRICS countries. Russia’s population is falling, and is also ageing the fastest –
funding is thus an important issue. Further, a tendency towards self-medication makes
OTC drugs a large 50% of the overall market. Lastly, attractive pricing, weak local
manufacturing and high sales force productivity drive strong margins.
The regulatory risks that worry the market are, in our view, unlikely to derail these
prospects: 1) Greater localisation is likely to be a multi-year theme, and not imminent;
2) Expanding the tender-based government funded scheme to 33% of the population may
run into funding constraints and is not as negative as it seems; and 3) Extension of the
vital and essential drugs (VED) list price cuts to a broader portfolio, though possible
(especially as 2011 is a pre-election year, and pensioners make a high percentage of the
electorate), is not likely.
Russia has largely been a happy hunting ground for Indian companies. Dr. Reddy’s is by
far the largest Indian company in Russia, with a strong franchise in its therapy areas, and
good channel reputation. As it expands its OTC footprint (a recent tie-up with Cipla helps),
the company should maintain its above-market growth. Torrent has also been successful,
but its conservative stance has meant it remains small. Market feedback on Glenmark
suggests its entry through smaller cities may not have been very successful.
Different drivers, but still large and growing
The Russian market has had a 19% CAGR (in local currency; 16% in US dollar) over the
past four years, and is now a large US$18 bn. This momentum is expected to continue,
with Pharmexpert forecasting 15% growth in 2011 (Figure 34). Price cuts introduced in
April 2010 through the VED catalysed strong 12% YoY volume growth in 2010 (three
quarters of total growth). The YoY increase in ASP despite VED-led cuts is due to hikes
taken before VED implementation in April 2010.
As per Pharmexpert only ~30% of the market is generic, of which about 4% is unbranded
generics, dominated by Russian companies. The addressable market for Indian
companies entering Russia would be close to US$3.5-4 bn, if they target all sub-segments
of the market, i.e., hospitals and OTC as well. Much of the growth in the private market is
generics driven.
■ Government initiatives: do lower prices and higher demand imply a larger
market? No discussion on the Russian market, especially from the funding
perspective, is complete without focusing on reforms instituted by the government.
These present opportunities as well as risks.
Russia’s high import dependence (>70% by value is imported, see Figure 45 below)
makes prices extremely vulnerable to currency movements – in 2008, rouble
depreciation drove up to 200% increases in the prices of some drugs (e.g. anti-viral
drugs). Thereafter, the government drew up a VED list which enforced methods of
calculating prices, drug registration by manufacturers before April 2010 and the
approval of wholesale (8-15%) and retail mark-ups (20-25%). While prices of VED
drugs fell 9% YoY in 3Q10, leading to average prices declining 3% YoY for the market
(Figure 41), the overall market still grew 11% due to 14% volume growth (Figure 42).
Figure 42: Market volumes grow when prices fall Figure 43: Value share of VED in private
What is perhaps more interesting is how the market behaved during implementation of
the VED. Since the April 2010 date was well known, many manufacturers increased
prices in the run-up to the date, and then took the price cuts. In our discussions with
companies and industry experts, we noted a unanimous view that the VED impact has
not been high on the industry as the list is very basic, and because of the way it has
been implemented. In general policymaking, many market experts have flagged the
gaps between regulations and on-the-ground impact due to implementation problems.
However, there is a risk, well understood by investors, of the VED list being expanded
beyond the current ~30% of the market value (Figure 43). But, some experts we
talked to suggested that by convincing doctors to prescribe brand names and not
INNs companies can offset some of this risk.
■ High acceptance of generics and imported drugs: Perception of quality of branded
generics is good among both doctors and patients – this allows companies to sell at
relatively low discount to innovator brands. Large multinational companies do not
usually launch their patented portfolios because: 1) high out-of-pocket funding (nearly
75%, Figure 39) implies the ability to pay is low, and at high prices there is not much of
a market; and 2) innovator companies remain wary of registration data becoming
available to generic competitors: they believe it is difficult to dispute such challenges in
the courts. Further, doctors are willing to prescribe branded generics according to
patient affordability. Thus, generics comprise ~30% of the market (Figure 35). While
locals dominate in terms of volumes (65%), their value share is a mere 30%.
Acceptance of international players (including Indians) is high.
Productivity high due to sales concentration: Sales and growth in Russia are still
concentrated in the 18 major cities with population larger than 1 mn. Moscow and St
Petersburg lead in growth not only because of the growth drivers mentioned above,
but also because of: 1) healthcare infrastructure development; 2) income
concentration and increasing migration; and 3) a skew in central government budgets
towards these cities.
Thus, with an average sales force strength of 350-400 (versus 3,000-plus for at-par
coverage in India), companies can generate much higher revenues. FY10 sales force
productivity for DRL for example was US$440,000/medical rep, 4-5x of India. Even for
a vast country as Russia, such a sales force is sufficient to cater to the market with a
product basket serving three to four therapeutic areas.
■ A consolidated channel: The top-10 distributors account for 70% of the market, and
top-10 pharmacies about 30%. Channel consolidation is increasing as distributors,
having run out of scope for more wholesale distribution points (having 50 branches
which cover a 300,000 population each suffices), are now investing heavily in
pharmacy chains, e.g., SIA International’s acquisition of a large share of stock of
Apteki 36.6 chain, and Finnish distributor Oriola-KD’s buyout of the remaining 25%
interest of the company managing the Staryj Lekar drugstore chain. Pharmacy chains
generate only 35-40% of their sales through drugs, the rest coming from products like
shampoos. Their rapid growth is expected to help reduce price disparity between
geographies as they have centralised structures. For now, though, fragmentation in
pharmacy chains still exits, with the top-10 players having a combined market share of
~30%.
Channel margins are usually 8-15% for wholesalers and ~20-25% for retailers: these
mark-ups vary between geographies. Easier to reach pharmacies, say in Moscow,
may have 20% mark-ups, whereas those in remote towns may even get 35%.
Brazil: attractive but tough
The Brazilian pharmaceutical market is ~US$26 bn in size, though the effective market for
Indian companies, which focus primarily on branded generics, is a smaller US$3-3.5 bn.
The market is growing rapidly (by 22% in local currency and 32% in US dollars in 2009),
due to rising incomes, especially among the poor, and a healthy acceptance of generics.
Government programmes like “Zero Hunger” drove the acceleration after 2005, and the
planned expansion in the programme is expected to maintain the momentum.
The market is also very profitable despite high channel consolidation and intense
competition. Discounts of 65-70% to the channel therefore are common. Companies
therefore tend to set high list prices, and then offer discounts – the net result is the
manufacturer prices several multiples of that in the US or in India. Further, an urbancentric
market keeps sales productivity high.
While competition is intense (four large local incumbents and most international players
making a beeline for the market), Indian companies do have a material cost advantage.
However, most seem to have struggled with the local market complexities, in particular
with the pricing model. It seems even Sanofi has struggled with Medway. Torrent is the
largest Indian company in Brazil, and is easily the most successful. Its focus on particular
therapy areas and geography has helped it respond well to local market needs. For
several others, an attempt to play on price (introducing products at 50% of the
incumbent’s) has led to doctors thinking of them as low quality. In general, it seems hiring
empowered local management is an important ingredient for success.
Several growth drivers in place
According to industry experts, including government expenditure of ~ US$8 bn, Brazil’s
pharmaceutical market size is estimated to be ~ US$26 bn. Much of government spending
is via tenders, which are supplied mostly by local companies. Thus, ~ US$18 bn is an
effective market for foreign companies. IMS estimates that generics constitute ~49% of
sales: likely an understated number, as like in India, we believe the rural market (where
“Similarés” dominates) is not adequately covered. Moreover, with the exception of
Ranbaxy, Indian companies are mostly in the branded generics segment, which is a much
smaller 14% of the market, but growing the fastest (Figure 52). A high 80% of these
“private” market sales is paid out of pocket, making them very attractive in a growing
economy.
Competition intense; focused strategies succeeding
■ Large incumbents, many newcomers: Whereas there are about 230 pharmaceutical
companies in Brazil, 75% of the sales come from the top 20. For generics, the top
four, i.e. Medley, EMS, Ache and EuroFarma completely dominate the market (~80%
share). This by itself does not make the market unattractive, but occasionally local
regulations can get inimical to importers. Further, given the large and growing market
and high manufacturer margins, most large generics as well as multi-national
companies with generics aspirations are increasing their attention to the market. A
simple “my costs are lower, and I can brand” approach is unlikely to succeed.
■ Similarés market transitioning to branded generics: there are three types of drugs
in Brazil – the patent-protected innovator drugs, the patent-expired generics drugs,
and the Similarés market (see Figure 52above for the split of market). The Similarés
are copies of innovator products that existed before the Generic Law of 1999 and
before Brazil became a signatory to TRIPS (Trade Related Intellectual Property
Rights) under the WTO. These received approval only on safety and absolute
effectiveness, but are now required to prove bioequivalence by 2014, or be phased
out.
There was (and, perhaps, still is) some hope that as the Similarés are phased
out/become more regulated – the branded generics market will benefit. The Similarés
comprise about 70% of the generics market, and have well established brands,
making them important from a scale perspective. However, market experts believe
they should be able to transition to the branded generics model. Earlier, they
dominated the rural markets (some believe for this reason their size is understated),
but over the past five years have been coming to the larger cities too.
■ Lack of manufacturing strength: There is very little API integration in the larger
generics companies – most of API is imported from India/China. Thus, they hold a
significant cost disadvantage to their Indian competitors.
Japan: expectations too high
Genericisation in Japan is a low 20% by volume, about a quarter that in the US, but the
value share is 6-7%, about half that of the US due to significantly higher generic pricing.
Regulatory steps have driven a steady but by no means rapid increase in genericisation:
the US$3.8 bn market has a 7-8% CAGR. The government’s 30% target by FY12 has
generated much newsprint, but is unlikely to be met anytime soon. Generics are generally
viewed as lower quality drugs: doctors are less willing to prescribe them and pharmacies
and patients don’t see economic reasons to substitute them. We expect steady growth in
the market driven by regular policy pushes, expiring patents and a consolidating channel.
Pricing is regulated, and insurance (government plus ~1,500 private insurers) covers most
of the spending. Despite the ageing population (~43% are above 50 years old), the plans
seem to be well funded – at ~8% of GDP Japan’s healthcare expenses are the lowest in
the developed world. There seems to be no funding crisis for healthcare that can trigger a
drastic change – likely a reason that generic prices are high and genericisation low.
Competition is primarily local, and most foreign entrants need to and are partnering with
local players. Most generics’ companies are small, family-owned, and heavily leveraged.
Consolidation though expected, is not imminent. Japanese generic companies have
mediocre EBITDA margins despite the high prices – their lack of manufacturing integration
is the most important decision. It is also not clear if the companies will eventually need the
350-400 sales forces they maintain. For companies importing material from low cost
locations like India, margins can be substantially higher: 2-3x the ~15% current industry
average. Lupin can target such margins once supplies start from India.
A significant opportunity, but expectations too high
Genericisation in Japan is a low 20% (versus ~75% in the US): even this volume share is
mostly due to vitamins and OTC products. Value share though is not as insignificant due
to significantly better pricing: the 6-7% (versus ~12% in the US) translates into a generics
market size of ~US$3.8 bn. Generic market growth increased from a 7.5% CAGR (2003-
08) to ~10% in 2010, driving the volume share of generics from 17% to 20% (Figure 58).
The government’s 30% target by FY12 generated much newsprint, but this target is
unlikely to be met soon. The system views generics as lower quality drugs: doctors are
unwilling to prescribe, pharmacies are reluctant to substitute and even patients are
hesitant to accept generics.
Profitability can be very high with integration
■ Channel consolidation likely to help genericisation: In the pharmacy channel (60%
of total prescriptions, Figure 67), while pharmacies are fragmented but getting
consolidated, the top-four wholesalers already dominate the market. The 55,000
pharmacies tended to be near the point of care for patients (hospital, clinic), but this is
changing, as more pharmacies are appearing in shopping areas. The top-four publicly
traded companies have around 10% of the market. Both pharmacies and wholesalers
in the current system would prefer selling innovative products even after patent expiry
as their mark-up is a fixed percentage of the selling price (~15% for wholesalers) – the
more expensive the drug, the more money they make. So much so that most pureplay
generic companies sell through Hanshas (dealers) which are smaller than
distributors, and usually affiliated to one hospital or community.
However, as the pharmacy chains expand, they are likely to better respond to the
various government incentives for pharmacies for increasing generics dispensing, and
could influence wholesalers to source more generics.
■ High generic prices: There are biannual price cuts in Japan which lead to low prices
for innovator products as well. Assuming that the ~6.5% average cut we saw in April
2010 was the regular decline in the price of a brand over its lifetime, prices would fall
~50% over 20 years. So, assuming starting price points are similar, by the time a
brand goes off-patent, it could be down 35-40%. For example, Aricept (branded form)
is priced 50% lower in Japan compared to the US. However, given the low discount,
the generic price is much higher than that seen in the US
Barriers to entry are high; local partnerships needed
■ Soft barriers to entry: While there is no “nationalistic” sentiment while prescribing
medicines, regulations are so stringent that getting approvals to ship finished products
into Japan slows down new entrants. Lupin is implementing a separate line for Japan
shipments using Kyowa’s help in its Goa facility due to different regulatory
requirements. Further, establishing relationships with the channel is not easy,
especially as the Hansha through which most of generic drugs are supplied are small
and fragmented. Not surprisingly, the top-three players in the industry are domestic.
■ Competition mostly from locals: There are types of competitors – the pure generics
companies like Sawai and Towa, and the hybrids – companies that have so far been
selling innovative products, but believe their relationships with the doctors and the
channel can help them succeed even in generics. The more astute among these
hybrids are setting up parallel organisations for the generics market (e.g. Daiichi-
Sankyo), but many believe their innovative products and generics can flourish under
the same umbrella. Our research indicates that the first type of competitor is likely to
be more successful, though both types don’t have much of a pipeline to speak of.
More pure generics’ companies are small, family-owned, and seem to have a lot of
debt on their balance sheet. The last is not really a situation of panic, especially given
the low interest rates in Japan. There has been some consolidation in the industry.
While more is expected, it is not imminent.
Foreign entrants are still positioning themselves in the market, usually via local
partners (Figure 71). Such partnerships/acquisitions allow them to get product
registrations, get local manufacturing capacity, and valuable channel relationships.
The recent Sanofi-Nichi-Iko deal is one such example where a big pharma company
and a big domestic player have come together in Japan.
Among Indian companies, only Lupin and Cadila have a meaningful presence. Lupin
generates 11% of its sales from Japan and has experienced a 17% CAGR since its
acquisition of Kyowa in October 2007. It has also managed to increase Kyowa’s gross
margins from 33% to 42%, and with sourcing from India (not started yet), hopes to reach
55-60% gross margins. It is now setting up a line for Japan in its Goa factory with the help
of Kyowa engineers.
South Africa: small but attractive
The South African pharmaceutical market is ~US$3.5 bn in size, and growing at 10-12%
annually. The private generic market, that Indian companies can target, is about US$850-
900 mn in size. The government tender Anti-Retroviral (ARV, or anti-HIV) market is also
large, but very low margin, and not as attractive (e.g. prices fell 53% in the recent tender).
That said, the market is very profitable – large local incumbents like Adcock and Aspen
generate 25-30% EBIT margins despite having very low manufacturing integration.
Despite price controls (SEP starting 2003 and now reference pricing), generic prices are
healthy, with the discount to innovator prices being only 40%. SEP actually allowed for
significant price increases over the past four years. Thus, despite high channel margins
(e.g. 50% mark-ups to wholesalers) and several consolidated counter-parties (pharmacies,
doctors), manufacturers get to generate high profits. The market has higher barriers to
entry, but with persistence and a local partner, market shares can increase, and generate
significant profits.
Small market with low generic penetration
The South African pharmaceutical market was ~US$3.5 bn in June 2010 (MAT), having a
10-12% CAGR. Only 18% of this market is government funded – the rest (Figure 74; 82%)
is private, and largely (70%, Figure 76) out of pocket.
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