Indian Firms’ US Revenues Slow Sharply But Balance Sheets Still Solid

Between 2011 and 2015, India’s pharmaceutical companies logged an enviable spurt in revenue from their main US market at a compound annual growth rate (CAGR) of 33%. India’s drug-makers provide around 13% of the US generic drug supply, making them the second-largest generic sellers to the US after Canada. But that heady revenue growth was before Indian firms began really feeling the squeeze from tighter regulation and high single-digit price erosion.

US CAGR crashed to 15% in 2016 and slipped to 12% in the first nine months of this financial year, reflecting headwinds that show no signs of abating quickly. “We feel in terms of the overall outlook for growth, the industry’s likely to face further pressures,” ICRA vice-president Gaurav Jain told Scrip.

Among other factors, “generic adoption is reaching saturation, there are limited large near-term FTF (First-To-File) opportunities in the US and also there’s the consolidation of supply chain in the US market which is pressuring prices,” he added.

“Our expectation is that growth will be 10-11% on a one-year basis and CAGR could be slightly lower on a five-year horizon as the base becomes bigger,” he said.

US President Donald Trump’s aggressive rhetoric on lowering drug prices – on Mar. 20 he told a political rally that medicine costs “will be coming way down, way, way, way down” – has added to the chill. Indian companies already have significantly less pricing power with mergers between wholesalers and retailers. The big four buyers in the US now have at least an 80% market share, according to Indian industry figures, compared with 52% five years ago and this has turned up the pricing heat.

Indian Firms On Edge

The Indian Pharmaceutical Alliance, which represents India’s top 20 domestic drug-makers, urged in a letter to a government advisory body Feb. 28, that the government pitch for favorable treatment for the Indian generic industry by the Trump administration while avoiding any "ugly confrontation." (Also see "Avoid ‘Ugly Confrontation’ With Inward Looking US, Indian Firms Ask Govt" - Pink Sheet, 6 Mar, 2017.)

Indian firms also are worried about a proposed value-added tax on imported goods known as BAT, the short name for a destination-based cash-flow tax (CBCFT). On April 1, Trump signed an executive order seeking a review of a $500bn annual trade deficit with 16 countries - part of his “America First” policies to spur US manufacturing and job creation. While China is seen as the chief target, India’s also on the list. As well, there are concerns the Trump administration may get tougher on issues like intellectual property rights – long a US bugbear. India has been marked by the United States Trade Representative (USTR) as a “priority watch list” country for two straight years due to the country’s stringent patent laws that Washington charges unfairly favor local firms.

Still there is also an argument that the Trump administration’s emphasis on lower prices could well help the Indian generic industry expand its share in the US with its medicines that are normally around 80% cheaper than branded versions. “Indian drugs are much cheaper so shutting the doors to them won’t help the government bring down prices, in fact the reverse could happen,” an industry executive who did not wish to be identified said. The Indian Pharmaceutical Alliance is urging the government to make the case to Trump that savings from cheaper Indian imported drugs would outweigh job-creation benefits from manufacturing the medicines on US soil.

Base Business Growth Flat

Indian drug companies don’t need any bad news that might depress revenues further. Aggregate revenues of leading Indian players grew by just 9% in the third-quarter-to-December with nine-month growth at 8.9% as against 10.1% growth in 2015-16. Growth was buttressed by FTF opportunities like generic versions of Zetia and Tamiflu, ICRA noted. But when stripping out consolidation benefits for some companies that acquired businesses and favorable currency movements, base business growth was flat amid price erosion and much tighter regulatory scrutiny that’s increased remediation costs and constrained the abilities of some Indian companies to supply the US market.

Even India’s biggest drug companies such as Sun Pharmaceutical Industries Ltd., Wockhardt Ltd. and Dr. Reddy's Laboratories Ltd. (DRL) and big-name contract research firms are under fire for flunking FDA quality compliance standards. The impact of warning letters and import alerts “being issued to manufacturing units of companies like Sun, DRL, Wockhardt, Cadila Healthcare Ltd. and Ipca Laboratories Ltd. have also contributed to lower revenue growth from the US,” said ICRA. Unfavorable reports keep rolling in and not only from the US. On March 24, the European Medicines Agency (EMA) said it had recommended suspension of over 300 medicines in the EU due to “unreliable” data from bioequivalence studies conducted by India’s Micro Therapeutic Research Labs. (Also see "India’s Micro Therapeutic says EMA’s ‘Sweep’ Suspension Will Hurt; CRO Industry Shuns ‘Bad Eggs’" - Pink Sheet, 27 Mar, 2017.)

Building for the future but pinching profits in the meantime are higher R&D spends that in aggregate have increased to close to 9% now from 6% of sales in the 2011 financial year. This reflects Indian companies’ growing focus both on regulated markets and complex molecule and therapy segments in the US and elsewhere to grow revenues. That R&D spend, by the way, is up from the just 3.8% of revenues companies allocated to R&D around in the middle of the last decade, according to Indian credit rating agency Crisil.

“Companies are having to step up their spend on R&D because most of the pure generic opportunities are over, there’s a limited number of large-size patents expiring,” said ICRA’s Jain. Behind that aggregate R&D spend, individual numbers show that leading Indian pharma players are allocating anywhere between INR5-17bn for R&D which represents some 8-12% of their sales.

Only Way For Indian R&D Spending Is Up

“We expect this trend to continue as most of the leading companies are in the midst of expanding their presence in the complex therapy segment such as injectables, inhalers, dermatology, controlled-release substances and biosimilars,” ICRA said. These segments entail higher R&D costs during the development stage due to product complexities and need for clinical trials.

“We expect a significant rise in R&D budgets, especially for companies that are developing biosimilars for regulated markets or have portfolio of NCEs (New Chemical Entities) under development,” ICRA said. Also, as these firms get closer to conducting clinical trials, they’re likely to pursue JVs and alliances to share investments and secure technological capabilities.

The regulatory, pricing and other pressures have all hurt Indian drugmakers’ shares. After shining as a star sector, the S&P BSE Healthcare Index fell 13% in 2016 and for the year-to-date, the index has fallen 8.47%.

But for investors looking closely at the numbers there is also reassurance. The credit metrics of leading pharmaceutical companies are stable and are expected to remain so. Balance sheets are relatively robust with capital structure and coverage indicators seen remaining remain solid despite some pressure on profitability and a marginal rise in debt levels due to acquisitions.

“Balance sheets are strong and aggregate operating margins remained strong at around 25% in the third quarter which is very, very good,” Jain said. “Domestic margins are also very healthy as companies have been able to cut costs and reduce distributor margins,” he noted.

Ultimately, Jain said, ICRA believes Indian companies will “continue to experience steady growth in the US over the medium-term on the back of continued generic opportunity and a healthy product pipeline of pending ANDAs with an increasing proportion of complex generics.” Also, continued inorganic expansion by domestic companies as they seek to acquire expertise rapidly will likely support scaling-up of business, he added.