The Big Story. Indian Pharma betting big on Uncle Sam

Indian investors are once more queuing up to buy pharma stocks and the CNX Pharma index is up 20 per cent since January. Besides being the most preferred defensive plays in volatile markets, there are two other factors working in their favour — the rupee movement and the potential in the US market.

The rupee has lost about 4 per cent against the dollar since January this year. Worries about the impact, on India, of a slowdown in the Chinese economy, yuan depreciation and uncertainty regarding the US Fed’s rate hike moves may keep the rupee in check in the near future too.

The country’s pharmaceutical industry has been a big beneficiary of this depreciation as India is the world’s third-largest exporter of pharmaceutical products in volume terms. Drug makers with a large export pie are, therefore, a happy lot. Of this lot, those exporting to the US are better placed to benefit from the large generic opportunity in that market and weakness of the rupee vis-à-vis the US dollar.

India supplies almost 40 per cent of the generic and over-the-counter drugs required by the US. The most successful of Indian pharma companies have focused on the US market, making strategic acquisitions that enhance their presence in this market and concentrating on research specifically targeted at this market. 

In the last four years, the rupee has lost almost 25 per cent. During this period, pharma companies such as Dr Reddy’s Laboratories, Sun Pharma, Lupin and Cadila Healthcare, which derive a meaningful portion of their revenues from the US, have seen a healthy ramp-up in revenues from this market.

 Take Dr Reddy’s, for instance. The company’s revenues from the US market have more than trebled to ₹6,472 crore in 2014-15 from ₹1,900 crore in 2010-11. From 25 per cent then, the share of the US in the company’s consolidated revenues has swelled to almost 44 per cent in 2014-15.  

 So is the case with Lupin. Despite the generic competition in two of its branded drugs — Antara and Suprax — Lupin managed to more than double its revenues over the last four years to ₹5,658 crore in 2014-15. This geography now accounts for 44 per cent of Lupin’s consolidated revenues, compared with 36 per cent in 2010-11. Likewise, Cadila Healthcare’s (Zydus Cadila) revenues from this market have grown three-fold over the last four years to ₹3,393 crore in 2014-15. The company derives 39 per cent of its revenues from this geography, which is almost double the 21 per cent in 2010-11. 

Besides currency weakness, the strong performance of Indian pharma majors in this market was also aided by higher investment into building a differentiated portfolio in the US, which will enjoy low competition. There has been a pragmatic shift in focus from ‘me too’ generic products in the oral space to complex generics, such as oncology injectables, nasal sprays, vaccines and transdermal patches, where the competitive intensity is much lower.

The profitability in these products is much higher than oral dosage form drugs and is far more sustainable compared to other exclusive opportunities, such as first-to-file opportunities. In the US, drug makers who file first for a generic equivalent of a patented drug are entitled to exclusive marketing rights for a period of 180 days.

It is only post the six-month period that other generic players who have filed for the product subsequently will be granted approval by the US drug regulator, the Food and Drug Administration (FDA), to market the product.   

To build a niche product pipeline, pharma companies have increased their research spend significantly, in the last four years. For instance, Lupin’s revenue R&D spend rose from ₹483 crore in 2010-11 to ₹1,099 crore in 2014-15. 

 Cadila Healthcare’s investment in R&D has nearly doubled to ₹524 crore, compared with ₹301 crore in 2010-11. Cadila’s revenue from the US market has more than trebled during this period to ₹3,393 crore in 2014-15.

 Dr Reddy’s research expenses have risen three-fold over the last four years to ₹1,745 crore in 2014-15. As a percentage of revenue, the company’s R&D spend has jumped to 12 per cent now from about 7 per cent four years ago.  

 Dr Reddy’s efforts to build a niche product pipeline over the last two to three years aided the healthy performance in the US market. The company has been steadily gaining share in select low-competition injectable products, such as decitabine and azacitidine, launched over the last two years.

In addition to niche generic drugs, the company has been strengthening its proprietary, novel drug pipeline too. Dr Reddy’s has filed a new drug application for three innovative drugs, seeking approval from the US FDA. The filing has been made through its subsidiary Promius Pharma. These three products, if approved, should support the company’s growth in the medium term.  

Similarly, Sun’s R&D spend has risen six-fold to ₹1,837 crore in the last four years. In 2014-15, the company spent 6.7 per cent of its revenue towards drug research. This is higher than the 5.8 per cent it spent in 2010-11.

In 2014, Sun licensed Merck’s innovative molecule, which targets plaque psoriasis, to strengthen its specialty products pipeline. The drug is currently under phase 3 trials. If successful, the drug can spice up Sun’s profitability in the medium term.   

Given the healthy profit margin in this geography, Indian drug majors are keen to expand their business in the US market. They are exploring inorganic opportunities in the US market. This should also support growth over the short to medium term.

For instance, Sun’s astronomical growth in US revenues during the 2011-15 period was partly fuelled by acquisitions, such as Taro Pharma, DUSA and the generics business of URL Pharma. Last year, the company made public its decision to acquire Ranbaxy and completed integration of the latter with itself by end of last fiscal. The integration of Ranbaxy’s US business has added muscle to Sun’s business in the US. The latter expects synergy of $300 million from Ranbaxy in the medium term. 

Similarly, Lupin, which was long looking out for good opportunities in the US branded and generics space, entered into an agreement with US-based Gavis Pharmaceuticals LLC and Novel Laboratories Inc to acquire them for a consideration of $880 million in July.

These companies reported revenues of $96 million in 2013-14. With a pipeline of 66 drugs pending approval and 65 drugs under development, the acquisition should strengthen Lupin’s US generics business.

 The depreciation of the rupee against the US dollar and higher contribution from the US market has not only added to the revenues of Indian pharma majors but also played a role in bumping up their profits.

For instance, consider Dr Reddy’s. Its operating profit margin has expanded from 21.9 per cent in 2010-11 to 24.4 per cent in 2014-15. Likewise, Lupin’s operating margin has doubled in the last four years — from 13.6 per cent in 2010-11 to 26.6 per cent in 2014-15.

Sun’s profit margin has increased by 10 percentage points between 2010-11 and 2013-14, to 44.7 per cent. The company, however, reported lower margin of 29 per cent in 2014-15 on account of integration of Ranbaxy, which had abysmally low margins primarily due to compliance and regulatory issues.

 Companies that expanded presence in the US market have immensely benefited from the generic opportunity in the world’s largest pharma market. But ramping up business in the US has not been an easy task for Indian drug makers. This market has its own set of challenges too. For one, regulatory tightening by the US FDA and increasing instances of surprise inspections caught select pharma majors on the wrong foot.

For instance, the US FDA conducted a surprise inspection at Sun Pharma’s Halol (Gujarat) plant and Dr Reddy’s Srikakulam (Andhra Pradesh) active pharma ingredient plant last year.

During the inspection at Sun’s Halol plant, the drug inspector found that workers conducted ‘unofficial trial tests’ on samples, before testing them officially and in one case the raw data of the trial tests was even deleted by an employee, as it did not conform to prescribed standards. Imports into the US from this facility have since been halted. Recently, the FDA revoked the approval granted to Sun Pharma for the epilepsy drug Elepsia XR, developed based on Sun Pharma Advanced Research’s patented technology, and filed from Sun’s Halol facility.

Also, imports from Dr Reddy’s Srikakulam facility into Canada have been halted since late 2014.

Though regulatory action by the US FDA on both these companies is clearly a setback, their track record of addressing/fixing such regulatory issues successfully in the past gives confidence about the companies’ ability to handle the ongoing issue. For instance, Sun was successful in resolving the issues at its Cranbury facility, New Jersey, in about one year.         

The other challenge facing pharma biggies supplying to the US market is the delay in new product approvals by the US FDA. Following the introduction of Generic Drugs User Fee Amendments of 2012 (GDUFA), it was expected that the approval timelines for generic drugs would be fast-tracked.

Under GDUFA, the FDA collects fees from finished dose and API manufacturers and uses it for drug filings and facility inspections until 2017. But contrary to expectations, the approval timelines have only stretched since the introduction of GDUFA, 2012.

From about 31 months three years ago, the average approval time has increased to 42 months in 2014.  However, industry bodies, such as the Generic Pharmaceutical Association, have expressed concern over the delay in approvals and are hoping it would be resolved soon.

 Despite these challenges, the US continues to remain an attractive market for Indian companies, given the huge potential for generics as several billion dollars worth products are slated to lose patent protection over the next few years. Companies such as Dr Reddy’s, Sun Pharma, Cadila and Lupin have a large pipeline of drugs pending approval in the US. This should help them sustain healthy growth in this market over the medium term.

 These companies have also de-risked their businesses by diversifying into other geographies. For instance, Dr Reddy’s has been strengthening its domestic business over the last two years.

The growth in its India formulations business, which now accounts for 12 per cent of its consolidated revenues, has improved from mid single-digits to low double-digits over the last few quarters, helped by strong growth in its biosimilar portfolio and product launches. Similarly, Sun is increasing its footprint in other markets, such as Canada, Australia, Europe and Sri Lanka, as a diversification strategy.