By Jyotivardhan Jaipuria

After a dream run due to covid, FY23 has been a challenging year for the pharma sector on account of slowdown in overall growth, margin contraction as a consequence of high raw material costs, price erosion in the US generics business and enhanced regulatory concerns. However, we see a ray of hope with the easing of pricing pressures in the US generics market.

We classify the pharma segment into three broad segments and while we have avoided the US generic business, this could be a dark horse going forward.

Firstly, the Indian domestic branded business valued at ~US $20 billion has been growing at a CAGR of ~11% (FY12-22) and is expected to continue to grow at the same pace for the next five years. We like this segment particularly because of its very nature acting like consumption sector with high stickiness and brand recall, low capex and R&D, high margins and strong FCF with low working capital cycle.

Only regulatory hurdle is that India’s drug pricing authority has restricted branded generic prices. Price hike of products under the NLEM is linked to the WPI and non-NLEM products are allowed to take a maximum 10% price hike per annum.

While the IPM grew around ~8% in FY23 (compared with ~18% in FY22) mainly because of high covid base , we expect stronger growth going forward.

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Second is CRAMS, a niche segment which involves novel molecules’ R&D and generic and innovative molecules’ manufacturing. China has evolved as a major hub for R&D outsourcing over the past decade. However, as geopolitical tensions rise, western firms are looking for an alternative to China.

We believe select Indian companies with niche capabilities and a global footprint stand to gain. Contract manufacturing business in India is pegged at ~US $14 billion and has grown at 14% CAGR in FY16-21 and will continue to maintain a similar run-rate. Select companies have capabilities that match global standards and should benefit from the increased outsourcing wave.

Last is the US generics/export segment which we have been avoiding so far due to steep price erosion but there are signs that price decline in the US is slowing. US generics market is 6x that of the IPM and growing with ~US$141 billion of drugs going off-patent over CY22-26 vis-à-vis ~US$57 billion during FY17-21.

Historically, the US price erosion was around mid-single digit but post-covid, a majority of the companies faced double-digit price erosion in the US base business, mainly due to high competition and inventory liquidation due to elevated inventories in the channel. However, price pressure seems to be cooling off and we think it will be at low single digit going forward.

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On the flip side, the USFDA inspections are still on the lower side (330 in CY19 against 77 in CY22) and the same are expected to increase from here on. Drugs going off-patent, reduction in price erosion, increase in new drug shortages gives us some confidence to be positive on this segment.

The writer is Founder & MD, Valentis Advisors

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