The Indian pharmaceutical sector accounts for 20% of the global exports in generics. The industry also supplies over 50% of the global demand for various vaccines, 40% of generic demand in the U.S. and 25% of all medicine in the UK. The fact that India has a much lower cost of production as compared to the U.S. and EU gives India a competitive advantage. Large cap pharmaceutical stocks in India have high exposure to the U.S., primarily in the generics segment.
What’s wrong with pharmaceutical stocks in India?
Customer consolidation in the U.S. has led to heavy price erosion of medicines in the market, since customer consolidation gives the customers the power to negotiate. Top 3 medical retail companies in the United States now account for almost 80% of the buying in the market. This price erosion has resulted in a dip in profits for a lot of the Pharma majors.
As per the 2018 NADAC (National Average Drug Acquisition Cost) list, 71% drugs showed a decline in prices and 26.5% of the total drugs witnessed price erosion of more than 20%.
Apart from this, there is constant regulatory pressure from the Food and Drug Administration (FDA) in the form of issuances of form 483 along with observations for manufacturing plants. The manufacturing plants need to comply with the FDA observations in order to start supplying to the United States. Further, this also causes a delay in approvals of any ANDA’s (Abbreviated New Drug Applications) that have been filed from the same manufacturing plant.
Pharma majors have also faced some legal scrutiny. Recently, Sun Pharma, Aurobindo, Lupin, Zydus & Glenmark were named along with several other drug makers in a lawsuit filed by 44 states in the U.S. The lawsuit alleged that:
The drug companies engaged in numerous illegal conspiracies in order to unreasonably restrain trade, artificially inflate and manipulate prices and reduce competition.
The story on the domestic front does not look that bright either. As per data from AIOCD Pharmasofttech AWACS Pvt. Ltd., a pharmaceutical market research company, the country’s pharmaceutical market slowed to a seven-quarter low between April and June this year. For first quarter of Financial Year 2020 pharmaceutical market growth was recorded at 7.9%, the slowest in the past 7 quarters & one of the lowest in the past 5 years.
Pharma companies in India have therefore started to look at alternatives in order to keep up with the changing industry dynamics. The first alternative which companies have started looking at is to develop speciality products to boost sales. For this, these companies spend more on R&D with a view to boost sales on the back of new product introductions.
Apart from this, companies are also looking at expanding geographically into other territories so as to tap new opportunities as well as reduce exposure to any one particular geography. Cipla for example is one of the largest supplier of anti-malaria drugs to Africa. It tied up exclusively with Serum Institute India for the same & also acquired South African Company Mirren in 2018. Sun Pharma purchased a Japanese Company, Pola Pharma as part of its plans to strengthen its global presence. Dr. Reddy also stated its plans to expand into China, Russia & other emerging markets as part of its diversification strategy.
The issues of price erosion and regulatory pressures are being faced by the Industry as a whole & has resulted in a sharp fall in the price of pharmaceutical stocks in India. This drop in price presents a great opportunity to invest in some these beaten down stocks that are available at a discount to their Industry peers and to the overall market.
P/E ANALYSIS – FAIR PRICE
Last Close(as on 30th July 2019)
Price As per Average P/E
Premium% or –Discount %
Sun Pharmaceutical Ind. Ltd.
Dr. Reddys Labs Ltd.
Piramal Enterprises Ltd.
Aurobindo Pharma Ltd.
Torrent Pharmaceuticals Ltd.
About the table above-
- I used the current PE multiple of companies under review to arrive at an average.
- Based on this average, I calculated a fair price at which the stock should be trading.
- The table highlights the discount/ premium at which the stock is trading at in comparison to its – FAIR PRICE
Going by the above study, Aurobindo Pharma has the maximum upside potential and is trading at a very heavy discount as compared to its industry peers.
Individual stock reports below.
Aurobindo Pharmaceutical Ltd
Aurobindo Pharma Limited (the “Company” or “Aurobindo Pharma”) is a leading global pharmaceutical Company and is the 2nd largest pharmaceutical Company in terms of sales in India. It markets its products & solutions across 150+ countries; with growing penetration in the US and Europe.
Aurobindo Pharmaceutical Limited has several manufacturing facilities approved by the likes of the U.S. FDA (Food and Drug Administration) and UK MHRA (Medicines and Healthcare Products Regulatory Agency). It produces generic formulations & Active Pharmaceutical Ingredients (API’s).
Its product portfolio spans over 6 major therapeutic areas including antibiotics, antiretrovirals (ARV’s), cardiovascular, gastroenterological, anti-diabetics & anti-allergics.
- In FY19 the company witnessed a strong growth of 18.6% over the previous year with a 21.3% increase in US formulation sales as well as a 13.9% increase in the Europe formulation sales.
90% of Aurobindo Pharma’s revenue for the FY 19 was generated from the international markets with 46.2% generated in the U.S. followed by 25.4% in the EU and 6.1% in Growth Markets of Canada, Brazil & South Africa (with plans of further expansion into select markets of APAC, Africa & the Middle East.)
Aurobindo Pharma continues to grow with consistent spending on R&D, it filed for 63 ANDA’s (Abbreviated New Drug Application, which is used for the approval of generic drugs) including 21 injectables in FY19 and received final approval of 48 ANDA’s including 8 injectables,
Apart from spending on R&D the Company acquired 7 branded oncology injectable products in the U.S. from Spectrum Pharmaceuticals Inc. via a wholly owned subsidiary. It also completed the acquisition of commercial operations of Apotex in the EU as well supporting infrastructure in 5 European Countries.
What’s driving the stock?
Sandoz Acquisition: In September 2018, Aurobindo announced that it will acquire the dermatology and oral solid business from Sandoz Inc. for $900 Million, which will make it the 2nd largest generic player in the U.S. by number of prescriptions. The transaction which is all cash will be financed through fully committed debt.
Consistent Growth in the US: Aurobindo Pharma has witnessed consistent growth in the U.S. from where Aurobindo gets majority of its revenue. U.S. businesses such as AuroMedics the injectables business & Aurohealth the OTC business have seen growth of 30% & 90% y-o-y respectively. This has primarily been fueled by the launch of new products (50 products across oral, injectable & OTC segments) as well as the of approval 65 of injectable ANDA’s.
Focus on R&D and Capacity expansion: Apart from acquisitions, the Company has been spending on R&D (4.5% of sales for FY19) in order to grow organically. Aurobindo has expanded capacity with the commissioning of a new facility to produce Beta Lactam injectable in FY18 and has made acquisition of Apotex INC, in 5 European countries including Poland and Spain.
What’s dragging the stock?
Global recall of Valsartan: Popular blood pressure medicine Valsartan was found to be carcinogenic by the U.S. FDA and owing to the same has been subject to a global recall. Aurobindo Pharma voluntarily recalled 80 lots of the drug in January 2019 and despite not impacting sales heavily, the recall has resulted in negative publicity for the entire sector.
Observations by U.S. FDA: The company received a total of 11 inspection observations (i.e. form 483 issued by the U.S. FDA) as well as OAI Status of 3 units, 2 API facilities & 1 intermediate facility. Form 483 highlights areas that need to be worked upon in order to remain compliant. The observations are related to valsartan and will impact the company with delays in approvals of new products.
Legal proceedings: Aurobindo Pharma was recently named in an anti-trust lawsuit along with 19 other generic pharma manufacturers for fixing prices and allocating customers. More recently charges of fraud & sabotage have been filed against a subsidiary of the Company, Aurolife Pharma LLC & Mr. P.V. Ramprasad Reddy a Director in the Company.
Closing Price(as on 31st March)
5 Year Average P/E = 16.5
EPS (TTM) = 40.37 Current Market Price = 551.95 Current P/E = 13.67
As per previous year earnings, the average P/E ratio of the past 5 years is 16.5. Using the EPS of the trailing 12 months and the current price we can see that the current P/E ratio is at 13.67. The stock is trading at 17.13% discount to its average P/E mainly due to the legal proceedings initiated against it as well as the U.S. FDA observation on its unit.
Dr. Reddys Labs Pvt. Ltd
Dr. Reddy’s Laboratories Ltd. (“The Company” or “Dr. Reddy’s Labs”) is an Indian multinational pharmaceutical company based in Hyderabad. It markets & manufactures a wide range of pharmaceuticals in India and overseas. It has over 190 medications, 60 API’s (active pharmaceutical ingredients) for drug manufacture, diagnostic kits, critical care, and biotechnology products.
The Company has a vast portfolio spanning several therapeutic areas including Gastrointestinal, Pain Management, Urology, Dermatology and Oncology. Gastrointestinal generating the highest revenues, followed by Oncology.
- Dr. Reddy’s Labs showed positive momentum in FY19 where the revenues grew by 8% y-0-y. EBITDA and PAT grew by 42% & 92% respectively. This growth has been attributed to operational efficiencies as well as the divestitures of 2 manufacturing facilities as well as a dermatology portfolio indicating management’s goal of a leaner & more focused business.
- Revenues are dominated by the global generics segment followed by PSAI (Pharmaceutical Services & Active Ingredients) & Proprietary products. Geographically speaking majority of its revenues were generated in the U.S. followed by India.
Dr. Reddys Labs has been divesting some product portfolios. The strategy is to run a leaner more focused business. Simultaneously Dr Reddy’s has launched several new drugs in the market. As per the management, in FY 19 alone the Company filed 20 new ANDA’s. As of 31st March 2019, the company had 110 generic filings pending comprising of 107 ANDA’s & 3 NDA (New Drug Applications). Of the 107 ANDA’s, 34 are believed to have the first-to-file status, which gives the Company exclusive marketing rights of the drug for a period of 180 days.
What’s driving the Stock?
Divestment of brands in the US and sale of plants: In June 2019 the Company sold 2 neurology drug brands for US $110 million to Upsher-Smith Labs LLC. Earlier in FY 2019, the Company had sold off 4 dermatology proprietary products belonging to its subsidiary Promius Pharma to Encore Dermatology. The sale proceeds of US $110 million will be used to finance R&D of new proprietary products. Apart from this, the Company also sold off its API manufacturing facilities in Hyderabad as well as its amoxicillin-based antibiotics producing plant in Tennessee.
Positive news in litigation of Suboxone and settlement of case with Celgene: In June 2018 Dr. Reddy’s Labs launched an FDA approved generic version of Suboxone, a drug used to treat opioid addiction, an issue which costs the U.S. government an approximate $80 billion annually. In June itself the owner of the Suboxone NDA (New Drug Application) filed an injunction to ban the manufacturing of this drug. After appeals to the court the Company has now resumed production and sale of Suboxone and in July 2019 the U.S. Court of appeals ruled in Company’s favor that it did not infringe patents pertaining to Suboxone. The Company also settled its case with US based Celgene related to a generic version of Cancer Drug REVLIMID, the terms of the settlement were not disclosed.
Launch of new products and growth in emerging markets: Dr. Reddy’s Labs has constantly been launching new products in the U.S.. In June this year it launched products such as Phytonadione Injectable Emulsion, Tobramycin Inhalation Solution & Zenatane with a cumulative MAT (Moving annual total) of $668.6 million, $525 million from Zenatane alone. Apart from this, the Company has also seen a growth of 28% in revenue from emerging markets. In light of regulatory changes in China on Indian drug imports, the Company has identified a total of 70 products from its U.S. portfolio which it believes can be manufactured and sold in its Chinese facilities. It also stated that it has plans to add another manufacturing facility close to the one it already has in China. In July this year, the Company also received approval from Greek drug regulators for their Srikakulam plant.
What’s dragging the Stock?
U.S. generics price fixing case: The Company was 1 of the 5 Indian companies named in a U.S. lawsuit. The anti-trust lawsuit filed by 40 states and based on a 5 year investigation claims that 20 drug makers conspired and inflated prices of more than 100 different drugs in the United States. The complaint is an expanded form of a suit filed in December 2016. The justice department’s antitrust division is conducting a criminal probe into the same.
Price pressures on U.S. generics: In July 2019 the U.S. FDA had issued an inspection (form 483) with 5 observations for Dr Reddy’s API manufacturing plant in Bolaram, Hyderabad. This was in addition to the two observations for its Vizag plants issued in June 2019. These observations came in after it received 11 observations for its formulations plant located in Bachupally in February 2019.
Closing Price (as on 31st march)
5 Year Average P/E = 28.29
EPS = 129.49 Current Market Price = 2560 Current P/E = 19.77
As per previous year’s earnings, the average P/E ratio of the past 5 years is 28.29. Using the EPS of the trailing 12 months and the current price the current P/E ratio is at 19.77. The stock is trading at a 30.11% discount to its average P/E mainly due to U.S. FDA observations on its plants as well as the pricing pressures in the generics market. The Company aims to shift its strategy and focus more on emerging markets as well as specialty products.
Lupin Limited (the “Company’’ or “Lupin”) is engaged in producing, developing & marketing a range of branded & generic formulations, biotechnology products & active pharmaceutical ingredients (APIs) across the world. Amongst largecap pharmaceutical stocks in India, Lupin has fallen the most in price.
It is the 8th largest generic pharmaceutical company by sales and the 3rd largest Indian pharmaceutical company by global sales.
It has 18 manufacturing sites globally with 12 being U.S. FDA inspected sites as well as 9 R&D sites for continued innovation.
- Overall sales in FY 19 increased by 5% over the previous year despite a 5% drop in sales in the U.S. which is geographically the largest revenue segment for the Company. The Company witnessed a 23% increase in sales of API’s as well as a 12% increase in sales in India for FY19.
- The largest chunk of its revenue in FY 19 came from the U.S. market at 34% followed by India 29% and Developed countries other than the U.S. at 18%.
Lupin is in the core business of manufacturing generics, but faced reduced profits due to consolidation of the distribution supply chain, in the U.S. market which accounts for a majority of its revenue. 3 large players in the U.S. control 80% of the distribution network. These are – Walgreen, CVS and RiteAid. In response to this Lupin Limited is aiming to increase its business by concentrating on high value generics and specialty branded medicines. In FY 19, Lupin received approval of 30 ANDAs, which are filed for approval of a generic drug product. In addition Lupin has 40 pending First to Files ANDAs (First to File gives the company a 180-day period within which no other company can market a similar product).
The management has been actively looking to grow its business with a heavy spend on R&D (9.6% of sales in FY19) which is on the higher end amongst the largecap Indian pharmaceutical stocks in India.
What’s driving the stock?
Reduced pricing pressure in the U.S. market: The price erosion in the U.S. generics has reduced from double digits to single digits and is looking to stabilize. In response to these pressures the company has also moved towards expanding its product portfolio with a greater concentration on high value complex generics as well as branded medicines.
Acquisition of Symbiomix therapeutics: The acquisition allowed the company to produce Solosec a medicine which is the only single dose treatment of disease bacterial vaginosis. Lupin has a remaining 9 Year exclusivity patent to produce the drug and will expand the brand in the coming 3-4 years. It projects the drug to contribute over US $100 anually million after expansion.
What’s dragging the stock?
Drug recall: In June 2019, Lupin was asked to recall 18,408 bottles of Cefdinir due to complaints received of metal piece identified in the product bottle. Before that in May 2019, the Company had to recall 46,700 bottles of Morphine Sulfate due to “failed impurity/degradation specification”.
Regulatory Hurdles: Lupin has faced plenty of regulatory hurdles in the form of inspections and OAI’s (Official Action Indicated) from the U.S. FDA. Its Somerset facility in the U.S. was subject to inspection in December 2018, followed by inspections in its Pithampur facility as well its Goa facility in 2019. All facilities have been classified as OAIs whereby the facilities may be subject to regulatory or administrative action & the U.S. FDA may also withhold approval of pending applications further delaying production & innovation.
Closing Price (as on 31st March)
5 Year average P/E = 55.77
Current Market Price = 752.6 EPS = 13.41 P/E Ratio = 56.12.
As per previous year earnings, the average P/E ratio of the past 5 years is 55.77. Using the EPS of the trailing 12 months and the current price the current P/E ratio stood at 56.12. The stock is trading at a fair value with a small 0.63% premium to its average P/E.
Sun Pharmaceutical Industries
Sun Pharmaceutical Industries is India’s largest pharmaceutical company (by market capitalization) & as of May 2019 is the 4th largest specialty generic pharma company in the world (by worldwide generic sales in 2018).
It has a presence in over 100 countries and a portfolio of more than 2000 products. Its products serve several therapeutic areas including but not limited to psychiatry, anti-infectives, neurology, cardiology, orthopaedic, diabetology, gastroenterology
- The revenue from operations for FY19 increased to INR 28,686 crores up 9.9% from the previous year & net profit increased to 2,665 crores up 27.2% from previous year.
- The U.S. formulations business drives majority of the revenue followed by its India formulations business. APIs (Active Pharmaceuticals Ingredients) account for smallest share.
The Company became the largest pharmaceutical company in India after its acquisition of Ranbaxy from Japan’s Daiichi Sankyo Co. Ltd. for US $3.2 Billion. As of May 2019 the company has a cumulative portfolio of 453 ANDA’s as well as 51 NDA which have been approved. It has 118 ANDA’s & 8 NDA approvals pending from the FDA.
What’s driving the Stock?
Effective Dealing with whistleblower complaints: In Q4 of FY 19, Sun Pharma saw a reduction in revenues on account of a change in its India distributions business, away from Aditya Medisales, a firm which has been alleged in a whistleblower complaint for related party transactions. Adjusting for this expense of INR 11 Billion, the sales grew 18% YoY. The U.S. generics sales also grew by 22% sequentially from Q3 FY19 to Q4 FY19 on account of new contracts for generics as well as traction gained by Taro, its US based generics manufacturing arm.
New product launches: The company has been spending consistently on R&D. Management will continue to spend in the range of 8%-9% of sales in order to improve its product mix. The Company recently launched Ezallor Sprinkle (rosuvastatin) tablets, for treatment of lipid disorders for people who have difficulty swallowing, a problem that is estimated to affect 30-35% of long term care patients. Apart from this, the Company recently announced promising results from a Phase 2 study on Drug Ilumya. The drug is already approved in the US for treating moderate-to-severe plaque psoriasis and is now being investigated for psoriatic arthritis. The near term sales estimates for Ilumya range between US $90-$110 million with a peak sale estimate of US $300 million.
What’s dragging the stock ?
Whistle-Blower Complaints: In January 2019 a whistleblower was filed against the Company with SEBI. The complaint alleged financial irregularities as well as related party concerns with Aditya Medisales (mentioned above in article). This came at the back of another whistleblower complaint filed in December 2018, linking founder & CEO Dilip Shanghvi and his brother-in-law Sudhir Valia, with a key figure from 2001 stock market scam Ketan Parekh. Though the company has taken steps to mitigate these issues by removing Sudhir Valia from executive role as well as delinking themselves from Aditya Medisales, there are still doubts over their corporate governance.
Legal Proceedings: Sun Pharma was recently named in an antitrust lawsuit along with 19 other generic pharma manufacturers for fixing prices and allocating customers. A spokesperson for the Company said “We intend to vigorously defend against these allegations and are in the process of filing our response with the District Court of Connecticut”.
Issues with Halol Plant: The Company seemed to be all set to resume production at its Halol plant, which manufactures most of the products for the U.S. market; but in June 2019 Sun Pharma was again served with a form 483 with 4 observations from the FDA, further delaying clearance of this plant.
Closing Price (as on 31st March)
5 Year Average P/E = 40.15
EPS = 11.01 Current Market Price = 410.35 Current P/E = 37.27
As per previous year earnings, the average P/E ratio of the past 5 years is 40.15. Using the EPS of the trailing 12 months and the current price the current P/E ratio is at 37.27. The stock is trading at a 7% discount to its average P/E mainly on account of whistle blower complaints & legal proceedings against the Company.
About the Author
Rajat Sharma is a well known stock market analyst and commentator. He has covered Indian markets for over a decade and is regarded for consistently identifying early stage investment opportunities. Attorney by qualification, Rajat has done extensive work for improving corporate governance and disclosure standards.Follow @SanaSecurities