Bull run in drug stocks face first hurdle as old headache returns


MUMBAI: Besides information technology and steel, no sector has enjoyed as much favour with investors as the pharmaceutical space has since the calamitous selloff of March 2020.

The Nifty Pharma index has returned 96 per cent since April last year on the perception that the sector will be a long-term beneficiary of the pandemic, as healthcare spending surges in the coming years, and multinational companies diversify their supply chains out of China.

While producers of bulk drugs and contract manufacturers have done well for themselves so far, the rally in shares of generic drugs manufacturers is now facing its first hurdle.

With several export markets like the US returning to a semblance of post-pandemic normalcy, old headaches of price erosion and regulatory uncertainty are returning for companies and investors alike. So far in the June quarter, some US-focused drug manufacturers are already highlighting concerns over rising price erosion in the US market.

To be sure, the US drug market is the world’s largest by value and the biggest export market for most Indian generic drug manufacturers.

“We are withdrawing our EPS guidance for the year 2021-22 on account of softness in US business due to additional competition, which has led to price erosion as well as a delay in FDA inspection of our facilities,” Alembic Pharmaceuticals said after June quarter earnings.

The Gujarat-based company is not alone in issuing a warning over the increase in price erosion. Lupin, one of the largest generic drug manufacturers in the world, earlier this week surprised investors with a weak guidance for the September quarter and an indication that it too is facing price pressure in the US market. Same goes for Hyderabad-based Dr Reddy’s Laboratories.

For investors, who had suffered at the end of the previous bull market in 2015, the re-emergence of management talk around price erosion in the US would evoke bad memories. Back then, it was a rise in price erosion due to high competitive intensity in the US market along with stricter regulatory scrutiny by the US FDA that put an end to a multi-year bull market in drug stocks in India.

Sun Pharmaceutical Industries, India’s largest generic drug maker, suggested predicting a bottom for price erosion in the US market “is the million dollar question” to which nobody in the industry has an answer.

“…competition is intensifying, FDA is giving permissions or approvals to products, so the competitive environment is actually gaining strength rather than reducing,” Sun Pharma’s North America CEO Abhay Gandhi said at the June quarter earnings call.

While individual companies that have suggested a rise in price erosion have seen their stocks being hammered by investors, the overall sector has so far escaped scrutiny from investors.

“This issue is more stock-specific. Extrapolating this (price erosion in the US) across the sector may not be the right thing to do at this moment. It’s too early,” said a city-based analyst, who has covered the sector for more than 10 years.

Price erosion is a function of lack of new high value product launches as old products face higher competitive intensity. With companies like Dr Reddy’s, Lupin, Alembic Pharma and others still unable to get clarity on their units under the US drug regulator’s lens since before the pandemic, price erosion is a bigger threat as their ability to launch new products is hamstrung.

Market participants believe the below-par June quarter earnings from the sector so far has also dented some enthusiasm among investors along with the tepid commentary for the US market.

“The multiples that pharma stocks were getting so far, one needs to put a halt to that because management are not providing visibility on earnings beyond six-to-nine months. Long-term story remains intact but FY22 can be a little bit of a washout in terms of earnings,” the city-based analyst said.


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