Since the violent face-off in the Galwan Valley between India-China, the Indian government is clamping down on business with China and reducing dependence on China for growing imports. Pharma is one such sector where the government is seriously looking to curb dependence as India imported close to $3.5 billion worth bulk drugs/drug intermediates from across the world in CY2019, of which, 67% ($2.4 billion) was from China. Intermediaries and APIs are crucial chemical compounds (raw materials) required to manufacture formulations or medicines. Thus, dependence on a single country for such a crucial thing is not prudent in India’s national interest, hence there is a need to diversify the sourcing and develop domestic capacity.
Dependence on China is particularly high for products like Antibiotics/Penicillin, for which, more than 90% of imports are from China.
The Indian pharma industry is the third-largest in the world by volume and 14th largest in terms of value.
In order to push local manufacturing, the government has announced plans to localise the manufacturing of 53 critical APIs and intermediates. It has offered a Rs 6,940 crore production linked incentives between 5%-20% for incremental sales and plans to set up three mega drug parks to drive sustainable cost competitiveness. Moreover, the government is considering increasing the import duty on APIs to 20-25% from the current 10%, to help boost local manufacturing of the bulk drugs.
The Indian government’s recent incentives to boost domestic manufacturing of APIs and intermediaries would improve backward integration over the next few years and curtail supply-chain disruption risk for Indian drug makers. The incentives should address core issues of pricing competitiveness and funding and make domestic production more competitive.
During the Q1FY21 results, API sales grew 35% Y-o-Y/20% Q-o-Q for healthcare companies. This was largely led by (a) non-inclination to buy from Chinese suppliers, which led to better market share, (b) Covid led higher off-take of medicines, (c) re-stocking to some extent, and (d) favourable pricing. Thus, going ahead, with the inclination to buy from Chinese suppliers reducing, we expect better growth prospects for the API business.
After three to five years of the downtrend in P/E, Healthcare is now back to its 10-year average over the past three months. Strong quarterly results, rising US FDA approval, and favourable government policies have boosted pharma stocks. Export-oriented companies witnessed increased demand for their products (API/ formulation) across developed as well as ROW markets. The ANDA approvals have been better than previous quarters, implying the smooth functioning of the USFDA. Further, we expect steps taken by the government to be positive for some of the API players. We prefer Divis among large caps while we prefer IPCA, Alembic Pharma, Laurus Labs, Alkem Labs, and Granules among mid-caps.
Divis is well placed to benefit from its (a) API prospects, and (b) a strong relationship with Innovators for CRAMS (Contract Research and Manufacturing Services).
We are positive on IPCA on the back of a) superior performance in the DF segment, b) the addition of new APIs as well as increased traction in existing API molecules, c) product launches under its own label in the UK, and d) increased backward integration to derive further benefit by improving manufacturing efficiency.
We are positive on Alkem given the healthy ANDA pipeline for the US market and expect the outperformance to continue for chronic therapy in DF and trade generics segment.
Laurus Labs: Formulations/Synthesis segment to drive the revenue. Change in regimen and in-house API consumption to affect ARV API segment growth. Update in new molecule additions in API segment. Outlook for ANDA-led Formulations business is a variable to watch.
Granules has multiple growth levers, such as (a) the ANDA pipeline for US generics (with some products having limited competition opportunity), which should drive an increase in the share of formulations for developed markets, (b) enhanced reach for core molecules, and (c) reduced operational expenditure through backward integration.
(The writer is the Head, Equity Strategy, Broking & Distribution, at Motilal Oswal Financial Services)