Indian equities have made a strong comeback in the last three months, recording healthy gains of over 10 per cent since end December 2016. But the recent rally was not broad-based; quite a few themes have lagged the broad market. Interestingly, many pharma stocks — which, until last year, were fancied by investors — also figured in the laggards list. And the BSE Healthcare Index has shed over 2 per cent since December 2016.
The recent investor scepticism can be attributed to two key developments. One, the growth challenges in key developed markets faced by large pharma companies, on account of heightening regulatory activism and tightening control by global regulators such as US Food and Drug Administration (FDA). Second, pricing pressure from increasing competitive intensity in these markets and longer approval timelines has had a negative effect on profitability in these markets.
The increased regulatory oversight over the last couple has not only challenged the near- to medium-term growth prospects of drug-makers but has also had an impact on their profitability. This is thanks to higher compliance costs — for both preventive and corrective actions. Consider this — in the last two years several large and mid-sized drug makers have seen their manufacturing facilities come under the regulatory scanner. The list not only includes Indian pharma majors such as Reddy’s Laboratories, Sun Pharma Industries, Zydus Cadila and Lupin but also other mid-sized drug makers supplying to the US, such as IPCA Laboratories. Besides a downgrade in near-term growth expectations, this has had a negative impact on profitability owing to the additional costs incurred to bring facilities back on track.
Longer recovery time
For instance, Sun Pharma’s operating profit margin declined from 29 per cent in 2014-15 to 28 per cent in 2015-16, following the higher spend at its Halol facility (Gujarat) to make the plant compliant with regulations.
Likewise, Dr Reddy’s also saw its operating profit margin decline from19 per cent in 2015-16 to 10 per cent in the nine-month period ended December 2016, led by regulatory issues at three of its plants — the Srikakulam and Duvvada facilities in Andhra Pradesh, and the Miryalaguda facility in Telangana.
So also with IPCA Laboratories; serious deviations were reported at its Ratlam (MP) facility in September 2014 even as the official warning letter came in February 2016 which unravelled issues at its two other facilities – Indore SEZ and Pipariya, both located in Madhya Pradesh.
It is true that regulatory action is not new to pharma companies. Sun Pharma’s Cranbury (US) facility received a warning letter in 2010 citing quality issues. The company managed to bring the facility back to compliance in just about a year.
But the situation today is not the same as it was a few years back. The resolution period for regulatory issues has increased significantly in recent times. For instance, a warning letter was issued for Sun Pharma’s Halol facility in December 2015; the facility was inspected in September 2014, after which observations were made in Form 483. The company appointed consultants, undertook remedial actions and sought re-inspection in mid-2016, following which the facility was re-inspected in December 2016. Rather than clear the facility, however, the FDA made fresh observations during its inspection, leading to further delay in clearance of the unit.
Growth delayed
Dr Reddy’s, which was hoping for a positive outcome following re-inspection at its plants early this year, has little reason to cheer. The US FDA raised 483 fresh observations during its inspection of the company’s Miryalaguda facility this year.
Likewise, IPCA Laboratories’ Indore facility was served a warning letter in 2016, but is still grappling with regulatory woes.
This has not only delayed the growth process but also led to escalation of costs.
Players in the contract research and manufacturing space have not been spared either. Divi’s Laboratories, which until recently had not faced any regulatory issue, was issued Form 483 observations for its Visakhapatnam-II facility in December 2016.
While neither warning letters nor regulatory action is new to drug-makers, the longer resolution time-lines are a cause for concern.
And the impact of regulatory tightening will not be limited to those that have been under the scanner, but will have an impact on companies across the board, as they will all now have to step up their quality and compliance standards. This will mean higher investment in automation and expanding their quality compliance teams.