It’s been a rugged ride for Indian equities over the last five years. The Nifty 50 and Sensex have seen two rally and corrective phases during this period. However, one sector that remained completely immune to the weakness was pharma. Even as the Sensex and the Nifty gained a meagre 30 per cent in the last five years, the BSE Healthcare Index jumped 2.7 times. But not all pharma stocks delivered stellar returns. While companies with a strong presence in key overseas markets such as the US fared well, those that derived a lion’s share from the home market did not match up.
This is despite the domestic pharma market staging a recovery in 2015. After a weak show in 2013-14 following steep price cuts after the implementation of the new pharma pricing policy, drug sales in the home market rose 14.9 per cent for the 12-month period ended October 2015, according to research firm AIOCD AWACS. With barely a third of the country’s population having access to healthcare, the room for growth in the home market is certainly immense. But there are challenges too.
Regulatory activism in India has increased in the last two years. The steep differential in the prices of various brands of the same drug triggered stringent action by the pharma price regulator.
Most innovators continue to sell their drug brands at a whopping premium to local, substitutable brands. The premium in some brands was as high as 15 times; even long after these innovator brands had lost patent protection.
Pricing anomalies
The drug price regulator National Pharma Pricing Authority’s (NPPA) strong intent to address such anomalies in the pricing mechanism came out loud and clear when it imposed a restriction on the selling price of 108 cardiovascular drugs outside the National List of Essential Medicine (NLEM) in July 2014.
This, the NPPA did by invoking para 19 of the Drug Price Control Order 2013, which empowers the government to restrict the selling prices of all scheduled and non-scheduled drugs under ‘certain circumstances’ and in ‘public interest’. Though the NPPA had to withdraw the July 2014 order in less than two months due to inadequate legal backing, one cannot rule out the government using other ammunition in its armoury to bring some sanity into the drug pricing mechanism. For instance, the Government could revise the NLEM list to include critical, life-saving drugs.
So, should the drug price regulator decide to wield the whip on the domestic pharma industry to ensure rationality in drug prices, which companies would be the worst affected? Any move to crack down on the current free pricing regime for drugs outside the NLEM will impact companies that adopt a premium pricing strategy.
Patent protection
The Indian arm of multinational drug firms that have enjoyed premium pricing for many of their parent’s novel drugs even after expiry of patent protection may have to bear the brunt of regulatory tightening. While price cuts, at one end, may eat into their profits, the firms may, on the other hand, lose market share to cheaper, alternative Indian brands.
The revenues and profit of multinationals took a beating in 2013, post implementation of the new drug pricing policy. GlaxoSmithkline Pharma’s operating profit margin slipped from 34 per cent in 2010 to less than 18 per cent in 2014-15, as a result of price cuts mandated by the new pricing policy. The company’s stock price gained barely 35 per cent over the last five years, while the stock prices of peers such as Sun Pharma, Lupin and Dr Reddy’s, that have diversified their footprint, delivered multi-fold returns.
Most multinationals derive a chunk of their revenues from the Indian market. Thus, high dependence on the domestic market makes them vulnerable to any adverse regulatory changes in India. Given that further price cuts and policy tightening cannot be ruled out, the pain for multinationals may be far from over.
Consolidation
In contrast, diversified pharma companies may be better placed to weather any adverse development in the home market. Healthy growth in other markets may offset the weak domestic performance.
Also, given the fragmented nature of the market, consolidation may be the way forward. Indian pharma companies are pursuing aggressive acquisition strategies and may be better placed to benefit from consolidation in the domestic market. This is because multinationals, being majorly owned by the foreign parent, may not have the freedom to take strategic decisions.