Investors in the stock of Divi’s Laboratories were in for a rude shock last week. The stock shed over 20 per cent in just one trading session following the announcement that its Unit II facility at Vishakhapatnam has received an import alert from the US drug regulator FDA.
What is it?
Companies that sell medicines in the US market are required to comply with the regulations mandated by the FDA. Manufacturing units that supply drugs to the US are inspected by the FDA periodically. If there aren’t any lapses in compliance with regulatory standards, the facility gets a clean chit and can continue its supplies to the US market. However, if any lapses in the adherence to the mandated regulations are observed by the inspectors, the same is notified by the FDA in Form 483 as observations. This is the first level of action by the FDA in case of deviation from the so-called good manufacturing practices (GMP). The company is given time to respond to the observations and if the reply is not convincing the FDA may issue a warning letter.
A warning letter restricts the ability of that manufacturing unit to supply drugs to the US from that facility. The company in that case needs to appoint consultants to advice on corrective actions and also monitor implementation of the same. After this, the company approaches the FDA and makes a request for re-inspection. If the regulator is satisfied with the corrective measures, it can issue a close-out letter.
If the FDA is unhappy, it can issue an import alert, implying a ban on the facility from supplying drugs to the US. This is perceived a big negative as the deviations in this case are usually found to be serious in nature and have a considerable impact on the quality of the drug manufactured from the facility. Hence the timeline for resolution in the case of an import alert can be quite long. However, there have been instances in the past where the FDA has directly issued an import alert even without issuing a warning letter, keeping in mind the seriousness of the deviations observed.
Why is it important?
The US is the largest pharmaceutical market in the world. Given the slew of patent expiries expected over the next few years, the generic opportunity in this market is huge. Also, the share of Indian pharma companies in the US market has risen significantly over the past few years.
India caters to nearly 40 per cent of the pharma drug requirement of the US, thanks to the ability of Indian drug makers to manufacture quality generic drugs at competitive prices. As a result, the US is a critical market for India’s large drug makers. Companies such as Sun Pharma, Lupin, Dr Reddy’s, Cadila Healthcare and Torrent Pharma derive a big chunk of their revenue from this market. Thanks to the large generic opportunity in this market, the share of the US is only bound to increase in the near term.
Why should I care?
If you are an investor in pharma stocks that garner a significant portion of their revenues from the US, it is important to keep a close tab on the regulatory action by the FDA as they can pose growth risks.
The bottomline
The progression of observations into import alerts and warning letters has been increasing of late. But investors need to focus on the speed with which a company resolves these issues. For the recent spate of warnings letters and alerts can provide a long-term buying opportunity.
(The article first appeared in The Hindu BusinessLine.)