ICRA expects growth trajectory for Indian pharmaceutical industry to moderate on back of slowing growth from US given the relatively moderate proportion of large size drugs going off patent, increased competition leading to price erosion in high single digits, generic adoption reaching saturation levels, regulatory overhang along with base effect catching up.

Growth from US has come down to less than 9% in H1 FY2017 despite consolidation and currency benefits and going forward the growth momentum is likely to face further pressure. Increased regulatory scrutiny and consolidation of supply chain in US market resulting in pricing pressures along with increased R&D expenses will have an impact on profitability of Indian pharmaceutical companies.

In spite of these ongoing challenges, several Indian pharma companies are increasing their R&D spend, targeting pipeline of specialty drugs, niche molecules and complex therapies. The domestic pharmaceutical industry has gained adequate scale and drug development capabilities over last decade of growth which will keep them in good stead to capture new opportunities in the US market.

Aggregate revenues of ICRA sample of leading players grew by 9.4% in Q2 FY2017 as against 8.4% in Q1 FY2017. The revenue growth for Indian pharmaceutical industry remain moderate in Q2 FY2017 despite recovery in domestic growth and consolidation benefits of acquired businesses. The base business continued to face high single digit price erosion in US, and continued macroeconomic challenges in key emerging markets.

The domestic formulations business of companies within our sample registered growth of 14.1% in Q2 FY2017 as against 7.0% in Q2 FY2017 despite WPI linked price cuts taken for NLEM portfolio, and regulatory interventions in form of expanded list of NLEM along with ban on 344 fixed dose combination (FDC) drugs which resulted in liquidation of stocks by traders. The FDC ban has been challenged in courts with companies getting interim stay against same and actual impact remains to be seen.

In ICRA’s view, continued regulatory interventions in domestic market are expected to put some pressure in near term though long term growth prospects for domestic pharmaceutical market remain healthy given increasing penetration, accessibility and continued new launches. There are limited major FTF launches in US market in near term and base business is expected to continue to face competitive pressures affecting growth from US market.
 
The operating environment in emerging markets (EMs) like Latin America, CIS countries and South Africa has been affected by confluence of factors including devaluation of currency, frequently evolving regulatory landscape and weakening macro environment across some of the commodity dependent economies though currency tailwinds provided some benefits in Brazil market. Select pharmaceutical companies have taken sizeable write offs in Venezuela due to currency devaluation and have stopped dispatches there on back of repatriation issues.

Despite growth pressures along with increased R&D and compliance related investments, profitability for the industry has remain relatively stable with aggregate EBITDA margins for ICRA’s sample at 24.6% for Q2 FY2017 excluding one-time write offs. Certain companies has been facing margin pressure on back of slowing growth in US along with remediation costs though improving product mix and productivity improvement has provided overall cushion to margins.
 
Over the past few years, pharmaceutical companies have increased their R&D budgets significantly in view of their growing focus both on regulated markets and complex molecules/therapy segments. The aggregate R&D spends of top few companies in domestic pharmaceutical market have increased from 6% of sales in FY2011 to close to 9% now. ICRA expects this trend to continue as most of the leading companies are in the midst of expanding their presence in complex therapy segment such as injectables, inhalers, dermatology, controlled-release substances and biosimilars.
 
The credit metrics of leading pharmaceutical companies are expected to remain stable in view of steady growth prospects in regulated markets and relatively strong balance sheets. The capital structure and coverage indicators are expected to remain strong despite some pressure on profitability and marginal rise in debt levels given inorganic investments. The key sensitivity to ICRA’s view remains productivity of R&D expenditure, increasing competition in the US generics space and operational risk related to increased level of due diligence by regulatory agencies.