Q3 results: Five trends to watch out from Indian drugmakers

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Viswanath PillaMoneycontrol BureauAs Indian drug makers brace up to report their third quarter earnings in the days ahead, analysts predict Q3 to be a tough quarter with revenue growth moderating to 11.7 percent in October-December period compared to 18.4 percent compounded annual growth rate (CAGR) over last 10 year (Source:Motilal Oswal). Moneycontrol has put together some key factors that may influence earnings of Indian makers.Pricing pressure in US market:One of the key factors to look out for in the third quarter is the extent of price deflation of generic drugs that has eaten into the base business. Analysts say the base business erosion ranges anywhere between high single digit to low double digit and the concerning aspect is that its accelerating on account of consolidation of distribution channel and rising competition. Companies with first-to-file launches, limited competition and specialty drug portfolio are the ones who are positioned to withstand price erosion and still deliver healthy growth rates in US, the world’s largest market for generic drugs.Sun Pharma, Dr Reddy’s, Lupin and Aurobindo are the companies to watch out for with half of their revenues coming from US. Glenmark and Natco may through positive surprises with exclusive launches of generic Zetia (cholesterol lowering drug) and Tamiflu (antiviral) in December second week.For Sun Pharma analyst expect US revenue growth to be lacklustre at 9 percent year-on-year to USD 528 million owing to moderation in generic Gleevec (blood cancer drug) and possible decline in estimated earnings from Taro. The launch Daiichi Sankyo's licensed blood pressure medications Benicar, Benicar HCT, Azor and Tribenzor is expected to compensate the price erosion in US market.Dr.Reddy’s – could see yet another tepid quarter in the US without significant new launches – at the same time the base business is eroding and competition intensifying for its prized complex generic drugs Dacogen (anaemia), Vidaza (anti-cancer) and Valcyte (antiviral). Lupin is expected to benefit from the sustained exclusivity of generic Glumetza (anti-diabetic drug) and Aurobindo from the launch of generic Crestor (blood thinner drug). With 15 final approvals from US FDA - Aurobindo is leading the pack in the third quarter, while Lupin and Torrent stood second at 5 approvals each. The new approvals will allow Aurobindo to grow its US business, despite some erosion of its base business. Remediation status:Third quarter we will get some clarity on the status of ongoing remediation work at various facilities under US FDA scanner. US FDA’s regulatory action in forms of observations, warning letters and import alerts have put spanner on US business growth of various companies. Most of these companies have hired third party consultants and are working on strengthening their compliance systems in line with US FDA expectations. A few of them sought re-inspection indicating the completion of their remediation exercise. Meanwhile Sun Pharma and Dr.Reddy’s have initiated site transfers for some of their important products to the plants that didn’t face the ire of US FDA. Site transfers are not that easy – as they may sound – as it is time consuming and involves cost.In particular – the market will be interested in updates from Sun Pharma’s Halol facility, Dr.Reddy’s Srikakulam, Miryalaguda and Vizag units and Cadila Healthcare’s Moraiya plant on the status of their resolution. Higher R&D costs:The number of plain vanilla small molecules going off-patent has plateaued in the US market, at the same time competition has intensified with US FDA fast tracking generic approvals through GDUFA (Generic Drug User Fee Act) route. The drugs that are coming off-patent in the future will be mostly biologics and complex injectables – that are not that easy to copy, needing sophisticated biology and synthetic chemistry capabilities – including clinical and regulatory expertise. Leading Indian drug makers have increased their R&D budgets over the past five years. In fact R&D spending of the top seven Indian drug makers rose to around Rs 8,500 crore in FY16 from Rs 2,700 crore in FY11, according to credit rating agency ICRA. On an average top seven Indian drug makers spend nearly 9 percent of sales on R&D as they eye high-margin complex and specialty therapies. Analysts are expecting meaningful returns of Sun Pharma, Dr.Reddy's, and Lupin who have developed specialty drug portfolios in US. Domestic formulation business:The domestic formulation business – the safe bet for Indian drug makers - will be under some pressure in the third quarter with seasonal factor and demonetization playing out. According to data from market research firm AIOCD-AWACS – Indian pharmaceutical market growth rate dropped to 10.5 per cent in the quarter ended December – compared to 15.2 percent growth in the same period previous fiscal year. Even on sequential basis – the growth of Indian market contracted by two percentage points in the third quarter. The acute segment, which includes anti-infective drugs and pain management medications is under pressure, while chronic segment continued its growth trajectory. The price-led growth of pharma companies has been on a decline in the current financial year due to price-control regulations of the government. Sun Pharma, Cipla, Cadila, Alkem, Lupin, Glenmark, Abbot and Glaxosmithkline are some of the companies with huge domestic formulation businesses to watch out for in the third quarter.Other geographiesWith oil prices hardening with OPEC's deal to cut production – some of the challenges like currency depreciation and ongoing macroeconomic uncertainties faced by emerging economies like Russia, Nigeria, Middle East and North Africa could ease in the third quarter. Venezuela continues to be problem for Dr.Reddy’s and Glenmark – as both companies are finding it challenging to repatriate their profits from the Latin American country, which is in political and economic turmoil.Performance of Lupin in Japan, Dr.Reddy’s in Russia & CIS, Cipla in Africa, Aurobindo and Wockhardt in Europe are some of the things to look for in the third quarter.