Outlook : Pharma Sector by Aditya Khemka
Pharma business is divided into two models:
Domestic
Export
Domestic Model
This model is typically like an FMCG business. In domestic markets, those pharma companies that have branding power will have a good pricing power among other competitors.
In pharma, doctors are the main customer of the product and the patient is just a consumer. The patient is going to follow what the doctor suggests and he will prefer only those drugs that will be suggested by a doctor, he won't switch to a generic drug if he is not getting the brand prescribed to him.
Export Model
This model is basically like a steel business. A demand curve is almost always downward-sloping, reflecting the willingness of consumers to purchase more of the commodity at lower price levels.
The pharma demand curve is going to be straight, so the question here is what will determine the price?
The answer is simple, supply will determine the demand. The company that can afford the lowest price is going to have the highest market share.
Pharma Rally in 2015
This pharma rally was observed in the sector mainly due to export. As earnings growth and valuation were re-rating, ROE was 20-25% it was attracting new competitors in the market.
As competitors started to step into the industry the price wars among the players started which ultimately separated the wheat from the chaff.
Current Scenario of the industry
Currently, the ROE stands at 10-15% which is low in comparison to the past few years. Indian players have the two largest competitors in branded drugs i.e European markets and American markets.
To revive the sector supply needs to be controlled and that has started happening gradually.
Many big pharma companies in the USA are filing bankruptcies or getting merged or getting out of the markets. which slowly and gradually is going to control the supply and help the sector revive.
Price to Book value Revival
Price to book value is reviving. A price war is slowly and gradually declining as the best will survive, soon price inflation can be observed.
In recent times it can be seen that pharma stocks have started picking up, it's just a fact that the sector has just corrected itself, from the bottom of P/B value of the 2.5 sectors is trading around 4-5 P/B and has its own peak of 7-8 P/B.
Currently, this hype in prices is observed due to various investors from different sectors like cement, steel, media, etc have started to invest in pharma companies looking at stable growth.
USFDA will be seen to go lenient on terms of inspection approvals as they will be more focusing on the supply side of the drugs in US markets.
More consolidation to be seen
There is going to be more handshakes with other companies. As loss-making companies would not be able to survive alone will join their hands with other companies which will be a value addition for the companies and some fixed cost will get clubbed which will remove cost and add the synergies.
Pharma is a globally competitive industry, those companies having moats will have no fear of facing price wars among competitors.
Pradhanmantri Jan Aushdhi yojana
A campaign launched by the Department of Pharmaceuticals, Government of India, to provide quality medicines at affordable prices to the masses through special kendras known as Pradhan Mantri Bhartiya Jan Aushadhi Kendra.
Pradhan Mantri Bhartiya Jan Aushadhi Pariyojana Kendra (PMBJPK) has been set up to provide generic drugs, which are available at lesser prices but are equivalent in quality and efficacy as expensive branded drugs.
But pharmacies that are set up for this yojna are usually less appreciated, whereas the government also provides subsidies for the initial two years, and after that those pharmacies are usually turned into grocery stores to compensate their fixed cost in the long run.
Medical technology and medical devices (Blessing in disguise)
This modern artificial intelligence in the pharma sector, effectively is going to be the future for the healthcare sector and will help the patients, doctors in an effective manner but will slowly and gradually disrupt the whole traditional markets going on in India, sooner or later.
There is a long runway for growth in this domain of the sector.
In India, there are hardly any players that have diversified themselves in this domain, but there are lots of opportunities to be grabbed in near future in AI for pharma companies.
US Markets
Drug manufacturing prices are higher by 25-30% in the US in comparison to India.
Healthcare is closest to the heart of consumers. A trade war between China and the US will gradually give some space to developments of Indian players in US markets as Indian manufacturers hold 47% of the volume share in the US.
CRAMS business
In the export model this type of business won't get affected. The CRAMS model is supported by some tailwinds. CRAMS is a type of business where they have their fixed return as per the contract allocated to those companies.
Drug selling pressure is going to stay on other players who have their business of selling , packaging of the drugs.
CRAMS players are just service players and not drug sellers.
China has a 55bn model when it comes to CRAMS and India has a 5bn market share due to anti china scenario, the demand from Chinese players is going to reduce and India has its foot to capture those markets. Companies with pure-play CRAMS models are expected to grow in near future.
Some Cherry on the top Points:
Healthcare is the consumer-driven market, though your income rises or reduces you are not going to switch from a branded drug to a generic on the cost of your health.
How safe your cash is known from how sustainable that company has cash flows and not from how big that company is.
When per capita GDP increases it will simultaneously increase healthcare expenses.
Developing economies will always focus on branded drugs.
The government banned an irrational combination of drugs.
Pharma is a government-protected industry so competition in the domestic players is bound to be seen.
Most pharma companies do business in spite of having low ROE, having a good risk appetite of suffering loss for 10-15 years, and then earn for 5 years but gradually such companies get merged with sustainable players.
Companies focusing on chronic therapies will have growth opportunities.
Due to this covid 19 affect healthcare and pharma spending globally will go up.
This summary is totally based on the learning that I gained during the webinar held by ZEN MONEY (DSP Mutual Fund) conducted by Aditya Khemka on 23 May 2020. It was a great learning experience to learn from the sector expert.
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