Best Pharma Stocks To Buy | HDFC Sec Research Report

Comeback on the cards…

Beleaguered by regulatory clampdowns, channel consolidation in the US and increased competition, earnings of US-focused Indian pharma companies dropped 30% over FY18. Despite the all-too-visible business challenges, they persisted with higher R&D activity (related to complex generics and specialty business), which aggravated the pain. As a result, the NIFTY Pharma index has corrected ~30% over three years (after 30% CAGR over FY11-15).

We believe FY19 may see a gradual comeback for large cap pharma companies, driven by (1) Actual and likely regulatory resolutions, (2) Moderating price erosion and (3) Several product launches across generic and specialty categories in 2HFY19. We believe earnings have bottomed out, while the base is favourable. Upgrade Sun Pharma to BUY.

What has changed?

1. US price erosion moderating: Price erosion has been ever-present in the generics business; however, it has historically been in the range of 5-6% vs. the double digit decline witnessed over FY16-18. Except Glenmark, all major players have seen moderating price erosion during 4QFY18 and have guided for stable single digit price decline ahead.

2. Diversified manufacturing base: Three years ago, 50% of US revenues of most Indian pharma majors were contributed by two plants. Since then, they have added plants and diversified filings across multiple facilities. Lupin has seven formulation plants now; SUNP has built one more injectable plant while the Mohali plant has also received clearance from the US FDA. CDH, ARBP, TRP and ALPM have also scaled up manufacturing base (both in numbers and capability). This has significantly reduced concentration risk with respect to future regulatory adversity.

3. R&D as % of sales has topped out : R&D spend for the 10 companies in this note has increased from Rs 72bn in FY15 to Rs 106bn in FY18. Most of them have guided for flattish R&D spend in FY19. Only SUNP and ARBP are likely to see some scale up owing to fresh clinical trials for novel products and bio-similars. However, we expect R&D spend to remain in the range of 8-9% of revenues over the next two years for most companies.

4. Lucrative product launches in FY19/FY20: Absence of niche product launches in the US was a key reason why Indian companies did not perform well over FY16-18. But the filing pipe looks rich and mature enough now. FY19 can be a breakthrough year in terms of niche product opportunities. SUNP (Tildra, Sceiera, Yonsa), LPC (Solosec, Levothyroxine, gRanexa), DRRD (gNuvaring, gSuboxone), CDH (gAsacol HD) and ARBP (Ertapenem) will launch several lucrative products in FY19. Inhalers, bio-similars, trans-dermals and niche injectables launches are expected to start from FY20.

5. Aided by these factors and a favorable base (GST & US tax impact), we expect earnings to grow 22%YoY in FY19. Valuations are still attractive for key stocks like LPC, ARBP, and GNP. With five big specialty launches in FY19, SUNP will see back ended returns. But looking at enormous market opportunity, we believe it will get factored in very soon.