The leading Indian pharma companies operate from three main markets: India, the US and other emerging markets (EM). In our earlier Big Story on Indian Pharma, in June 2022, we highlighted the robustness of branded markets (India and emerging markets) compared to the challenges in US generics. We also discussed the various pathways companies are adopting to secure growth in the US through differentiated pipelines.
Here, we build on the argument and assess the market valuations assigned to US business vis-à-vis their pipelines to ascertain over- or undervalued opportunities.
How we valued the parts
Valuation assigned to India, the US and emerging markets, based on respective growth opportunities, are summed up to arrive at the fair value in the SOTP method of valuation. Inversely, by stripping value assigned to India and Emerging Markets (EMs) (by way of peer multiples), one can judge the value being bestowed on the remaining US business.
Companies focused only on Indian markets (Mankind, Eris, Abbott India and Sanofi India) are currently trading at a range of 18-36 times EV/EBITDA (trailing) with an average of 24 times. This valuation is on account of ‘branded’ nature of the Indian market with pricing power, unless interrupted by NLEM (National List of Essential Medicines). .
We have assigned 20-22 times EV/EBITDA to Indian businesses (a 10-20 per cent discount to average). The multiple is then applied to Indian segment’s EBITDA contribution. We have assumed Indian EBITDA margin to be 100 bps higher than company EBITDA margin. These assumptions are directional and may vary within companies.
The other two businesses consisting of emerging pharma markets sales and API business is valued at 12 times and 10 times respectively and EBITDA margin to be lower than company average by 100 bps considering volatility and non-core operations. Stripping out India and EM Enterprise value (EV) from consolidated EV, the EV assigned to US segment and hence the EV/EBITDA of the segment can be implied.
The resultant US business metric, EV/EBITDA, is then compared to US peers — either generics or innovators — based on the pipeline product mix of the companies. Companies operating primarily in US generics (Aurobindo from India, Teva, Perrigo, Viatris and Hikma) trade at a range of 7-15 times EV/EBITDA (trailing) with an average of 10 times. The constant price erosion of US generics is well reflected in the valuation range.
At the other end of the spectrum are Innovator companies that trade at 10-30 times EV/EBITDA, which is based on the patent cliff timeline, portfolio in ramping stage and pipeline expectations. Novo Nordisk (29 times EV/EBITDA) and AstraZeneca (22 times) are trading at a premium, compared to Merck or Roche (12-15 times range). Pfizer and Sanofi (the MNC) with weakly perceived pipeline replacing patent losses are trading at 6-9 times EV/EBITDA.
Based on the above assumptions, here is what our analysis of the valuation of the US business of 5 Indian pharma companies reveals:
Cipla: Undervalued, but overhang from plant issues
Cipla’s implied valuation for US business may be in the range of 4.5-8.1 times EV/EBITDA, which is below the benchmark. US business delivered 17 per cent CAGR growth in preceding five years compared to India’s 11 per cent CAGR growth at Cipla. Even ignoring the strong growth (ascribed to one-time gRevlimid bump-up in FY23), the strong pipeline makes the case for valuing Cipla’s US business higher, with plant status as the spoiler.
Along with two respiratory product launches, two peptide launches and gRevlimid launch have boosted US performance. The pipeline includes five respiratory assets of which three have been filed, one complex generic and four peptide injectables. The respiratory pipeline includes gAdvair with end market sales of above $700 million, despite three generic launches so far. The overall pipeline falls on the higher end of complexity spectrum, which implies a lower than ‘plain generics’ level of erosion and higher margins. This should support Cipla’s US segment valuation in the 10-12 times EV/EBITDA range that speciality generic manufacturers command, including Perrigo.
Dr Reddy’s and Zydus Lifesciences: Fairly valued
Dr Reddy’s has been a US-centric business along with fair contribution from EMs, mainly Russia and CIS countries. Implied US business valuations range 7.5-8.4 times EV/EBITDA which, in our view, is fair, considering the pipeline.
Dr Reddy’s 180-day exclusivity window, in an already lucrative gRevlimid opportunity, may close in Q4FY23. But post-exclusivity it should still generate sufficient cash flows in FY24. The company aims to launch 25 products in FY24 (launched 25 in FY23). The launch number is barely sufficient to offset the expected annual erosion of 8 per cent in the base portfolio, which is now around $1.2 billion per year. If the company manages to augment value added products (similar to gNexavar, gVasopressin last year) in launch-mix, it may possess a fair chance of reporting growth in the US.
Dr Reddy’s has a strong OTC presence even in the US, which it intends to expand from 4 to 15 in the next few years. Cross-leveraging its biosimilar base, currently marketed in EM primarily, is under way. One partnered product is about to launch in the US and one more is expected to be filed A few more biosimilars are in the pipeline.
The well-rounded US generics strategy of Dr.Reddy’s — numbers to offset erosion and complex products to secure growth — matches its implied valuation (8 times EV/EBITDA). This has evolved after the company wrote off its proprietary development plan for US markets and chose the safer approach.
Zydus’ US business trades at 11-12 times EV/EBITDA. Incidentally, the segment outlook is also similar to Dr.Reddy’s: a whole lot of simple generic launches along with a few complex launches. But the company has a background in unveiling complex limited competition products regularly, which explains the slight premium to Dr.Reddy’s. Current mix includes Asacol HD, gRevlimid and Topiramate, which can be classified as complex similar to the five launched in previous years. But in the current plan, Zydus seems intent on delivering high number of launches (planned 30-35 launches per year) including complex products, which should comfortably offset the single-digit erosion in the base of $926 million in FY23.
Zydus’ current mix, along with filings for five more complex launches in next few years, should sustain mid-single digit growth in US segment despite erosion in base portfolio. With recent clearance for its Moraiya facility, the company can unlock its complex product pipeline, including transdermal products along a new solid dosages facility to support the high launch plan
Zydus also bears a strong New Chemical Entity (NCE) optionality, even though not included in valuation. The company’s in-house product, Saroglitazar, is under Phase II(b)/III clinical trials in the US for PBC (primary biliary cholangitis). Saroglitazar is a leading driver in India, approved for NAFLD and NASH — indications related to inflamed liver conditions.
Sun Pharma: US Valuations akin to innovator business
Assuming India valuation range of 20-22 times EV/EBITDA, Sun Pharma’s US segment’s implied valuation ranges 26-28 times EV/EBITDA. Even assigning 25 per cent premium to multiples in India, EM and other business, on account of market leader status, the implied EV/EBITDA range of US descends only to 20-22 times EV/EBITDA.
This valuation range of 20-30 times is applied to innovator companies in their up-cycle stage. Global speciality revenues (largely from the US) of Sun Pharma account for an average of 75 per cent of US sales, excluding Taro in FY23, and are growing at 26 per cent YoY. This is double the US revenue growth rate in FY23. This implies that the valuation range and the revenue contribution are in line and pointing towards a high speciality mix, which justifies the valuation range
Even within the ‘innovator’ bracket, the upper end of the valuation range can be attributed to the ramping stage of the portfolio and strong replacement value in the pipeline. The current speciality portfolio is led by Ilumya (approved for Psoriasis), Cequa (dry eye disease), Winlevi (acne) along with Odomzo, Levulan, and Absorica. The largest Ilumya is expected to reach peak sales of $500-700 million in the next two years.
The pipeline, on the other hand, is led by deuruxolitinib, a best-in-class asset for alopecia treatment, which has cleared Phase III stage and acquired as part of Concert Pharma for $576 million. The asset though has faced SAE (serious adverse event) in further trials recently but is not expected to be a major impediment. Ilumya is also undergoing Phase 3 trials for Psoriatic arthritis. The other pipeline includes assets for Atopic dermatitis (Phase 2), pain (Phase 2), and even a GLP asset for diabetes (Phase 1) which is most lucrative pathway in diabetes currently.
Lupin: Strong expectations drive overvaluation
Lupin’s US business bears implied valuation range of 26-28 times EV/EBITDA, which is in the overvalued range for the complex generics pipeline of Lupin.
At the current juncture after reporting lowest sales growth amongst peers in last five years and lowest EBITDA margins strong recovery is expected. gSpiriva, a respiratory asset with end market sales at $700 million and a three-player market, is expected in H1FY24 (after a few rounds of delay).
Also, gDiazepam gel, gNascobar spray, gDarunavir and gBromfenac, expected in FY24, should help rebound flagging sales in the US. Similarly the pipeline further down can veer towards high value injectables and inhalation assets with R&D focussed on such assets. A biosimilar approval and launch is also expected for Lupin in FY24-25.
Outside of pipeline assumptions, recovery of margins also seems to be built into the current overvaluation. Lupin’s management expects close to 300 bps improvement in EBITDA margins by FY24 to 15 per cent and further improvement to 18 per cent in FY25, compared to 12 per cent currently in FY23. The strong launch plan and ongoing cost savings plan do support assumption of margin recovery, but the valuation expectation based on the same would be stretched.
What investors should watch out for
Given the over/under valuation, investors need a calibrated approach to position oneself in the stocks. In case of Cipla, the way plants regulatory status unravels will have a bearing on the stock. Meanwhile, de-risking launch schedule by transferring products or additional competition in gAdvair will aid or hurt the valuations respectively. Dr Reddy’s and Zydus Lifesciences, though fairly valued currently are heading towards a glass ceiling of sorts.
As the portfolio size increases to $1.5 – 2 billion a year, assuming $3-4 million per plain generic launch, the two would need 40 launches per annum just to report flat earnings growth in US. This would imply a high regulatory oversight and execution risks, just as Aurobindo faced in the last two years.
Lupin’s overvaluation is riding on strong launch schedule to revive earnings growth and also to scale-up margins. The pipeline should deliver on expected lines, timing and market share gains wise, to support the valuations. Delay in product approval, any new plant issues or announcement of new competition can impact the precarious valuations.
Sun Pharma’s current set of products sold in the US and the pipeline under development support the innovator-level valuations for the business. As explained, innovator valuations can swing from single digit to 30 times as pipeline is exhausted or replenished. Ability of Sun to consistently replenish the portfolio pipeline without straining its financials (in form of oversized acquisitions) is crucial to support the valuations.