Q1FY22: Domestic portfolio delivers for pharma majors; worry over US headwinds

BL Research Bureau

The first quarter results of large Indian pharma companies have disappointed investors, bringing the US pricing debate back into focus. Even as domestic sales grew strongly, the Nifty Pharma index has declined by 3.3 per cent since the start of the results season on July 23. The index constituents fared far worse. The Sun Pharma stock, which moved up by 13 per cent during the period, was the only exception, while the other stocks declined between 5 per cent (Cipla) and 24 per cent (Aurobindo Pharma). The extended rally of pharma stocks, which started last year, appears to have had a brief pit stop even before the Covid-related headlines abate.

Domestic growth driven by second wave

Sun, Dr. Reddy’s, Cipla and Cadila reported a sequential growth of 25-50 per cent in domestic sales in the June 2021 quarter, driven by the second wave of Covid during this period. During the second wave, which was far more widespread, the domestic portfolio of most companies included Covid-specific products, adding significantly to revenues. The period also marked an incremental return to hospitals by non-Covid patients, which drove new prescription growth in the base portfolio (products launched over a year ago). For instance, Sun Pharma and Cipla, which reported 24 per cent and 50 per cent sequential growth in Q1FY22 domestic sales, respectively, may have experienced an actual sequential growth of 16 per cent and 31 per cent, respectively, adjusted for Covid. Similarly, compared to the previous year’s first quarter, the average 60 per cent YoY growth reported for companies like Dr. Reddy’s, Cipla and Cadila may have been aided by base portfolio growth and Covid-related sales on an eroded base last year.

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The first quarter’s domestic performance, mainly for Covid sales, may in all possibility be a one-time event as inoculation rates keep improving. This may also prove to be a high comparable for future periods. But for specific companies including Cadila, Aurobindo and Dr. Reddy’s, the upcoming quarter may include the approval and/or ramp-up of vaccine-related sales ZyCoV-D, Vaxxinity and Sputnik V, respectively. More than first dose, these companies may have to rely on follow-on shots for opportunity, as India’s vaccination rate stands at 55 crore as on date and most first-dose vaccinations require using the same vaccine for the second dose.

US concerns

Most stocks, except Sun Pharma, reacted negatively to the results, sidestepping domestic strengths, as growth rates in the US may have raised concerns. A homogenous perspective on US price erosion may not be suitable for the segment any longer. The generics portfolios marketed in the US face pricing pressure depending on duration of competitive intensity, scope for new entrants and complexity, among other myriad factors. Even as companies need new launches to rejuvenate their portfolios, a weathered base portfolio may offer lower erosion. This invokes a tradeoff between margins and volume-based growth, which will differentiate the company’s performance. Compared with the same quarter the previous year, Sun Pharma, with a higher proportion of revenues from speciality products, and, to an extent, Cipla, with recently launched respiratory products, reported strong growth in the US. Aurobindo Pharma’s wide base of operations, including older generics, helped the company report a flat growth in the US (adjusted for a sold division), which it ascribed to higher stocking at all levels of the supply chain. Lupin and Dr. Reddy’s could not leverage their high-value launches due to transitory causes, while Biocon faced operational challenges in the quarter. Overall, the commentary from companies refrained from calling a bottom on the erosion and indicated that pockets of portfolio that offer sufficient margins will attract new entrants and sustain the pricing pressure.

The other critical risk that may have been factored into the stock prices was the start of US FDA plant inspections. Aurobindo received a Form 483 with seven observations for its Unit I, which were described as procedural. Many other companies including Lupin, Cipla and Biocon are long overdue for a product or plant-specific inspection. Given the chequered track record of plant inspections during 2018-19, which paused over the past year, the prices may have baked in a portion of the upcoming overhang as well.

Margins and PAT performance

The margin and adjusted PAT performance of the companies followed their respective performance in the US as Sun, Cipla and Aurobindo reported improved or sustained margins and PAT. On the other hand, the EBITDA margin contraction of Dr. Reddy’s, Biocon and Lupin (15 per cent adjusted for milestone) was noteworthy, owing to product mix, higher erosion and Covid-related supply chain challenges in the case of Biocon. While Dr. Reddy’s expects to return to its target of 25 per cent, Lupin expects headwinds to margins at least for the next couple of quarters. Many companies reported a strong control over operational expenditures over the past year on account of restricted movements, which may slowly recover to earlier levels. Even as margins are a function of product and geographic mix, operational costs may inch up, proving detrimental to valuations.

In all, the first-quarter performance brought to fore the strong potential of the US generics market consistently and selectively attracting new entrants; it also brought out the domestic companies’ need for faster turnover of new product development to hold on to some form of pricing power.

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