Drugmakers With Exposure To Essential Medicines May Record Best Growth In Years

After years of moderate margins due to limited price hikes, drugmakers with heavy exposure to essential medicines are expected to register better growth.

The government approved a 10.8% hike in the price of essential drugs regulated under the Drug Price Control Order, 2013, in line with the Wholesale Price Index effective from April 1. However, the actual impact on the numbers was seen from June 1 due to channel inventory. As a result, the full impact will be reflected second quarter onwards, improving margins in the regulated drug portfolios.

"While we were always hyper-bullish on India branded generics, we are even more bullish right now due to price hike allowed to NLEM-heavy companies," said Aditya Khemka, fund manager, InCred PMS Healthcare.

Khemka is optimistic about even more hikes. "The current year January to August year-to-date WPI is at around 14%, indicative that the permissible price hike in the coming year could be around 11%-12% in April 2023," Khemka told BQ Prime.

By comparison, in fiscals 2018-22, companies manufacturing scheduled drugs covered under NLEM were allowed 0.5-4.2% year-on-year hike based on the WPI of the preceding calendar year—which is representative of inflation in the country.

The Math Behind Potential Growth

Citing the example of FDC Ltd., Khemka said that the company has NLEM exposure to the extent of 45%.

"A 10% hike on this 45% of business would result in growth of around 5% year-on-year and on the remaining portfolio. Even if it were to register a 3% growth (considering 5% year-on-year price hike on the non-NLEM basket), the overall growth of the company led by pricing would be at around 8%," he said.

Comparing this to Eris Lifesciences Ltd., that has around 10% exposure to NLEM, he said that 1% year-on-year pricing-led growth would come from this portfolio, and around 4.5% from the remaining non-NLEM portion, leading to an overall growth of 5.5% year-on-year due to pricing.

While the price cap for drugs not falling under the NLEM is at 10%, the 5% year-on-year growth on the non-NLEM portfolio is considered taking into account competitive pressures.

However, Khemka cited RPG Lifesciences Ltd. as a possible exception. Competitively, the prices of RPG drugs are lower than that of peers at current levels and this may allow the company to take a price hike of around 10% on both NLEM and non-NLEM portfolio, possibly allowing it to register higher growth in the coming year, he said.

According to public disclosures, InCred Healthcare owns stocks such as Indoco Remedies Ltd., RPG Life Sciences Ltd., IPCA Laboratories Ltd., FDC Ltd., JB Chemicals and Pharmaceuticals Ltd. and Torrent Pharmaceuticals Ltd., that have high exposure to India branded generic business.

Easing Inflation

Khemka expects margin benefits to accrue to Indian pharma companies from easing of inflationary cost pressures in FY24.

According to him, most of these companies rely on imports for raw materials. Freight costs have eased by 40-45% as compared to last year, he said.

Most of the raw material exporting pharma companies in China are energy intensive with 70% reliance on thermal power. As coal prices come off, raw material prices are expected to come down reducing input import costs for Indian companies, Khemka said.

"While they may not go back to pre-Covid levels, import costs cooling off coupled with price hikes will provide a double leverage to Ebidta margins."

Smaller Firms May Choose Volume Push

While bigger companies and established brands may take price hikes, as allowed under the government-set limits, smaller players may see this as an opportunity for price competitiveness and subsequently, prefer focusing on volume growth, said Abdulkader Puranwala, pharma analyst at Elara Capital.

"Smaller companies may want to expand market share," Puranwala said.

While the price hikes from September FY23 onwards may have an impact on margins, it's too early to comment for FY24, he said.

Back-to-back price hikes are a "never-seen-before" phenomenon and therefore, "one cannot be sure of whether the government will allow the hike and whether the pharma companies will actually take a subsequent hike next year", Puranwala said.

According to Vishal Manchanda, pharma analyst at Systematix, while the price hike provides respite to costing pressure faced by pharma companies during Covid-19 from supply chain disruptions, if inflation were to ease in FY24 they may choose to not take the benefit of the WPI inflation-linked hike because of competition.

Deepak Jotwani, assistant vice president and sector head at ICRA, said that inflationary cost pressures over the past year prompted most companies to take price hikes in order to protect margins.

According to Jotwani, the government, too, allowed such hikes on essential medicines partly as compensation towards high raw material and sourcing costs. Thus, companies with high exposure to NLEM will gain from surging prices in FY23. However, subsequent growth is a function of the therapeutic areas the company is present in, geographic mix and product portfolio, Jotwani said.

"In FY24, it is to be seen whether government permits a similar hike on essential medicines and whether pharma companies opt for price hikes if cost inflation normalises."

(Names of companies in PMS Healthcare portfolio are for representative purposes and not a buy/sell recommendation. InCred PMS Healthcare may or may not have interest in the stocks mentioned.)