Margin Pressure Won't Ease For Makers Of Two Key Drugs

"Elevated raw material import prices, U.S. pricing pressures owing to buyer consolidation, and revival in travel and marketing costs post-Covid will continue to negatively impact margins of drugmakers in FY23 by 200-250 basis points," Aniket Dani, director at Crisil Research told BQ Prime.

"This is despite passing on some of the cost increase to customers," he said. "Most of these companies have taken a price hike of 6% to 8% this year."

Several key antibiotic active pharmaceutical ingredients or key starting materials such as Pen-G, 7ACA, Clavulanic, Amoxicillin, Metronidazole continue to remain elevated, according to an Aug. 18 report by IIFL Securities. The moderate correction seen in prices of certain APIs might not provide any enough room to help Indian pharma companies in the near term, it said.

IIFL Securities' analysis of import pricing for 16 key APIs/KSMs shows that costs moderated by about 2-2.5% in July after having increased by about 35-40% since pre-Covid levels.

These 16 API/KSMs are used across antibiotics, anti-infectives, neurology, cardiac, diabetes, and vitamin segments, the report said. India's dependence on China for these inputs varies from 60% to 100%. Nine of these APIs/KSMs are also part of India’s proposed production-linked incentive scheme, it said.

The scheme is aimed at reducing reliance on China for bulk drugs.

Many drugmakers were optimistic that moderation in raw material cost would reflect on their margins from the second half of the current fiscal as 70-80% of the high-priced API inventory has already been consumed. But IIFL Securities' analysis showed there has not been any meaningful cost reduction.

Imported input prices will remain elevated for FY23, said Dani of Crisil Research. Even from FY24, he said, the raw material import prices will stabilise at higher than pre-Covid levels despite push from the PLI scheme.

"Raw materials prices that have gone up by 30% to 150% during Covid-19 will remain elevated till supply disruptions ease and inflation comes down," he said. "They may, thereby, not come back to normal levels in the medium term."

Some of the companies had spoken of easing of input pricing pressure:

• Granules India Ltd. in its first-quarter concall had indicated that paracetamol prices have seen some normalization as one supplier in India has started supplying, and one domestic and two Chinese suppliers are working towards supplying soon.

• Aurobindo Pharma Ltd. that imports from China in its post-earnings concall had indicated that its gross margins should improve from third quarter on the back of improving freight and raw material cost.

• Alkem Laboratories Ltd. that relies on critical Chinese imports for use in antibiotics and neurology said in the earnings call that while its first-quarter gross margins were impacted around 2.5% due to material cost, they are now seeing a softening. Although it has not come back to its original position, the management said "Going forward, we'll start getting benefit of this raw material cost."

Import price of Penicillin-G—a key starting materials for several antibiotics in India—shot up from $19-20 per kilogram in calendar year 2021 and $7-8 per kg during pre-Covid times to $33-34 per kg over the past four to five months, according to IIFL Securities.

Similarly, prices of other antibiotic APIs/KSMs such as 7-aminocephalosporanic acid, clavulanic, amoxicillin and metronidazole have sustained at elevated levels and have increased by around 1-2.5% in July 2022 from Q2CY22 levels.

"This might continue to present cost and margin headwinds for players with sizeable acute portfolios such as Alkem Laboratories, Ipca Laboratories Ltd., Alembic Pharmaceuticals Ltd., Zydus Lifesciences Ltd., Dr. Reddy’s Laboratories Ltd. and Cipla Ltd," the brokerage said.

The few APIs/KSMs such as erythromycin, azithromycin, PAP, artemisinin, CDA, DCDA that have seen price correct by 3-10% in July is not much, the brokerage said.

"We believe this marginal correction in API prices is unlikely to provide any material margin benefit to Indian pharma companies and these players remain largely dependent on passing on these cost increases to customers through price hikes," the brokerage said.

The top picks by IIFL Securities are Cipla, Sun Pharmaceutical Industries Ltd., J.B.Chemicals & Pharmaceuticals Ltd. and Torrent Pharmaceuticals Ltd. It cited the lowest risk to their FY23 margin estimate.

For these companies, the impact of US price erosion on margins has been limited, the brokerage said. This is due to Sun Pharma’s specialty and Cipla’s respiratory portfolio and sustained strong growth in the India franchise for JB Pharma and Torrent, the brokerage said, aided by price hikes will provide margin tailwinds in H2FY23.

IIFL Securities said that if these cost pressures sustain, it sees maximum downside risks to the FY23 margin estimates for Alkem, Alembic and Ipca.

Margin improvement for Dr. Reddy’s, Lupin and Biocon is also contingent on scale-up in key US products, where there could be disappointments, the brokerage said.