PHARMACEUTICAL SECTOR- A CONTRAST BETWEEN MNC SUBSIDIARIES AND INDIAN PLAYERS

Transcription

1 PHARMACEUTICAL SECTOR- A CONTRAST BETWEEN MNC SUBSIDIARIES AND INDIAN PLAYERS The Rs.150 billion (US$ 3 billion) Indian pharmaceutical industry is characterised by an even presence of both the Indian pharmaceutical majors and subsidiaries of leading global pharmaceutical giants. A CRISIL study based on its vast experience of rating the entities in the pharmaceutical sector for over a decade reveals interesting findings about the business and financial profile of these entities. While each of these companies have their own unique competitive strengths in this highly fragmented market, sharp contrasts do exist in the business and financial profiles of the two sets of companies the Indian pharmaceutical majors and the MNC subsidiaries. A trend analysis of the financial profiles of these companies also highlights the key issues driving change in this sector over the past decade. While Indian companies have outscored MNC subsidiaries on parameters such as growth and operating margins, MNC subsidiaries have fared better on parameters such as ROCE, gearing and debtors as days sales. Export thrust and aggressive new product introductions have been the prime contributors to growth in operating income for the Indian companies, while focus on high margin specialty therapeutic segments and strong process engineering capabilities nurtured by the process patent regime have provided them superior operating margins. Absence of export opportunities, though has led to relatively lower growth and operating margins for MNC subsidiaries. This has also meant low investments in manufacturing facilities and R&D, and lower working capital requirements, thus resulting in lower gearing levels and higher ROCE levels for them. Scope of the Study The study is based on the financials of 20 leading companies (10 Indian and 10 MNC subsidiaries) in the Indian pharmaceutical sector for which CRISIL has executed credit rating assignments. These 20 companies account for around 40% share of the total pharmaceutical market by value. The companies studied also have a fairly significant share of the industry's pharmaceutical exports and R&D investments, and are therefore representative of the emerging trends in the industry. Revenue Growth: Indian Companies outpace MNC Subsidiaries in the Past Decade The domestic pharmaceutical industry has largely remained insulated from demand cyclicality and has thus witnessed growth rates in the region of 12-15% p.a. over the past decade. However, the industry has witnessed some sluggishness over the past couple of Operating Income(Rs Crores) Indian Cos MNCs Total YOY Growth in the Indian Pharmaceutical Sector Indian Cos MNCs Overall 35% 30% 25% 20% 15% 10% 5% 0% Page 1 of 6

2 years due to substantial price driven competition and demand slowdown in the antiinfectives segment, which is by far the largest therapeutic segment in the domestic market. An analysis of the growth rates exhibited by MNC subsidiaries and Indian players over the past decade reveals a distinct trend of divergence between the two sets of companies. While MNC subsidiaries have grown at around 10% p.a., Indian companies have grown at a high rate of 20-25% p.a. The key driving forces behind the high growth of Indian companies, in CRISIL s view, are the aggressive new product introductions especially in the fast growing chronic disease segments of cardio-vascular, respiratory, diabetology and neuro-psychiatry and a high emphasis on generic bulk and formulation exports. Strong process development skills and a benign patent regime have been the prime enabling factors for Indian companies in this regard. Also contributing to the higher growth of Indian companies have been the small brand/company acquisitions from time to time. The growth of MNC subsidiaries, on the other hand, has been largely constrained by limited representation of their parents' product baskets in the domestic market due to pricing constraints and inadequate intellectual property protection. Consequently, their product portfolio has remained restricted to old mature brands which though strong in their respective segments have witnessed only moderate growth rates due to greater competition from brands based on newer generation molecules. Limited export opportunities have also contributed to lower growth rates of MNCs in comparison with the Indian companies. Charting the International Waters the Indian Refrain One of the defining features of the past decade for Indian pharmaceutical majors has been an increasing internationalisation of business. Driven by their strengths in chemical synthesis and reverse engineering skills, many of the Indian companies have been able to successfully tap the large export markets for both bulk drugs and formulations especially in the Asia Pacific, Africa, Middle East and CIS countries. Exports as a percentage of sales have more than doubled from around 10% in 19 to over a quarter of sales in In sharp contrast to this, the export presence of MNC subsidiaries has remained limited to around 7-8% of the total sales over the past decade. Concomitant with the increase of exports as a proportion of sales, debtors have also risen during the period as a percentage of sales. Traditionally, higher credit terms have been a norm in the export markets especially since a sizable proportion of these exports are in the generic markets where credit terms are the second most important differentiating factor after price. For the Indian companies, the debtors as days sales have increased from a level of 60 days in 19 to around 90 days in while the debtor levels of the MNCs have remained low in the region of days. Exports as Percentage of Sales Indian cos MNCs Average 40% 35% 30% 25% 20% 15% 10% 5% 0% Debtors as Days Sales Indian cos MNCs Average Page 2 of 6

3 While most of the exports by Indian companies have been to the less regulated markets of Asia-Pacific, Africa, Middle East and CIS countries, some of the leading companies such as Wockhardt, Cheminor Drugs, Aurobindo Pharmaceuticals and Ranbaxy have begun to make successful inroads into the developed markets of USA and Europe. Considering the enormous growth opportunity opened up by drugs worth nearly US$30 billion going off patent in the US and UK markets over the next few years, an increasing number of Indian companies are expected to join the race for generic exports to these markets. CRISIL believes that Indian companies are ideally positioned to take advantage of these opportunities, given their inherent cost competitiveness and strong process development skills. However, these companies could face rough weather during their initial years in these markets due to intense competition from large established generic players like Teva Pharmaceuticals, Watson Laboratories and Kings Pharmaceuticals as well as from generic arms of established global pharmaceutical majors apart from legal wrangles with the patent holders trying to stretch the commercial life of their patents. Exports and Focus on Speciality Segments Drive Profitability of the Indian Companies A salutary feature of the industry has been the secular improvement in operating margins over the past decade. Driven by a higher proportion of exports and high margin specialty products in the product mix and lower DPCO coverage, the profitability of Indian companies continues to be better than that for MNC subsidiaries. The profitability of MNC subsidiaries has also shown a healthy improvement from around 10% to 16% over the past decade. A declining DPCO coverage for their products and reduced overheads on account of operational restructuring exercises such as Employee Voluntary Retirement Schemes and outsourcing of manufacturing from third parties have contributed to the increase in margins of the MNC subsidiaries Average Operating Margins Indian Companies MNCs Average % 20.00% 15.00% 10.00% 5.00% Given the strong brand franchise of MNCs in their segments of presence, CRISIL does anticipate their operating margins to remain buoyant over the short to medium term. As for Indian companies, CRISIL expects the operating margins to be under some pressure over the next few years as these companies increase their spend on R&D, and product registrations in the international markets. The success of the US and European generic market forays could then emerge as one of the key determinants of profitability for many of these Indian companies over the next few years. ROCE MNC Subsidiaries Score over Indian Companies Low capital intensity coupled with moderately high profitability has resulted in high return on capital employed (ROCE) for the pharmaceutical sector as a whole. Over the past decade, the average ROCE for the ROCE as percentage of (Networth + Debt) 45% industry has remained high in the 40% region of around 20%. However, the 35% 30% MNCs have outscored the Indian 25% companies on this count. Increasing 20% reliance on outsourcing, relatively less 15% 10% working capital intensive exports and Indian Companies MNCs Average Page 3 of 6

4 rising profitability levels have translated into a sharp rise in ROCE levels for the MNCs. For the Indian companies, the ROCE levels have remained stable as an increase in profitability has been offset by increased capital investments in R&D and manufacturing facilities necessitated to support the export thrust. Low Gearing A Defining Characteristic of the Industry So Far The pharmaceutical sector in India has historically been a relatively low capital intensive sector in comparison to certain other sectors of the economy such as Cement, Steel, Oil & Gas etc. This could be attributed to the brand franchise" driven business and limited investments in the R&D value chain. Reflecting this feature of the industry are the low asset base and the fairly low gearing levels of players in the industry. Moreover, the gearing has also shown a declining trend over the past decade. The decline was more pronounced between the years 1993 and 1995 when a lot of companies raised equity through public issues. Also, the gearing levels of Indian companies are marginally higher than those of the MNCs. This is primarily on account of a higher export thrust of Indian companies which has meant a higher level of debt funded capital expenditure for manufacturing, and higher bank borrowings for meeting increasing working capital requirements. While CRISIL expects the capital structure for players in the industry to remain favourable over the short to medium term, debt funded acquisitions in a scenario of increasing consolidation and greater capital investments in R&D and state of the art manufacturing facilities could result in an increase in gearing levels for some of the leading Indian companies. Ability to raise equity capital in a timely manner to fund these growth plans would then assume importance from a credit perspective. Waking up to a New Reality - R&D Matters Average Gearing Levels Indian Companies MNCs Average Internationally, the product life cycle characteristics of pharmaceutical products and the prevalence of product patents make it imperative for pharmaceutical companies to come out with a steady stream of new products on an ongoing basis, which in turn is critically linked to the company s R&D capabilities. Consequently, the top rung global R&D Expenses (Rs in crore) pharmaceutical majors like Pfizer, GlaxoSmithkline, 250 Novartis and Merck & Co. 200 typically spend around % of their annual revenues on 100 R&D efforts. In contrast, R&D 50 has traditionally not been an - area of focus for Indian Gross Block Comparison (Rs. Crores) Indian Companies MNCs Total Indian Companies MNCs Industry Page 4 of 6

5 pharmaceutical majors. Limited financial resources, absence of adequate patent protection and high risks associated with development of new molecules have been key constraining factors for R&D spend. Although, the Indian companies have increased their R&D spend over the past decade, it continues to be low at around 2-3% of their annual revenues. For Indian subsidiaries of MNCs, the R&D spend is abysmally low reflecting their limited mandate of representing their global parents in the domestic market. The role of R&D in the Indian pharmaceutical industry is, however, witnessing a dramatic transformation over the past couple of years with the emergence of opportunities for Indian players to participate in various segments of the R&D value chain of leading global pharmaceutical majors. Some of the Indian pharmaceutical majors like Dr. Reddys Laboratories and Ranbaxy have already made significant inroads in this regard. While Dr. Reddy s Laboratories has received milestone payments of $6.25 mn. from Novo Nordisk for two of its anti-diabetes drugs and has entered a tie-up with Debiopharm for clinical trials and registration of anti-cancer drugs, Ranbaxy Laboratories has received royalty payments of around $15 million from Bayer for licensing a single sustained release dosage form of Ciprofloxacin. As outsourcing arrangements such as these gain momentum, CRISIL expects R&D spend of Indian companies to increase to over 5% of annual revenues in the medium term. Consolidation Remains the Common Theme among the Indian Companies and Global Pharmaceutical Majors Consolidation appears to be a common feature of the pharmaceutical industry across markets globally. In the US and Europe, cost pressures driven by greater institutionalisation of healthcare and governmental pressures have heightened the need for rationalisation of the R&D efforts for global pharmaceutical majors. Coupled with this, the shrinkage of the product pipelines of some of the leading pharmaceutical majors has necessitated mega mergers and acquisitions at the global level over the past few years. The past one year has seen a slew of mega-mergers and restructuring initiatives at the global level - the $90 billion merger of Warner-Lambert with Pfizer, Glaxo-Wellcome s $76 billion merger with SmithKline Beecham, a $23 billion merger of Pharmacia & Upjohn and Monsanto, the divestiture of the agrochemical businesses of Novartis and AstraZeneca and their subsequent merger to form Syngenta. In tandem with this re-alignment at the global level, Indian subsidiaries of these pharmaceutical majors have also merged or restructured their businesses. Notable among the consolidation activites are the merger of GlaxoWellcome with SmithklineBeecham Pharmaceuticals and the hiving off of the agrochemicals division of Novartis Ltd as Syngenta India. The divestment of Aventis S.A's 40% stake in Rhone Poulenc (India) to Nicholas Piramal was also an offshoot of Aventis S.A.'s global re-structuring. As for the Indian pharmaceutical companies, the underlying rationale for consolidation appears to be the need to achieve a critical mass on the marketing and distribution fronts besides enhancing the therapeutic coverage. While large transactions such as Wockhardt's acquisition of Merind will continue to be few and far between due to the dominant promoter holding of Indian companies, CRISIL does anticipate a large number of brand / company acquisitions of a small to medium size as we get closer to the post 2005 product patent regime. The table below gives a list of brand/company acquisitions undertaken by the leading Indian companies over the past few years. Page 5 of 6

6 Company Year Merger/Acquisition Ranbaxy Laboratories 1996 Acquisition of Ohm Labs, US Acquisition of Rima Pharmaceuticals, Ireland 1997 Merger with Croslands Labs Buy-out of Gufic brands Acquisition of controlling stake in Vorin Labs Sun Pharmaceutical Labs Nicholas Piramal India Dr. Reddys Laboratories 1997 Acquisition of controlling stake in Caraco Pharma, US, Gujarat Lyka Labs and M.J. Pharmaceuticals 1997 Merger with Tamil Nadu Dadha Pharmaceuticals Buyout of Natco Pharma s brand portfolio Merger of Milmet Labs Merger of Pradeep Drugs Company Merger with Boehringer Mannheim and pharmaceutical division of Piramal Healthcare Acquisition of bulk drugs division of Sumitra pharmaceuticals Formation of joint ventures Reckitt Piramal, Sarabhai Piramal and with Boots, Allergan, Stryker etc Acquisition of R&D centre of HMR Acquisition of Aventis s 60% stake in Rhone- Poulenc Buy out of brands of Pfimex Pharmaceuticals, Sol Pharmaceuticals and Dolphin Labs Acquisition of American Remedies Merger of Cheminor Drugs Ltd with Dr Reddys Labs. Wockhardt 1997 Acquisiiton of Acumed Inc., US Zydus Cadila Healthcare Restructuring Driven by International Consolidation Acquisition of Wallis Labs, UK Acquisition of Merind De-merger of Wockhardt and Wockhardt Life Sciences Acquisition of controlling stake in German Remedies Limited Company Year Merger/Acquisition Hoechst Marion Roussel Merger with Roussel India Limited Novartis Formed by the merger of the life sciences businesses of erstwhile Sandoz and Hindustan Ciba Geigy De-merger of the agro-chemicals division of Novartis as Syngenta India GlaxoSmithkline Merger of GlaxoWellcome with Smihkline Beecham Pharmaceuticals Page 6 of 6