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A double whammy for the sector?

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20170930ep01As expected, the August 30 meeting called by the Department of Pharmaceuticals (DoP) to discuss the Draft Pharmaceutical Policy 2017 saw a laundry list of recommendations from representatives of pharmaceutical companies and associations.

While the Indian Drug Manufacturers’ Association (IDMA) gives the thumbs up to seven proposals, their written submission states that ‘the general impression from the Draft Policy is that the government wants to increase the span of price control through direct and indirect measures’. The letter calls for a ‘liberalisation of pricing policy and procedures ’ and also quotes the Niti Aayog’s Three Year Action Agenda, which recommends that the DPCO be delinked from the NLEM.

IDMA’s recommendations have some interesting points. For instance, one suggestion is that the production of key starting materials, critical intermediates and fermentation-based products can be taken up by pharma PSUs, maybe in partnership with private firms or joint ventures. Given the move to shut down pharma PSUs, this could be a good way to reduce the dependence on imports of APIs, especially from hostile countries like China, as well as ensure a steady supply of affordable quality APIs. The crucial role of pharma PSUs in the Make in India story, is highlighted in our cover story in the September 16-30 Express Pharma issue (See story: Make in India: The story so far). The story reviews the scheme two years after its launch but finds that the pharma sector has nothing much to show, inspite of being one of the focus areas.

The cost of quality could also increase if the draft proposal to implement BA/BE studies for class II and IV drugs is passed. On the trade front, IDMA also points out that restricting margins at the retail level will discourage chemists from stocking generics, especially in rural areas where the overheads are larger than the sales.

Financial analysts at Motilal Oswal have predicted that the draft policy in its current form can lead to a ‘double whammy’. A report dated September 7 analyses that that an enhanced focus on quality control, along with a shift toward trade generics, can lead to a significant contraction in the EBITDA margin (currently at 30-40 per cent) for domestic pharma companies.

The domestic pharma business’ rich valuation of 25-30x one-year forward P/E due to strong profitability, stable revenue stream and high RoEs will also be eroded. If the cost of quality increases and revenue/margins contract due to a shift toward trade generics, then it will be a double-whammy (shrinking profitability and valuations) for the domestic business. With the US business of mainstream players already under pressure due to a challenging growth outlook, this draft policy (if implemented) can lead to further pressure on profitability and valuations. But the crunch on margins could lead to an interesting fallout. The Motilal Oswal analysts opine that this pressure could, in the medium term, lead to consolidation in the sector, benefiting the bigger players.

The signs are clear that the pharma industry, both domestic and MNC companies, are united on their objections and will not accept the draft policy in its current form. But the Government too cannot back down entirely from its pro-people stance. Who will blink first?

Viveka Roychowdhury

[email protected]

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