No ceiling on prospects

While the overall impact of the new pharma policy will not be very harsh on the industry, the price ceiling based on the simple average may cut into bottom lines of many local and MNC drug companies

No ceiling on prospects
The main feature of the national pharmaceutical pricing policy (NPPP) is that it brings in 348 essential drugs formulations under price control. The new policy proposes to move to a mechanism of market share-based price ceiling compared with a cost-based price ceiling proposed earlier. The new policy said that addition of any new ingredients to original formulations, in any of these 348 essential drugs, would come under price control and the drug makers would require separate approval from the regulator for the same.

This is in contrast to the earlier recommendation of free pricing of new combinations of essential drugs.

The drug regulator will now review prices periodically compared with an earlier recommendation of a five-yearly frequency. The ministry of chemicals and fertilisers in a note on Friday confirmed that the list also contains anti-cancer drugs. On Wednesday, the department of pharmaceuticals informed the Supreme Court that it will notify the new pharmaceutical pricing policy in around two weeks. While more details of the policy are yet to come, the NPPP proposes to use a simple average price mechanism to decide the ceiling on prices of these 348 drugs, which have a market share of more than one per cent and are in the national list of essential medicines (NLEM), compared with the weighted average price (WAP) mechanism proposed earlier.

Market analysts say the price ceiling policy based on simple average may spell more trouble for the drug makers than the WAP mechanism. But the overall impact on the sector would have been more, had the government adopted a cost-based ceiling instead of the market price-based ceiling.

“The recent decision with respect to the NPPP 2011 will not have any significant negative impact on the earnings and profitability of the pharmaceutical sector as a whole. This is due to the geographical diversity associated with the sector’s earnings. Larger companies with diverse and wider product portfolios, revenues and profitability would be able to make up for any losses due to the NPPP with the other products in its portfolio. However, pharma multinationals as well as mid-sized and small companies, whose revenues are mainly domestic market based, could take a hit on revenues and profits. The extent of this will depend on the weightage of sales from the products under price control,” said Ashwini Picardo, associate director for corporates at India Ratings & Research.

The 348 drugs under NLEM are expected to cover 17 per cent of India’s retail market, which is valued at $12 billion. Earlier, 74 drugs were under price control under the Drugs Prices Control Order 1995.

“We believe the overall impact on the domestic industry’s profitability is likely to be less than five per cent. While it is difficult to gauge the precise impact of the policy on individual firms, MNC companies will see higher erosion in profit compared with their domestic counterparts with a more geographically diversified portfolio. Additionally, it will become difficult for the pharma players to circumvent price controls through minor modifications to existing formulations,” analyst Princy Singh of JP Morgan said in a note.

The policy is expected to be negative for companies like Cadila and Dr Reddy’s Lab.

“We carry our analysis based on a sample of 35 stock keeping units (SKUs) and compare the impact based on a weighted average method and an arithmetic-average method. Overall, we believe the impact of using the arithmetic average is about 22 per cent more than that of the weighted average. However, our analysis shows the incremental impact at the company level would vary significantly. It is likely to be more negative incrementally for Dr Reddy’s, Glenmark and Cadila,” said Saion Mukherjee and Aditya Khemka of Nomura India.

SC had objected to the NPPP proposed by the government in 2011, in which a group of ministers (GoM) proposed to have price ceiling based on the WAP of top three brands.

In September, the GoM modified the policy and recommended the WAP-based price ceiling for all brands (which means a bigger sample) having a market share of more than one per cent.

However, the finance ministry raised concerns and asked the GoM to further rectify the policy, resulting in the adoption of the simple average price mechanism.

“We feel the stance of the Supreme Court on the policy is very important in order to implement it smoothly. In case of a favourable stance by the apex court, the policy is likely to be implemented shortly. However, as we understand, in the previous hearing, the court had asked the government not to tamper with the existing cost-based pricing mechanism to determine the price of essential medicines. In this context, it is very important to see what stance SC takes on the new policy, which is based on market-based pricing,” said Amit Shah of Prabhudas Lilladher.

Last Thursday, the Supreme Court said it would examine the policy after it is notified.

Manoj Garg of Edelweiss Securities believes that the present proposal is incrementally negative for the industry, but its impact is manageable and is less severe than what was anticipated earlier.

“Moreover, with all differences resolved within the ministry, the likelihood of using the market-based pricing is high. We estimate the value loss under the simple average method at 4 per cent of the total domestic market versus 2.5-3.0 per cent under the earlier proposal for a weighted average pricing (brands more than 1 per cent market share). The impact on Cipla and Cadila will be 5.7 per cent and 5.9 per cent, respectively, while on other players it would be between 1 per cent and 4 per cent. The impact on the earnings of MNCs is likely to be higher (GSK 19.8 per cent, Ranbaxy 7.4 per cent). Glenmark, Lupin and Sun Pharma will be least impacted,” Garg said.

However, his estimates include only direct price cuts and do not factor in the indirect impact, which could be because of price increases and reassessment of portfolios by the industry players.

Stock performance

The new policy has brought some respite on the pharma counter, where the scrips have gained anywhere between 0.50 per cent and 20 per cent since the policy was announced.

Strides Arcolab, IPCA Labs, Wochardt and Dr Reddy’s have gained 19.9 per cent, 7.91 per cent, 5.04 per cent and 4.06 per cent, respectively since November 22. Cadila, Glaxosmithkline, Lupin and Biocon added 2.07 per cent, 1.98 per cent, 1.92 per cent and 1.90 per cent, respectively. Glenmark, Aurobindo Pharma, Cipla and Divis Labs have also clocked marginal gains.

“The domestic pharma companies continued their strong performance owing to new product launches. In our view, increasing market share for revenue growth and improving operating profit margins will continue to sustain the earnings momentum and in turn give good returns to investors. We reiterate our positive view on the pharma sector and highlight Glenmark, Dr Reddy’s and Lupin as our preferred picks,” said Barclays analyst Balaji Prasad. zz



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