Sun Pharma wants to rise on niche route

Lost 50% market value in 2 years due to competition

At 61, Dilip Shantilal Shanghvi has seen many cycles since he started Sun Pharmaceutical at Vapi in 1982 with just Rs 10,000. Almost 35 years later, Shanghvi is falling back on the same strategy of building a portfolio of niche products as competition erodes the pharma major’s profitability in its most important market — the US.

Investors in Sun Pharmaceutical have lost about Rs 25,000 crore in the last two weeks since its US subsidiary Taro Pharmaceutical announced a 32 per cent annual decline in net profit to $83 million for quarter ended March 2017. Net sales for the subsidiary declined 26 per cent to $196 million for the period. Parent Sun Pharmaceutical followed a similar trend, reporting a 17 per cent decline in consolidated net profit to Rs 1,385 crore. Net sales for the period dropped 8 per cent to Rs 6,825 crore. But what has hit the company’s stock the most is the bleak outlook for the generic business in the US.

“The US generic industry is facing rapidly changing market dynamics,’’ Shanghvi told investors in a post-result conference recently. 

Increased competitive intensity and customer consolidation are leading to pressure on pricing, he pointed out. Sun Pharma, with its 45 per cent revenue coming from the US market, has experienced its operating profit margin (PBDIT) declining to 26 per cent during the quarter ended March against 49 per cent of the sales three years ago.

What’s gone wrong

When Shanghvi spoke of change in dynamics, he was perhaps referring to the American drug regulator — USFDA — speeding up the product approval procedure, resulting in a higher number of generic drugs getting the nod. Consolidation among distributors, who buy from generic makers, has only added to the stress.

In fact, the distributor space in the US has shrunk to just a couple of big players who command the price at which they want to buy generics. So, the list of companies getting approval for selling these drugs is longer, while the product price is increasingly heading south. In the bargain, established players are facing erosion in both sales and profitability.

Even as the big picture in the generic or what some refer to as the copycat market was changing fast, Sun Pharma’s Halol plant continued to be under USFDA watch, hitting its sales and profitability in the biggest international market. The Halol facility, in Gujarat, catering to the US market, first received a warning letter from the American regulator in 2015. The regulator found breaches at the plant even after remediation work by the company last year. Foreign brokerage CLSA said half of 157 ANDAs (abbreviated new drug applications) pending approval for the company are filed from Halol. The brokerage expects resolution of the issue in the next financial.

Investor panic after bleak outlook

Analysts pointed out that investors sat up when the company shared its outlook for the current financial year.  “Growth would be a challenge in FY 18 and we may even have a single-digit decline in consolidated revenues for FY18,” Shanghvi said. He added, “Despite these challenges, we continue to invest in enhancing our global specialty and complex generic pipeline.” However, these investments may not have commensurate revenue in FY18, resulting in a dim outlook.

The 15-year dream run of 30 per cent compounded annual growth rate for the company that ended in 2016-17, had not only made the company’s founder Dilip Shanghvi India’s richest man but also created fortunes for millions of investors. The downfall in company’s stock has pushed his position to number six in the richest Indians’ list. It has also disappointed investors as company’s market value has slipped by around half to Rs 1.21-lakh crore on the BSE, down from an all time high of Rs 2.42-lakh crore on  April 6, 2015.

Looking back for success

Shanghvi is now revisiting his earlier strategy of getting into niche products to ward off competition. That’s the route he took while starting off, making niche drugs for psychiatry treatment to avoid powerful competitors such as Cipla and Ranbaxy (now acquired by Sun) who were busy making anti-infectives and drugs for gastrointestinal therapies back then.

Rather than fighting domestic and foreign incumbents in large therapies, Shanghvi had focussed on specialty and chronic therapies such as psychiatry, cardiovascular, neurology, oncology and dermatology to build his empire. The revenue opportunity in these drugs was small to begin with, but less competition translated into higher margins that provided Shanghvi the resources to reinvest in the business.

Shanghvi used Sun Pharma's superior profitability to crank up the growth engine through strategic acquisitions, first in India and then in the US through the acquisition of Caraco in 1997. Now again, Shanghvi is relying on the same strategy of niche products to beat competition. Though this time he is getting into specialty segment--patent drugs for niche therapies and complex generics (off-patent)--which require high cost of research and development, providing cushion from competition.

Looking ahead

With the company’s balance sheet having $1.5 billion cash and cash equivalent, it is ready to support Sun Pharma’s plan to build a differentiated portfolio of specialty drugs through both organic and inorganic routes, sources said.

The company recently introduced specialty products BromSite (ophthalmic) and Odomzo (skin cancer) in the US. A stronger ramp-up for these drugs along with progress on other specialty products including Tildrakizumab (expected launch in FY19 ) and Seceria (potential launch in late FY19) could provide confidence on specialty initiatives by Sun.

“Sun Pharma continues to invest in building specialty business, but is likely to see meaningful revenue from FY19 onwards with breakeven in FY20,” according to Neha Manpuria, analyst with J P Morgan. “The earnings pressure from elevated R&D (9-10 per cent of sales) and specialty infrastructure spend should keep earnings under pressure in the near term,” she said.