Sector downgrade hits pharma stocks

CLSA sees pressure on profit margins in the generic business

Pharmaceutical stocks have crashed in the last two trading sessions on aggressive selling after foreign broking firm Credit Lyonnais Securities Asia (CLSA) downgraded the sector, citing margin pressure in the generic business.

Domestic pharmaceutical majors such as Ranbaxy Laboratories, Dr Reddy's Laboratories, Cipla, Wockhardt, Sun Pharma and the recently listed Biocon has lost more than four per cent in just two trading sessions.

Ranbaxy was the biggest loser crashing 8.8 per cent, while others such as Lupin was down 6.74 per cent to Rs 629.75, Dr Reddy's down 4.72 per cent to Rs 753.35, Wockhardt down 4.90 per cent to Rs 250 and Cipla down 2.43 per cent to Rs 210.9 were the biggest losers in the last two trading sessions. These stocks were regarded as defensive shares.

Ranbaxy Laboratories was hammered for the second consecutive day with the stock down 5.7 per cent to close at Rs 910. The stock hit a low of Rs 908.50. Biotech major Biocon slipped 2 per cent to Rs 499.

CLSA had downgraded pharmaceutical stocks which are focussing on the US generic market, citing increasing competition and pressure on profit margins in the generics business.

The report says, "The profit pie has shrunk. The arguments of increasing pressure on governments to cut healthcare costs and huge patent expirations remain and these would definitely keep the generic industry on a growth path. There is a large number of drugs that are going off-patent over the next 8-10 years and the number ranges between $70-80 billion.

"However, we think that the potential of this $80 billion brands that translate into a generic opportunity has diminished. To put it differently, if we look at the potential generic opportunity of this drugs for the next 8-10 years and that two years back, the value of what we see on Friday is definitely lower than what was two years back. This is because of authorised generics, shared exclusivity and more competition from India.

"We are not writing off the Indian pharmaceutical theme. We continue to believe that the sector led by Ranbaxy would deliver long-term growth on back of the competitive advantages but growth would much lower than expected and hence valuations need to adjust. We are also not concerned on the earnings in the near-term."

The rapid commodisation of the generics market and the rising number of Indian players which are competitively positioned make it difficult to sustain margins, the report said.

An institutional dealer with a domestic broking firm said, "The pharmaceutical stocks were hammered as the sentiment turned bearish after the CLSA downgraded the sector on Wednesday."

Domestic pharmaceutical firms have witnessed a smart rally in the last one month in anticipation that those companies focussing on the US generic market are going to benefit post-2005 with the number of drugs going off-patent in the coming years, the dealer said.

The CLSA report also stated that the long-term growth would accrue for Indian pharma companies in the generics market given their competitive advantage in terms of low manufacturing costs, but the valuations of pharma firms appear stretched vis-a-vis a lower than expected growth.