Pricing challenge in US biz, rich valuations may weigh on pharma stocks

The tailwind of low price erosion in the US generics market, seen by domestic pharmaceutical companies in calendar year 2023 (CY23), may be reversing slowly, caution analysts.

According to the latest data from US-based Centers for Medicare and Medicaid Services (CMMS), price erosion in calendar year 2024 (CY24) on a year-to-date (YTD) basis stood at a high of 15 per cent in the oral solid dosage (OSD) segment compared to a low of 1 per cent in CY23.

This erosion, according to a report by Antique Stock Broking, was the highest in the last three years.

Data for complex generics like injectables and inhalation drugs also showed a price erosion of 6-7 per cent each against positive numbers seen in CY23.

Among individual players, Aurobindo Pharma, Dr Reddy’s Labs, and Zydus Lifesciences sourced 48 per cent, 47 per cent, and 46 per cent of their total revenues from the US generics segment, respectively, in financial year 2023-24 (FY24).

Others such as Lupin, Sun Pharma, Cipla, Alkem, Alembic Pharma, and Glenmark Pharma, sourced 23-37 per cent of their revenue from US generics during the period, the brokerage's report said.

“With a large portion of the revenue base coming from simple generics, companies are likely to see higher erosion in their base business portfolio,” Monish Shah and Pranav Chawla of Antique Stock Broking wrote in their report.

Going ahead, the negative surprise of price erosion, analysts believe, is unlikely to improve for the remaining part of CY24.

This is despite higher approvals by the US Food and Drug Administration (USFDA), lower product withdrawals, less regulatory action, and higher number of launches by major Indian generic companies.

Analysts believe the high price erosion in the base business may get offset by Revlimid for most companies.

Revlimid is indicated for the treatment of multiple myeloma in adults.

Also, data from the CMMS only represents a fraction of the whole medicine sales in the US as Medicaid and Medicare beneficiaries constitute those above 65 and people with limited income and resources, they said.

“The data accounts for roughly 30-40 per cent of the total generics sales in the US.

"While the overall price erosion may not be in double digits but in the range of 5-8 per cent for FY25, it may go higher FY26 onwards,” said Mehul Seth, institutional research analyst at HDFC Securities.

Investment strategy

Given the price-related headwind and stretched valuation of the pack, analysts suggest selectively cherry-picking stocks from the pack.

Shares of Glenmark Pharma, Aurobindo Pharma, Zydus Lifesciences, Ipca and Cipla, for instance, surged 87.4 per cent, 87.3 per cent, 112 per cent, 60.7 per cent and 59.2 per cent, respectively, over the last one year.

It was led by limited-period drugs such as Revlimid and Sprivia. This, coupled with a stable pricing scenario in the US, resulted in significant re-rating for leading peers.

By comparison, the Nifty Pharma, and the Nifty50 index soared 47.7 per cent and 22.7 per cent, respectively, during the period.

“Considering the risk of price erosion in the US generics business and no positive surprises expected in the domestic market, in terms of pricing upticks or volume gains, the pharma market seems overstretched and is offering a good opportunity to book profits,” said Surya Patra of PhillipCapital.

He has a 'Sell' rating on Lupin, Cipla, Ipca Labs, and Zydus Lifesciences due to stretched valuations amid limited growth opportunities.

In Sun Pharma, and Divi’s Labs, investors may book profit as the companies may face margin pressures ahead, he added.

Aurobindo Pharma remains his preferred pick in the sector.

Mehul Seth of HDFC Securities, meanwhile, said there may be more downside in Dr Reddy’s stock, as ex-Revlimid, the firm's revenue may struggle to grow post FY26.

He also remains 'underweight' on Lupin as most positive factors have been priced in.

He picks Torrent Pharma, Eris Lifesciences, and Mankind as his preferred picks.

Bitter Pill?

Aurobindo Pharma, Dr Reddy’s Labs, and Zydus Lifesciences sourced 48 per cent, 47 per cent, and 46 per cent of their total revenues from the US generics segment, respectively, in financial year 2023-24 (FY24)

Others such as Lupin, Sun Pharma, Cipla, Alkem, Alembic Pharma, and Glenmark Pharma, sourced 23-37 per cent of their revenue from US generics during the period

The negative surprise of price erosion, analysts believe, is unlikely to improve for the remaining part of CY24