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Indian pharma is betting big on the growing opportunity in the CRAMS segment. With many players in the mid-cap segment gearing themselves up for the expected gold rush in the outsourcing and contract-research and manufacturing services space, analysts are betting on them for future growth in the pharma sector.
Compared to the 11 per cent rise in BSE Health Care index, mid-cap pharma stocks in the CRAMS segment has run up quite sharply, reflecting the bullish sentiments at the counter.
Nicholas Piramal, one of the leaders in the CRAMS segment, has seen its stock price appreciate more than 35 per cent in the past year to Rs 283 levels, currently. Hikal stock has seen an appreciation of 52.64 per cent to Rs 575 in the same period.
Other leading players in the segment such as Divi's Laboratories (up 28.90 per cent to Rs 1400.65), Jubilant Organosys (up 17.96 per cent at Rs 998.45) and Dishman Pharmaceuticals (up 33.40 per cent at Rs 151.20) have also reaped the benefits of foraying into the CRAMS segment.
The growing pie
Why is Indian pharma so bullish on this opportunity? The reason is simple. With international competition heightening, pharma companies worldwide are seeking to reduce production and research costs. Indian companies, with their strong chemical engineering capabilities and low costs, offer these advantages.
According to analysts, global pharmaceutical manufacturing was estimated to be at $50 billion in 2004, out of which 30 per cent was outsourced. This, along with the contract research segment estimated at about $6-10 billion, makes CRAMS a very lucrative opportunity.
According to Pakhi Jain, analyst with Mumbai-based securities firm, Edelweiss Capital, given the long gestation period of this business model, the existing players should benefit.
What makes the case strong for future growth is the fact that the number of players focussing on this opportunity is still small. Jain notes that India has the potential to garner at least 35-40 per cent global market share in this segment. With foreign companies increasingly leaning towards India, the chances of big growth in future looks bright indeed.
The pressures on global pharma companies to outsource are growing for a couple of reasons. One, an ageing population in the West is straining healthcare budgets almost everywhere.
Most US and European governments are thus looking for cheaper generics and lower cost drugs. Two, with new drugs becoming more difficult to develop, pharma companies cannot sustain large R&D spending unless new blockbusters are developed cheaper.
This is where Indian outsourcing and CRAMS fit into the global picture.
"Pharmaceutical outsourcing ranges from a one-time supply to a partnering agreement. Today, it is on a high growth path with large global pharma companies facing the vagaries of pipeline surges and slowdowns, internal consolidation, and global expansion," says Jain.
On the acquisition mode
There has been a spate of tie-ups and acquisitions by companies in the CRAMS segment in India.
One recent example has been Mumbai-based Nicholas Piramal's acquisition of UK's Avecia Pharmaceuticals for a consideration of £9.5 million {about Rs 76 crore (Rs 760 million)}.
A global custom-manufacturing player, Avecia Pharmaceuticals' focus is on providing custom chemical synthesis and manufacturing services for innovator pharmaceutical and biotechnology companies.
Jubilant Organosys and Dishman Pharma were the other two companies to get into the acquisition mode recently.
In October, 2005, Jubilant acquired 100 per cent equity in Target Research Associates, a US-based clinical research organisation, for $33.5 million {around Rs 145 crore (Rs 1.45 billion)} in an all-cash deal. The acquisition makes Jubilant the largest CRO (contract research outsourcing) with operations in India and the US.
This was the first ever acquisition of an American CRO by an Indian company. According to the company, the acquisition is earnings accretive to Jubilant.
Even players who were not too keen on CRAMS segment to start with, are now eyeing the pie. Companies like JB Chemicals & Pharmaceuticals, which focuses largely on therapeutic segments have already taken steps to get into the CRAMS segment.
According to Nirav Mody, vice president - strategic marketing and business development of JB Chemicals & Pharmaceuticals, the company is betting on the outsourcing model and will focus in contract development of formulations. The company already has marketing tie-ups across geographies such as US, Europe and Australia and is looking at South Africa also.
"For pharma companies, acquisitions abroad are a means of strengthening their front-end. Through acquisitions, these companies gain access to the foreign company's clients, apart from their skill sets and marketing and distribution network in regulated markets," says an analyst with a leading domestic brokerage.
Set for growth
According to Jain, India's inherent strengths in this field - read, lowcost research, trained and experienced researchers and regulations which are aligned with those in the West, coupled with increased credibility and visibility will make country's share of the outsourcing pie grow rapidly.
"We expect established players to benefit more, given the high entry barriers and the large lead time for generation of revenues," she adds.
The earnings model is also thought to carry a lower risk, given the fact that it will mainly be driven by growth from the already-announced contracts.
"CRAMS is a long-term story. Since most of the players in the segment have entered into long-term agreement with their partners abroad, earnings volatility is likely to be less of an issue going forward," says an analyst.
Jain notes that companies in the CRAMS segment - which are mostly in the mid-cap space have a better return potential than players focused on the generics segment, given the high competition and patent uncertainties.
"We believe that the sector has high potential for growth, which current valuations do not factor in. On an average, the companies trade at 21x FY06E and 14x FY07E earnings," says Jain.
Here are some of the top picks in the CRAMS segment:
Top picks
Jubilant Organosys
Jubilant Organosys is among the biggest players in the CRAMS segment in India. Currently, about 30 per cent of the total revenues are derived from the CRAMS segment. Jubilant expects this segment to grow at 30 per cent in the next three years and more.
"We are trying to build our CRAMS business based on developing capabilities," says Rajesh Srivastava, head of Jubilant Organosys's CRAMS division. "Other CRAMS companies are service providers. We invest a lot in our facilities to build up our capabilities, and therefore we enjoy a good relationship with our customers. We don't compete on the basis of cost," he adds.
According to Jain of Edelweiss Capital, Jubilant's revenues are likely to grow at a 30 per cent CAGR (FY05-07E) to Rs 19bn, along with a high EPS growth (37 per cent CAGR over FY05-07E).
"We believe the company offers high quality growth. The market has still not fully factored in the growth," says Jain. The stock is currently ruling at Rs 1002 levels, at a P/E of 23x.
Nicholas Piramal
Nicholas Piramal has a strong presence across the CRAMS value chain from chemical synthesis to formulations. According to analysts, the company's strategy of non-infringing business model gives it an edge over other generics companies. The company also has the advantage of low-risk growth sourced from its CRAMS contracts.
The acquisition of Avecia Pharmaceuticals is expected to complement the Indian drug-major's existing operations in custom-manufacturing, besides helping it make a mark on the global stage.
The acquisition will give the company access to Avecia's customer-list and new technologies. At Rs 287.90, the stock trades at a trailing P/E of 28x. Jain forecasts a forecast 58 per cent EPS growth (FY05-07) based on stable domestic revenues and generation of CRAMS revenues.
Dishman Pharmaceuticals
Dishman Pharmaceuticals signed its first CRAMS contract with Solvay in 1999. Dishman's existing customers include several top global pharmaceutical firms including AstraZeneca, GlaxoSmithKline and Merck.
Dishman's management is ramping up its R&D facilities, keeping in mind the burgeoning opportunities in the CRAMS segment.
Analysts expect the company to corner more contracts going forward. The company has proven its chemistry skills by its success with specialty QUATs (quaternary ammonium or phosphonium compound), where it has a 40 per cent global market share.
With the company focussing on acquisitions, Dishman's earnings outlook is considered to attractive. The stable contracts from the CRAMS segment mean that risk is low. Jain projects an EPS growth of 83 per cent in FY06, stabilizing to 30 per cent in FY08. She projects a revenues growth at a CAGR of 40 per cent over FY05-08E. At Rs 152.60, the scrip is ruling at a P/E of 31x.
Shasun Chemicals & Drugs
Shasun's increasing focus on CRAMS should stand it in good stead. The company has been investing in its CRAMS business for some time and has offerings across the value chain. Shasun has put in place a created a multi-product facility for manufacturing and a new R&D facility to capitalise on the CRAMS opportunity.
"We expect a 50 per cent growth in the CRAMS segment revenues to above Rs 30 crore (Rs 300 million) in FY06. CRAMS division should constitute about 10 per cent of the overall business," says, Vimal Kumar, joint managing director of Shasun Chemicals & Drugs.
"Our philosophy is to enter into partnerships with companies who are looking to outsource manufacturing and R&D. We believe in partnering them rather than competing with them. Our strength is our organic chemistry skills," says Kumar.
Shasun has strong relationships with several large pharmaceutical companies like Eli Lilly, Glaxo SmithKline, Reliant Pharma, etc. These tie-ups are expected to lead to higher contracts for the CRAMS division.
Shasun's earnings are estimated to grow at 13 per cent CAGR (FY05-07E), driven by CRAMS and formulations. The stock currently rules at Rs 79.75 at a trailing P/E of 11x and is considered attractive.
A low down on CRAMS
Contract manufacturing comprises manufacturing intermediates and active pharmaceutical ingredients (API) for NCEs (new chemical entities) and the generic segment (drugs sold without patent protection).
Estimated to be a $15-billion industry in 2001, the market is expected to touch $30 billion by 2010, led by increased outsourcing and a large number of drugs going off-patent. Analysts expect this segment to a growth of 10-12 per cent going forward.
India, with its cost advantages, large number of US Food & Drugs Administration - approved manufacturing facilities and chemical skills, is likely to hugely benefit from the growth in this segment.
Contract research outsourcing can be broadly classified as clinical research outsourcing and drug discovery research outsourcing.
The high costs of R&D abroad coupled with the fact that many drugs are going off patent are forcing MNCs to increase their product pipelines and reduce the overall 'time to market'. The R&D outsourcing segment has been on the rise in the past decade. According to estimates, the contract research market is estimated to be $6-10 billion and has been growing at 16-18 per cent annually.
Of the overall contract research outsourcing segment, the clinical research outsourcing segment is expected to reach $14.40 billion by 2007, while the drug discovery segment is expected to touch $6 billion.
Patent drugs
Though growth in the patent drugs segment is slow, it is expected to pick up after the change in the Indian patent regime. During the initial phase, analysts expect contract manufacturing activities to remain restricted to the later stages of patent drugs development or segments with high dosage requirements and competitive pressures.
Intermediates for NCEs
The rise of generics and declining R&D productivity are forcing drug manufacturing companies to outsource a part (intermediates) of their manufacturing activities. This will allow them to concentrate on drug discovery, development and marketing and distribution.
The opportunity for Indian companies lies in working with innovator companies in the custom synthesis segment (for manufacturing intermediates and bulk drugs that are at various stages of research).
The long lead time in this segment and high exit barriers for innovator companies (it is difficult to change suppliers quickly in view of the high costs and lengthy FDA approval processes) work in favour of Indian companies.
