CRISIL analysis: Moderation in input prices to ease pressure on margins

After growing by 10 per cent in 2022-23, the pharmaceutical sector is projected to grow by 7-9 per cent this financial year (2023-24) and 8-10 per cent in the next, led by sustained healthy growth in export demand, especially for formulations, and largely steady domestic demand.
 

The export market, which accounts for approximately 52 per cent of the industry, logged a healthy growth of about 11 per cent last financial year (in rupee terms). It is projected to grow by 9-11 per cent this financial year and 10-12 per cent in the next, likely led by new product launches, better pricing, and diversification into untapped markets.
 

Among regulated markets, the US, which accounts for over a third of the formulations exported by India, is likely to witness healthy growth, easing pricing pressures, and India’s higher share in abbreviated new drug approvals.
 

Apart from creating a presence in generics, larger players are also developing specialty products, biosimilars, and complex generics, which will be key medium-term growth drivers for the industry.
 

Growth of semi-regulated markets (35 per cent of overall exports) is also expected to gain pace, with key markets recovering after their pandemic-led moderation, backed by demand revival and an improvement in foreign exchange (forex) reserves of select African countries.
 

Last year, growth was sluggish due to low forex reserves (impacting purchasing power) and high currency volatility, but going forward, we expect that companies continuing to venture into smaller/newer markets in Asia and Africa through new product launches and institutional sales will lead to healthy growth in these markets.
 

Bulk drug exports are expected to grow moderately, supported by volume growth from new launches, customised synthesis, and growing demand for complex drugs.
 

The domestic market, which grew by 10 per cent last financial year, is expected to grow by 6-8 per cent this financial year and 7-9 per cent in the next, led by higher prices and new product launches, while volume growth for existing products, especially for the acute therapy segment, is likely to remain modest, as during the last financial year.
 

Demand for the chronic segment (drugs to address issues related to neurological, cardiac and respiratory diseases, and diabetes), however, is more structural in nature and is, therefore, likely to continue supporting overall growth. Price growth in the domestic market is expected to partly stem from a 12 per cent increase allowed in the prices of drugs in the National List of Essential Medicines (NLEM), forming over a fifth of the domestic market sales.
 

The regulator allows pharmaceutical companies to raise the prices of NLEM drugs in line with the previous year’s annual Wholesale Price Index. However, part of this growth is expected to be negated by the regulator having fixed the ceiling prices of several of these drugs. Growth in the prices of non-scheduled drugs is capped at 10 per cent annually, and the actual increase depends on market dynamics.
 

The operating margin for the sector is likely to improve by 100-150 basis points this year to 21-21.5 per cent, after consecutive years of decline, mainly on account of a moderation in raw material and logistics costs and abating pricing pressures in the US.

Next financial year, operating profitability is expected to remain rangebound and continue to benefit from the improving scale of operations.
 

The credit profiles of rated players are expected to remain stable, benefiting from low leverage, moderate capital expenditure plans, and healthy liquidity. Debt/earnings before interest, tax, depreciation, and amortisation is expected to improve to 1.0-1.2 times this financial year and the next, from 1.3 times last financial year, led by improved profitability and lower working capital needs.
 

Players are also increasingly focusing on inorganic growth to diversify offerings and consolidate market share. While strong balance sheets provide support, sizeable debt-funded acquisitions, if any, remain monitorable.
 

Over the medium term, the production-linked Incentive scheme is likely to improve domestic manufacturing and lower import dependency for bulk drugs. However, over half the capacity additions under the scheme are for para-aminophenol and penicillin. As a result, import dependency on other bulk drugs will likely continue. Nonetheless, at an aggregate level, new capacities under the scheme will help reduce dependency on bulk drugs by nearly a fifth over the medium term.
 

Unanticipated increases in litigation costs in ongoing US antitrust suits, US Food and Drug Administration import alerts, and delays in the closure of pending regulatory issues, besides price caps on products in the domestic market, if any, will remain key monitorables.