Medicine Box Notes.docx

DISCLAIMER: Companies discussed below are not recommendation and the readers should do their due diligence.

1. Cracking the Biosimilar Code with Biocon's Kiran Mazumdar Shaw  Biological drugs comprise of large molecules whereas synthetic drugs/chemical drugs consist of small molecules.  Hence it is difficult and complex process to produce biosimilars  It is expensive to produce such biosimilars and even more expensive for use in treatment  Hence need of the hour is to develop a cost competitive production of biosimilars  India presently dominates global generic drug market (30% share) and API Market (40% share). India is known as pharmacy of the world.  Now it's time that India extend its dominance in bio-generics(biosimilars) market as well  A lot of investment is needed for creating such dominance which is done by Biocon over the past decade  Pricing pressure is determined by no. of competitors in the market and size of the market.  In the early phase of biosimilars i.e., next 5-10 years there won't be much pricing pressure as there are not many players in this space.  Biocon consistently invests 15-18% of revenue in developing biopharmaceuticals  These investments have long gestation periods. Biocon is reaping benefits of investments made in this space a decade ago, only from past 2-3 years.  Any new co. will at least require 4-5 years to develop and market biosimilars to foreign markets.  India is a very low-cost market. Hence pricing pressure will always be present in India. However growing market size is always a benefit.  Newer developments such as immuno-oncology has shifted focus from Cancer care to Cancer cure.

2. The Pharma Trends and Stocks that really matter (Saion Mukherjee, Nomura MD and Equity Research Head)  In general things are getting stable in US generics market. Many existing players are exiting loss making pockets and thereby showing rationality in their thought process.  Cost cutting measures undertaken by Sun Pharma, Dr.Reddys, Mylan, Teva are not indicative of slowing growth instead it is more of calibrating their resources and balancing the risk and reward better.  It is imperative for Cos. to shift from low growth plain vanilla generics to high growth complex generics and specialty drugs.  Sun Pharma, Dr Reddys, Lupin & Glenmark have invested in specialty drugs which can be a great earnings growth potential for these companies.  USFDA Inspections will be higher in cases where there were historical slippages in conforming to the data integrity and other critical standards. FDA is better staffed to conduct inspections frequently.  However, the outcome of such inspections need not be always critical or detrimental to the company.  Senior level management exits don’t bother because pharma industry is process oriented rather than people oriented. (Ex: CFO of Lupin leaving the company will not have much impact until the process is in place)  Torrent Pharma is India focused and with recent acquisition of Unichem it opens up a long-term growth path as India is still under-penetrated in chronic segment.  One should also understand the risks of operating in Indian Environment such as, Govt. intervention, low cost market, restriction on fixed dose combination and other regulatory hurdles.  Also, one cannot ignore the US market as it is the largest market and the value which can be derived for the products from there is quite large compared to India. The way forward is a healthy mix of sales to both Domestic as well as Foreign markets.  The investment cycle for healthcare players such as Apollo, Fortis is over and now there will be operating leverage at play as more and more capacity is utilized.

 One can see margins improving in these companies Q-o-Q as occupancy moves up. Healthcare presents a long-term growth potential in India.  Stability is likely to emerge in Fortis once the new owner IHH Healthcare takes full control.  Mid to high teen growth is expected to come back in the diagnostic space after several quarters of slow growth. Even competition is gradually decreasing.  Lupin, Sun pharma & Dr Reddys have specialty drug approval and launches in next one year, the cost with respect to which is already accounted in P&L.  So, in next 1-2 years the earnings from these products will significantly improve the profitability of these companies.

3. Decoding the USFDA's actions on Pharma plants with Amit Rajan (Expert on Quality & Compliance Issues)  Since there are many pharma cos. providing similar drugs, USFDA have an option to select the best manufacturer.  USFDA now gets inspection charges and hence more and more inspections are conducted. 10 years back USFDA had to bear the inspection charges of such Indian Pharma Cos.  Form 483 is an inspection report which is given by USFDA Inspectors on site after the inspection is done  Procedural issues highlighted in Form 483 need not be taken seriously. So even if there are many procedural issues it can be ignored from investor's perspective.  Data Integrity issues are highly critical and need to be carefully observed (i.e., proper audit trail needs to be in place). One critical observation can sign off the future of a company.  Big Pharma Cos have already implemented audit trail software and hence such data integrity observations are not found in such cos.  There are 3 types of Pharma Manufacturer - Pure API (Ex: Divis), API cum Drug Manufacturer (Wockhardt), API cum Drug & Injectables Manufacturer (Dr. Reddys)

 Injectable units need to maintain highest standards of hygiene and safety as those units are on radar of USFDA due to the very nature of the product. (Dr. Reddys Duvvada Injectable Plant got repeated observations from USFDA)  EU regulators inspect a particular line of production in a facility whereas USFDA inspects the entire facility.  If multiple sites get observation then there is a cultural issue which breaks the trust of USFDA. (Ipca & Wockhardt are finding it difficult to get inspection dates from USFDA)  Divis Labs API Plant observations got remediated in record time because API products are not directly sold to customers instead it is sold to other Pharma Majors like Sandoz, Teva, etc. which uses it in manufacturing of their drugs and hence Sandoz quality control team visited Divis plant and resolved the issues quickly.  India is 20 years ahead of China in terms of standards required by USFDA

4. Everything that you wanted to ask about investing in pharma stocks (Aditya Khemka, Fund Manager at DSP Investment Managers)  ROI on generic business is reducing due to severe competition and focus is shifting towards Specialty Drugs and many large cos. are investing heavily in this space.  Small & Midcap stocks with good domestic business are now investing towards exporting their products. They are entering into generic business which large caps are slowly shedding from their product mix.  Going forward Large caps will have more revenue coming from Specialty, Complex Generics, Biosimilars.  Small & Midcaps will have more revenue coming from generics export and not much from the Specialty space.  Last decade the earnings were motivated by high generic sales, where pricing pressure has seeped in now.

 R&D expense is being rationalized in Large Cos. considering the commercial benefit of the projects and not due to reduced margin from Plain Vanilla generics.  In the next decade quality of earnings will be high, secular and steady in these cos. due to R&D done in the innovative & specialty drugs and complex generics space.  However, specialty drugs and complex generics will also face competition and pricing pressure as more and more companies enter the market with similar product. So, these cos. will have to learn to survive in such markets and maintain their ROIs  Innovative & Invention space will not face similar competition but it takes years of research, trial and error, failures until such drugs can see light of the day and can be commercialized.  Healthcare & Diagnostics space is a high growth investing theme for next 5-10 years.  Healthcare is a low risk low reward investment (more consistent returns) whereas Pharma is a high-risk high-reward business (volatile returns)

5. In Conversation with Sailesh Bhan (CIO, Equity Investment, Reliance MF) on future of Pharma Industry  Earnings driven performance in the sector will be seen in next 3-5 years  US market is getting stabilized and the peak of price erosion in US is behind us.  Domestic Market sales are growing and Non-US market sales are also witnessing traction.  Quality of R&D Spend is changing. It is getting more focused with concentration on specific areas.  Companies have to build an entire portfolio of specialty drugs and they cannot rely on one or two specialty drugs to drive the topline.  Risk appetite and capital requirement for matching the US and other developed markets R&D is currently inexistent in Indian companies.

 Indian co.'s R&D is more towards improving the efficiency of the existing products and aim for longevity rather than US's R&D towards unknown and unchartered areas.  Indian R&D market is miniscule compared to the Global R&D market. India has a long way to go in terms of R&D spending and the quality of R&D.  Geographical diversity and expanding their presence in emerging markets like China will help Indian companies in generating revenues which in turn will help in funding their ambitious R&D initiatives.  Form 483 observations generally contain compliance issues and an investor before taking any decision must observe how the Mgmt. respond to such challenges.  Import Alerts for certain manufacturing plants by USFDA will be a huge risk not only for the company's revenue but it will also have to curtail its R&D due to lack of internal accruals.  Many companies in order to de-risk their supply of critical drugs have a policy of manufacturing it in different manufacturing facilities. So that if an import alert is issued in respect of a specific plant, other plants can still supply the drug to the customers and thus will not have much impact on the Co.'s revenue.  Data integrity issues which were hitherto highlighted in most of the USFDA observations are now contained due to change in the working culture, automatic data capturing investments and continuous internal checks.  9While investing in a pharma stock, check the core business component (sources from which sustainable revenue is generated) of that company and see what % of profits is derived from that area.  Also check the R&D investments being made and the product pipeline which is going to be launched in next 3 years.  Check how these R&D investments are written off in books. In case of excessive writing off the earnings will look depressed and in case of carrying the R&D spend to Balance Sheet the earnings will look bloated.

6. The best pharma bets, according to Ravi Dharamshi (CIO, Valuequest Investment Advisors)  Generic story is over in the US. Oral solids are saturated in the US market.  Shift in focus is required from Basic Generic drugs to Biosimilars and Specialty pharma.  Wealth Creation can be seen in next 2-3 years in the pharma space.  Biocon valuations have priced in the fact that a lot of global biosimilars will be going off-patent in next 5-7 years which will give Biocon an opportunity to increase its revenue and market share in those Biosimilar drugs.  Aurobindo Pharma was the first Indian Co. which faced the USFDA headwinds in 2011-12 and it resolved its USFDA conflicts within 18-24 months which in the hindsight looks like one of the fastest resolutions.  Promoters involvement at the shop floor level helps in ensuring that the USFDA regulations are adhered to.  Companies having USFDA issues at several facilities need to be analyzed thoroughly before taking the investment decision.  Two big pharma markets after US is China & Japan.  High R&D spend is not always an optimistic sign. One should rank the companies on the basis of how their R&D has delivered in order to create a product which has a protected pool of profits with high entry barriers for an extended period of time.  A company delivering on the above parameter will stand apart in the crowded pharma market.