Rising generic threat in India not reflected in Pharma valuations – Kotak Institutional

A new report by Kotak Institutional Equities suggests that investors may be underestimating the threat posed by generic drugs to the ‘branded generics’ business of leading Indian pharmaceutical companies.

The report highlights that current implied valuations of around 30-40x FY2025 EPS for most major pharma firms assume a relatively benign 10-11% growth in the Indian Pharmaceutical Market (IPM) over the next few years. This factors in only a 70-100 basis point annual hit to IPM growth from unbranded generics and Jan Aushadhi stores. However, if the pace of genericization accelerates, it could lead to a derating of the sector, it noted.

“In our view, the current implied domestic valuations of pharma companies do not adequately factor in
the threat from an accelerated pace of penetration of unbranded and trade generics in India,” Kotak Institutional said.

The threat to branded drugs in India comes via two avenues – the government’s push for Jan Aushadhi stores, and the natural rise in trade generics.

Jan Aushadhi Stores

The government has been aggressively pushing Jan Aushadhi stores to improve access to affordable medicines, Kotak pointed out.

There are now around 9,700 Jan Aushadhi stores across India, up from just 73 stores in 2015. Jan Aushadhi provides quality unbranded generics at substantially lower prices compared to branded formulations.

Sales per Jan Aushadhi store have been rising steadily post-COVID, indicating increasing traction. Unbranded generics from Jan Aushadhi now command a 4-5% share of total pharmaceutical volumes in India. The chronic therapies segment, including cardiovascular and diabetes, is seeing rapid growth at Jan Aushadhi, it noted.

The Prime Minister has recently announced plans to ramp up the number of Jan Aushadhi stores from 9,700 currently to 25,000. While timelines are unclear, this push could accelerate penetration of unbranded generics. However, supply chain issues and product availability remain a challenge.

Trade Generics

In addition to Jan Aushadhi generics, branded trade generics sold through wholesale channels are gaining share, especially in semi-urban and rural markets. Trade generics command around 20-22% volume share currently.

Earlier, most major pharma firms were hesitant to aggressively push trade generics to avoid cannibalizing their branded generics portfolio. However, with share of trade generics rising steadily, companies like Torrent, Dr. Reddy’s and Mankind have now set up dedicated divisions, the broker noted.

Altogether, Jan Aushadhi and trade generics put together now account for 20-22% of total drug volumes in India. Factoring in the impact of lower prices, the report estimates these channels dent branded formulations growth by 70-100 basis points annually. This assumes no meaningful acceleration in uptake of generics.

NMC Regulations

Besides the generic threat, there is also the possibility of adverse regulatory developments.

The recent attempt to mandate prescription of generics by the National Medical Commission (NMC), and its subsequent rollback, highlights potential regulatory headwinds, Kotak noted.

Though kept in abeyance for now, the regulations required doctors to prescribe generics or face penalties. However, enforcement would be challenging given quality concerns around generics, it said.

Low Testing and BE Studies

At the same time, the equity research firm pointed out that more infrastructure and rules need to be put in place before unbranded generics are pushed aggressively in the market.

The Indian Medical Association (IMA) has highlighted that less than 1% of generics sold in India undergo quality testing, it said. Bioequivalence (BE) studies, establishing equivalence with innovator products, are also not mandated for most generics.

This raises concerns around efficacy and interchangeability. Branded generics from reputed companies thus enjoy higher comfort and trust among doctors, Kotak said.

Abruptly mandating generic prescription, without addressing quality issues, can therefore be counterproductive. However, the NMC regulations underscore that the government remains intent on accelerating generic penetration, it said.

Outlook for Branded Generics

The Kotak report observes that current valuations do not price in any meaningful acceleration in adoption of generics over the next few years. Most companies continue to trade at 30-40x FY2025 EPS.

This implies only 70-100 bps annual impact from Jan Aushadhi and trade generics on IPM growth until FY2028, followed by a steady deceleration. However, if regulations push faster adoption of generics, valuations may see a derating.

Given quality concerns, the report expects branded formulations to continue dominating the Indian pharma market. But the risks of increasing genericization remain, if issues like common manufacturing standards and testing protocols are addressed.

Among majors, Cipla and Alkem, with established trade generics presence, are relatively better placed. Mankind Pharma, Sun Pharma and Dr. Reddy’s also have well diversified portfolios across therapies. Their valuations appear reasonable, but earnings growth visibility could be clouded if generics proliferation accelerates.

Overall, the threat from generics may be underappreciated. Investors need to monitor regulatory changes and competitive dynamics closely, even as broader affordability considerations come to the fore.