Institutional Equities

Pharmaceutical Sector Outlook

The China Opportunity
US pricing has stabilized / selectively correcting

Vishal Manchanda Gaurang Sakare

vishal.manchanda@nirmalbang.com gaurang.sakare@nirmalbang.com 04 September 2019
+91 9737437148 +9122 6273 8093
Sector outlook -China can be big, US should improve

 China generic market is 4x of IPM - Opening up of China market can provide the next leg of
growth for Indian pharma. Dr. Reddy’s, Sun Pharma and Aurobindo Pharma seem to be more
aggressive among Indian players. Indian players can carve a niche in complex generics
category.

 US markets stabilizing and price correction to happen selectively - US to remain a price

efficient market but expect no further downward pressure. With manufacturing capex and R&D
investments on a continued decline, and drug discontinuations gaining proportion, we expect
rational pricing environment. In addition to a declining manufacturing capex, existing capacities
are being shut down.
 Declining investments in manufacturing and opening up of China market bode well for
improvement - Opening up of China for Indian players may lead to diversion of manufacturing
resources from the US, which in turn can push up generic prices in the US. MNC Pharma will be
the losers in China and Indian players may benefit.
 IPM will continue to benefit from access but trade generics growing in proportion -
Ayushman Bharat, Jan Aushadhi stores, Private Generic Stores chain are helping access of
drugs in domestic markets. With growing popularity of generic brands, we might see stress in
API manufacturing capacities in India. We estimate ~10% of sales volume in IPM are generics.

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 China opportunity – Growing optimism

 China market is transitioning from a developing market to developed market - The

intention is to fund access for innovative drugs by controlling spends on generic drugs. In this
process, we expect the MNC/Innovator Pharma to move out of generic space while the
smaller unorganized Chinese players will also exit this space.

 Indian players entering JV deals and out-licensing arrangement to grab a share of

China pie
 Dr. Reddy’s has a better positioning in China than peers by virtue of its long presence. DRL has a JV with
Kunshan Rottam in China and a 100% subsidiary too. The JV was set up in 2000
 Aurobindo Pharma has entered into an agreement with Chinese firm Shanghai LongJin Investment
Company and Sveva Capitals, Hongkong to form a JV, Longxiang Pharma Taizhou Co Ltd in China
 Cipla has entered into a JV arrangement with Jiangsu Acebright Pharmaceutical Company
 Strides Pharma Ltd has entered into a JV with Sihuan Pharmaceutical Holdings Group Ltd (Sihuan),
one of China’s leading pharmaceutical companies
 Sun Pharma has taken the out-licensing route
 Alembic Pharma has signed a JV with SPH SINE Pharmaceutical Laboratories Co Ltd
 Natco and Lupin are also evaluating an entry into China

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 China Pharma Market – Scope of opportunity

 China generic pharma market is about 4x of Indian market size. The difference in
size largely emanates from the fact that a large share of prescriptions in China are written
in favour of MNC brands (despite generic options), which are priced multi-fold higher than
generics. Lipitor, which is no longer patent protected, generates sales of US$1.2bn in
China.

 Of the US$130bn market opportunity, 64% (US$84bn) represents generic sales. The
generic drug market is dominated by high value brands sold my MNC pharma.

 The off-patent originator (MNC pharma) brands in China dominate the generic
pharma industry. These brands contribute approximately US$20bn to the Chinese
pharma market. These brands put together are larger than the Indian pharma market.

 China’s new drug approval framework, which is in line with developed markets, intends
to build confidence of physician and public at large on generic version of these brands.

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 Top MNC pharma off patent brands and
their China sales
Brand Sales ($mn)
Lipitor (atorvastatin) 1200
Plavix (clopidogrel) 900
Pulmicort (budesonide) 675
Glucobay (acarbose) 525
Adalat (nifedipine) 500
Sulperazon (cefoperazone) 450
Norvasc (amlodipine) 400
Betaloc (metoprolol) 350
Crestor (rosuvastatin) 300
Top 20 drugs (off patent) from MNC pharma companies together generate about US$7.5bn in
annual revenue

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 Summary of China reforms

 QCE framework - Approved and new generic drug applications will be evaluated under QCE
framework. QCE stands for Quality Consistency Evaluation. The QCE framework harmonizes
approval process in China to developed markets like the US and Europe. The objective is to
eliminate brands and push procurement of drugs through tenders.

 Two invoice system – Bring bargaining power to large distributors - Shift to Two Invoice
System will eliminate sub distributors. Manufacturer will invoice to distributor, which in turn will
invoice to hospitals/retail pharmacies. The step makes selling to sub-distributors illegal. Share
of top three distributors is consistently increasing. It was ~35% in 2016. Only top 4-5
distributors have meaningful size to sustain the reforms, while the rest are fragmented with
market share < 3%.

 4 + 7 program is a centralized drug procurement effort which allows companies with

approvals under QCE framework to bid for tenders. The lowest bidder will be awarded 60-70%
of the generic market volume across 11 major cities that together contribute to almost 1/3rd of
China market sales.

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 Approvals under QCE framework lagging targets–
Indian players yet to score
 China drug regulator had set a target of approving generics for 289 drugs under EDL through
QCE review by end-2018. Since the launch of the consistency evaluation work in 2016, as of
the end of Nov’18, 112 varieties of evaluations have been completed, including 90 of
the 289 basic drug-related varieties in the National Essential Drugs List (2012 edition).

 The first tender under 4 + 7 Program was opened for bidding in Nov’18 for 25 drugs. The
tender translated to an average 52% savings in generic costs. At the bid prices, tender will
amount to a purchase of US$320mn.

 Among foreign players, Sandoz is the only player to have got a successful approval under QCE
standards, while none of the Indian players has received an approval.

 In the first phase, China is targeting generic drug approvals under QCE only for the plain vanilla
- generics which will be extended to the complex drugs later on.

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 Indian players can leverage their US experience for
China filings
 Chinese players will compete for a share with Indian players, but unlike Indian counterparts,
Chinese players are not as focused on generics. They are aggressively investing in R&D efforts
into NCE/NBE development and in-licensing global NCE China rights for growth.

 China is focussed on innovation - There are more than 800 molecules in the development
pipeline of Chinese biotech companies as well as those companies that are aggressively
licensing in and out of China.

 Chinese players have limited experience with regard to developing copy cats of complex
generics. While Indian players by virtue of their US filings are prepared to do a filing anytime.
Applications under review in China
Dr. Reddy’s 9
Sun Pharma 9
Aurobindo Pharma 3
Lupin 1

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 Dr. Reddy’s – List of clinical trials in China
Drug name Indication Test popular topic
Prevention of atherothrombotic thrombosis,
Clopidogrel Hydrochloride / Clopidogrel Bisulphate Tablets /
recent myocardial infarction, acute coronary Bioequivalence study of clopidogrel (75mg)
Trade Name (CLOPIVIX)
syndrome patients

Prevention of atherothrombotic thrombosis and

Clopidogrel Hydrochloride / Clopidogrel Bisulphate Tablets / Bioequivalence study of clopidogrel in healthy
recent myocardial infarction, acute coronary
Trade Name (CLOPIVIX) subjects with hollow abdomen
syndrome.

Open random single-dose two-cycle two-

Lenalidomide capsule Multiple myeloma
sequence cross-bioequivalence study

Bioequivalence test of pramipexole

Pramipexole hydrochloride sustained-release tablets Parkinson hydrochloride sustained-release tablets
0.375mg in fasting and postprandial state

This product is combined with prednisone to treat

Bioequivalence test of abiraterone acetate
Abiraterone acetate tablets metastatic castration resistant prostate cancer
tablets in healthy postprandial state
(mCRPC).

This product is combined with prednisone to treat

Bioequivalence test of abiraterone acetate in
Abiraterone acetate tablets metastatic castration resistant prostate cancer
healthy human body under fasting condition
(mCRPC).

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China has published a list of 34 drugs inviting generic
versions – Some Indian players that can participate
LIST OF 34 DRUGS FOR WHICH CHINA HAS INVITED GENERIC COMPETITION
Copycats Wanted Indian Companies that can participate Dosage
1. abacavir, Cipla, Aurobindo Pharma Oral
2. alcaftadine, Ophthalmic
3. atovaquone, Glenmark , Lupin Syrup
4. azathioprine, Zydus cadila Tablet
5. bosentan, Natco, Cipla
6. brivaracetam,
7. colesevelam hydrochloride, Aurobindo Pharma, Strides Shasun Tablet and Suspension
8. cyclophosphamide, Dr. Reddy Injectable
9. dapsone, Sun Pharma Tablet and Gel
10. deferasirox,
11. dofetilide, Aurobindo Pharma, Sun Pharma tablet
12. eletriptan, Aurobindo Pharma, Zydus tablet
13. ertapenem, Aurobindo Pharma Injectable
14. fezoterodinum,
15. formoterol fumarate, Cipla, Lupin
16. fosaprepitant, Dr. Reddy injectable
17. fulvestrant, DR. Reddy, Glenmark
18. glatiramer, Natco, Dr. Reddy
19. icatibant,
20. ixabepilone,
21. levodopa/benserazide,
22. levothyroxine, Lupin
23. mercaptopurine, drreddy
24. methotrexate, cadila
25. nitisinone,
26. posaconazole,
27. pyridostigmine, cadila
28. raloxifene, Aurobindo, Glenmark, Cipla
29. rilpivirine,
30. tafluprost,
31. tretinoin, Sun Pharma, Glenmark
32. treprostinil,
33. valganciclovir, Dr. Reddy, Aurobindo pharma
34. vigabatrin. dr reddy

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 US markets
Is the base business profitable for Indian players?
Prices to stabilize and selective pockets of improvement

Opening up of China may divert manufacturing resources from the US

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 US markets – Key trends
 US market is stabilizing after prices correcting to a point that major generic players had to
realign their business strategy.
 No. of ANDA approvals in the US has plateaued and seems to be on a decline.

 The pressure on prices is coming down as the rate of drug discontinuation has accelerated.
This is accompanied by large scale closure of manufacturing facilities.
 Drug shortages are again increasing. Oral drug shortages exceeding injectables in 2019 list of
new shortages is a new phenomenon.
 Manufacturing capex and R&D investments at an all time low. Indian players continue to gain
market share and focus is on profitability.
 We estimate the commodity business/base business margins for the Indian players in the US
is about 20-25% (pre R&D).

 Over the next 3 years, patent expiry worth US$31bn is expected. This should translate into an
opportunity of US$1.5bn in generic sales assuming 95% price erosion.

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Is the base business profitable – Limited competition
portfolio – Estimated cash flows
IMPACT OF LIMITED COMPETITION ASSETS ON US BUSINESS EBITDA MARGIN

Limited
Limited Commoditized
Competition EBITDA - EBITDA EBITDA
Limited Commoditized Competition Portfolio EBITDA - US R&D EBITDA
Assets - Commodity Margins Margins
Competition Portfolio Sales EBITDA EBITDA Business Pre Spend Post R&D
Addition to Portfolio pre R&D Post R&D
Sales ($mn) ($mn) Margins Margins (pre R&D (Rs.mn) (Rs. Mn)
EBITDA ($mn) (%) (Rs. Mn)
(pre R&D) R&D)
($mn)

Cadila Healthcare 200 650 90% 20% 180 130 310 36% 10000 11700 20%
Sun Pharma 500 850 95% 23% 475 195.5 671 50% 19000 27935 30%
Aurobindo Pharma 250 1200 95% 20% 238 240 478 33% 10000 23425 23%
Dr. Reddy 200 800 90% 25% 180 200 380 38% 16000 10600 15%
Lupin 200 750 95% 23% 190 173 363 38% 16000 9375 14%
Cipla 180 400 95% 20% 171 80 251 43% 12000 5570 14%

EBITDA Margins Geography Wise

Cadila Healthcare Lupin Dr. Reddy Sun Pharma Cipla Aurobindo
India Business 23% 25% 27% 29% 24% 0
US Business 20% 14% 15% 30% 14% 24%
Europe Business 8% 15% 15% 12% 18% 12%
Emerging Markets 5% 22% 27% 12% 24% 20%
Rest of World & others 15% 12% 20% 20%
API Business 15% 16% 18% 18% 16% 19%

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 Foreign generic players continue to exit the market in
big way
Teva Prescription Trend Mylan Prescription Trend
280 250
260 200
240 Units in
Units in Mn 150
220 Mn
100
200
2017 2018 2019
2017 2018 2019

Sandoz Prescription Trend

200
180
160
Units
140 in
Mn
120
100
2017 2018 2019
Over the last 3 years
 Teva has shed 20% of its prescription volume
 Mylan prescription volume is down 30%
 Sandoz prescription volume is down 25% and this does not include the offloaded oral and
dermatology business to Aurobindo Pharma

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Drug shortage is rising again

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For the first time oral solid shortage outpaced
injectables

Exit of foreign generic players is leading to shortages in oral solid dosages. In 2019,
61% of the new shortages were on account of oral drugs

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Indian players continue to gain share

Prescription Volume Growth

Company Name 2019 2018 2017
Alembic -22% 58% 412%
Aurobindo 33% 29% 10%
Cipla -3% -22% 54%
Dr. Reddys 0% 8% 3%
Lupin 3% 16% 4%
Mylan -14% -16% -10%
Sandoz -7% -14% -4%
Sun Pharma 8% 31% -8%
Teva -13% -4% -1%
Torrent 5% 45% 17%

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Trend of revenue ($) per prescription unit

Revenue ($ per unit prescription)

Alembic 12.0 8.6 10.4
Aurobindo 4.7 5.2 5.9
Cipla 7.2 5.8 3.8
Dr. Reddys 9.6 7.9 9.1
Lupin 3.8 3.3 4.4
Mylan 12.9 23.3 23.8
Sandoz 17.6 17.6 17.2
Sun Pharma 24.5 24.0 27.4
Teva 36.7 36.2 45.4
Torrent 2.4 2.7 2.9

In 2019, we are witnessing an upward trend in revenue per prescription for

witnessing a decline in 2018. These are signs of commoditization of base business
and rejuvenation in new approvals which are meaningful.

Institutional Equities
Capital expenditure as percentage of depreciation

700%

600%

500%

400%

300%

200%

100%

0%
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

CapEX as a percentage of Depreciation

Investment in manufacturing capacity is at an all time low. Capex is just covering

depreciation.

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Total R&D Spend of Companies under Consideration

(RsMn)
350,000

300,000

250,000

200,000

150,000

100,000

50,000

0
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

R&D Expense

R&D Spend by the companies under preview was rising up till 2017 but has slowed
down since then.

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Total Net Debt of Companies under Consideration

(RsMn)
4,500,000
4,000,000
3,500,000
3,000,000
2,500,000
2,000,000
1,500,000
1,000,000
500,000
0
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Net Debt

Net Debt has been rising for the past decade but has been flat for the past three years

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Prescription Trend for major Indian Companies

Units
32,000,000

28,000,000

24,000,000

20,000,000

16,000,000

12,000,000

8,000,000

4,000,000
May-15

May-16

May-17

May-18

May-19
Mar-15

Mar-16

Mar-17

Mar-18

Mar-19
Sep-14

Sep-15

Sep-16

Sep-17

Sep-18
Nov-14

Nov-15

Nov-16

Nov-17

Nov-18
Jan-15

Jan-16

Jan-17

Jan-18

Jan-19
Jul-15

Jul-16

Jul-17

Jul-18
Sun Pharma Aurobindo Pharma Dr. Reddy's Lupin Zydus Cadila

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 Declining capex aggravated by manufacturing site
closures/divestment

 Teva has announced plans to reduce manufacturing facilities to half in the

long term. Out of the 80 manufacturing facilities, it has already reduced 7
and would divest/close another 11 this year.
 Amneal post its merger with Impax also continues to realign its
manufacturing footprint.
 Having been able to find no buyers, Lannett has announced closure of its
manufacturing facility in the US. Lannett also laid off 50 employees at one
of its API manufacturing facilities.
 Pfizer announced closure of its two generic manufacturing facilities in
India at Aurangabad and Chennai, which together employs 1700 people.
 Hikma announced closure of its Eatontown (New Jersey) facility that
manufactured oral solids for the US markets.
 Post Mylan – Upjohn merger closure, we might get to hear more from
them on manufacturing sites.

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 US market – incremental competition

Units
1,000
900 858
821
800
700 634
595 569
600 534 542
500
394 401
400 356
324
279
300 233 213
201
200
100
0
CY15 CY16 CY17 CY18 CY19 (YTD)

ANDA Approvals ANDA Withdrawals (Approved) Net Additions - ANDA

No. of ANDA approvals peaked in 2017, but it has plateaued and now seems to be coming
down. If ANDA approvals are adjusted for withdrawals / discontinuation, we are seeing a
decline in net addition of ANDA.

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ANDA filings saw a steep decline in 2018

Units
1,200
1,016 997
1,000

800

600
477 482

400

200

0
CY15 CY16 CY17 CY18
ANDA Filings

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Competitive intensity remains the same despite rise
in ANDA approvals

Units (%)
200 50%
180 45%
160 40%
140 35%
120 30%
100 25%
80 20%
60 15%
40 10%
20 5%
0 0%
CY15 CY16 CY17 CY18 CY19YTD
No of Companies getting ANDA approval Indian Players' Share of Approval

The number of companies active in the US market remains the same despite an increase in
approval activity. Share of Indian players in ANDA approvals continues to rise.

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 Impact of ANDA approvals on change in competitive
intensity

Market Share Analysis

2014 2016 2019
Median # of Players per ANDA* 8 8 9
Median # of Active* Players per ANDA 4 4 4

# of ANDA's where market share is > 95% 55 61 53

• ANDA approvals may have gained pace, but ongoing discontinuations have led to median
number of players per ANDA remaining steady at around 8 to 9.

• Active competition is restricted to 4 companies per ANDA. Players with >5% market share are
considered as active in an ANDA.

• An analysis of market share of Top 15 generic players in the US suggests we still have around
50 -60 ANDAs which continue to be monopolies.

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