Synopsis–The US market has been getting tougher over the years, but the company has taken several steps, including rationalising costs and developing complex products. Its pipeline for the US now has a good number of limited-competition and high-margin products, which can provide operating leverage in the next two to three years.
There seems to be some renewed optimism around Lupin. This stems from better-than-expected earnings of the company in Q3FY21, after consistent subdued performance in the previous several quarters.
Lupin, which was once among the fastest growing Indian pharmaceutical companies, has been struggling over the last three-four years due to weakness in the business in the US, its largest market.
The company’s US business suffered because of price erosion in generic drugs, delay in product approvals, and quality-compliance issues at certain manufacturing facilities. Moreover, some bets such as the expensive acquisition of Gavis Pharmaceuticals in the US and the specialty products venture did not deliver as expected. These have weighed on Lupin’s profitability. ET Prime had written about the company’s pain points earlier.
With the US market getting tougher, Lupin’s earnings profile has deteriorated significantly and its return on capital employed has been one of the lowest among its peers over the last three years amid high costs and muted revenue growth.
But the tide appears to be turning now.
In Q3FY21, Lupin reported a recovery in the US business as well as expansion in margins. But can it show a sustainable improvement in the coming years? The answer lies in its ability to execute well on its US product pipeline of complex products, including inhalers and injectables.
Ramesh Swaminathan, executive director and global chief financial officer of Lupin, tells ET Prime the company is confident of improving its earnings trajectory due to launch of complex products in the US, continuous focus on controlling costs, and growth in the India business.
He says Lupin’s returns plummeted in the last three to four years, as it did not bring good products to the market. So, revenue took a hit and its costs on manpower and R&D (research and development) had gone up. “We set out to correcting a lot of that stuff and working on how to keep our costs on a leash.”
In FY20, Lupin’s staff costs at 20.4% of sales were the highest among the top five Indian pharma companies. Employee costs of Cipla and Dr. Reddy’s Laboratories were 16%-18% of sales.
The company has taken several steps to rationalise costs, and its product pipeline for the US has a good number of limited-competition and high-margin products, which can provide operating leverage to the company in the next two to three years, analysts say.
Swaminathan says if Lupin’s plans fructify, it can get back the RoCE to the levels seen in FY15-FY16.
The US story
Lupin’s business revolves largely around the US and India. While India has been a steady growth engine, the US has become an area of concern and needs to put back on track.
The US is the world’s largest and most lucrative pharmaceutical market, but over the last few years, it has become challenging for generic drug makers to create value in this market.
There are several reasons for it.
More players are entering the market and generic drug approvals by the US Food and Drug Administration (USFDA) have been on the rise consistently. While the number of suppliers are increasing, there has been a consolidation among distribution chains (the buyers), resulting in price erosion.
On the one hand, new challengers are accessing the market with low-priced products, on the other, pharmacies are joining forces with wholesalers to leverage purchasing power. Although the industry has recently begun to stabilise, generic drug companies will not thrive if they continue to employ momentum strategies, consulting firm BCG said in a January report.
The hope for these companies lies in moving away from their reliance on simple generics and focusing on higher-value, differentiated products, the BCG report said.
For Lupin, it has been a double whammy because apart from price erosion in base business, its three plants, one each at Pithampur, Goa and Mandideep, were slapped with warning letters by the USFDA due to deviations from good manufacturing practices, leading to delay in product approvals and higher costs as a result of remediation efforts at these plants.
While the US regulator has cleared the Mandideep plant, the other two facilities are still under its scanner. Three months ago, the company’s facility in Somerset, New Jersey, also received 13 observations following a USFDA inspection.
The US contributed 38% to Lupin’s revenue in FY20. Hence, revival in this market is crucial to move the needle for Lupin. The company has created a good pipeline of products for the US market, which are likely to be launched over the next three to four years and could make a meaningful difference to its earnings profile.
“Lupin’s US business profitability is among the lowest of all large-cap peers despite the large revenue base and fairly meaningful products. Given the low fixed costs in the US business, margin expansion will depend on continued high-value launches from its pipeline and significant cost optimisation in other businesses,” brokerage firm J.P. Morgan said in a report in January.
The company currently has 152 abbreviated new drug applications (ANDAs) pending with the USFDA. Brokerage firm IIFL Securities said in a report that Lupin is targeting 30-35 annual filings in the US, including 15-20 oral solids, over six injectables, including complex ones, and three or four inhalation products.
The inhalation portfolio
Swaminathan said the company has invested in developing a broad range of respiratory products, which are complex in nature and these products are likely to drive growth in the US.
“We have been working on the highest number of products in the inhalation space. Let’s say there are about 25 important products in the market, we are working on most of them and at least eight to 10 of those will come to fruition over the next five years,” he adds.
In August 2020, Lupin received a shot in the arm when the USFDA approved its generic albuterol metered-dose inhaler (MDI), which is likely to materially change the profitability trajectory of the company in the US.
Lupin’s albuterol sulfate inhalation aerosol is a generic version of Teva Pharmaceuticals’ ProAir HFA, indicated for the treatment of acute episodes of bronchospasm or prevention of asthmatic symptoms. Cipla is another Indian company that has launched its generic albuterol product in the US last year.
Another player, Perrigo, has exited the market and is unlikely to return this year, which will keep competition limited and give Lupin and Cipla an opportunity to increase market share.
The albuterol sulfate inhalation aerosol market in the US is worth USD2.9 billion, of which the ProAir HFA market accounted for USD1.3 billion in the 12 months ended June 2020.
“Albuterol is a stable market at about 63 million units dispensed per year. Competition for Albuterol is limited from other competing molecules or pipeline products. With its place in the asthma and COPD guidelines secure, we expect the market to remain largely stable for the next several years. Albuterol MDI is a complex product, and globally there are only five players who have invested in building capabilities in MDIs,” Nithya Balasubramanian, analyst at brokerage firm Sanford C. Bernstein said in a recent report.
She added Lupin is likely to enjoy gross margins of over 80% in this product and incremental Ebitda impact will be 26% for the company.
Over the next two to three years, more respiratory products are lined up for launch in the US, the biggest being the generic Spririva inhaler in the middle of 2022, for which Lupin is likely to be the first one to market.
Brokerage firm IIFL says in a report that with the launch of generic versions of Brovana, Dulera, and Perforomist expected in first half of FY22 and the generic Spiriva launch expected in mid-2022, these products can add incremental sales of USD170 million to Lupin’s US business by FY23.
Headroom for growth
Before the Covid-19-induced rally in pharma stocks, Lupin’s stock remained under pressure. But it has been rising over the last few months.
Lupin’s Ebitda margins have been much lower than its peers. The company expects to improve margins to 20%-22% next year from about 18% last year through better product mix and cost controls.
There is headroom for growth because the company has become cautious on the cost front and the revenue base is likely to improve. It has been reducing costs on research and development (R&D), on manpower as well as on sales and promotions. It expects to maintain R&D spend at 9% of sales next year and reduce further in the coming years. It has also scaled back spends on its specialty products.
Having burnt its fingers in certain acquisitions, Lupin is now looking to grow organically or through partnerships in certain markets. Effective tax rate is also likely to come down to 25%-30% from 40% earlier, as performance of certain subsidiaries improves, Swaminathan adds.
The company’s strong business in India is another growth lever. It has been growing well in the last few years and has good margins.
Lupin’s presence outside the US and India is limited. Europe and other emerging markets put together account for less than 20% of its sales. But the company is looking to leverage its inhalation products and biosimilars in Europe and other markets, which will help improve margins.
Analysts believe that from here on the downside risks are limited, as Lupin has dealt with some of its earlier problems through write-offs relating to Gavis acquisition, divestment of Japanese subsidiary Kyowa Pharmaceuticals and revisiting the cost structures.
There is still an overhang of compliance issues at its plants, and developments around it will be watched closely. With travel restrictions due to the pandemic, the USFDA has not yet done a re-inspection of the company’s plants that are under warning. Lupin said the inspections are likely to pick up only in the second half of this year, which implies that it is unlikely to be out of the woods anytime soon at least on USFDA compliance.
But as and when the plants get cleared by the US regulator, the overall sentiment will improve and the company will be able to focus more on pursuing growth opportunities instead of crisis management.
Overall, there is upside potential in the company. The consensus earnings-per-share estimates for FY22 and FY23 are INR37.96 and INR47.42, respectively, compared with INR24.45 estimated for FY21, according to numbers on Refinitiv, which provides data on financial markets.
But execution of its US pipeline and resolution of compliance issues at its plants remains crucial. The hope is that Lupin has learned from its past and will avoid more mistakes.
(Graphics by Sadhana Saxena)
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