Why Indian Drugmakers Are Cutting R&D Spends

Aggregate R&D spend of India's pharmaceutical sector as a percentage of revenue consistently fell in the last three financial years, according to data by Axis Capital. It stood at 6.2% in FY20.

That decline coincides with a period when domestic makers of copycat drugs faced intense competition in the U.S. That forced them to cut prices, hurting their margins.

A large part of the R&D costs of Indian pharma companies goes towards U.S. opportunities, be it specialty or generic, according to Jefferies. Aggregate R&D spending rose at an annualised rate of 12% from fiscal ended March 2014 to 2020, Jefferies said. In comparison, aggregate U.S. revenue for the period grew at 8%.

Sun Pharma cut its generic R&D expenditure, while Dr Reddy’s reduced spend on in-house proprietary products and biosimilars, Jefferies said in a report. Cipla forayed into specialty but restricted its efforts, it said.

Sun Pharma, Dr. Reddy's and Lupin have slashed their expenditure on R&D since the peak in FY17, the brokerage said.

According to the Jefferies report:

• Dr. Reddy’s R&D spend is down 21% from the peak in FY17. Its U.S. business stayed flat and margins improved by 300 basis points.
• Lupin’s R&D spend is down 33% from the FY17 peak, a period that saw its U.S. revenue decline 33% and margins narrow by 12.5 percentage points.
• Sun Pharma’s R&D spends have fallen 11% from the peak, a period its U.S. business declined 39% and its margins narrowed 7.9 percentage points. The company, however, increased the share of R&D on specialty business to 25%.

"Companies are now rationalising the assets that they are chasing. If earlier they were going after launching 20 products in the U.S. they are now going for relatively fewer,” Praful Bohra, research analyst at Systematix told Bloomberg Quint. “U.S. market dynamics have changed and because the FDA is approving products within 12 months. People have cut down on the products they are chasing, so they are chasing only complex assets."

According to Vishal Manchanda, research analyst at Nirmal Bang Securities, the U.S. market doesn't offer much viability that would translate well for profitability. “A lot of companies are not able to get pricing power in comparison to the research expenditure they incur.”

Another reason, Manchanda said, is the elongated gestation period. The period for monetisation of these R&D spends is very long, he said. “It takes time to reflect it into the bottom line, which is why the companies are getting more averse.”

Forecasts

The large pharma companies that have provided guidance plan to either cut or keep R&D spends unchanged in the ongoing financial year.

For Aurobindo Pharma, the R&D as a percentage of sales rose to 6.3% in the second quarter-end September, but it’s expected to remain 5.5-6% by yearend.

Sun Pharma and Dr Reddy's have guided for higher absolute spends. "With our continued investment on Ilumya (forplaque psoriasis)as well as additional indication plus the recently licensed product from SPARC, for which also the Phase II studies will start shortly, the overall spend, if the clinical studies get into the normal rhythm, will go up a little bit", Sun Pharma said in its second-quarter earnings call.

Dr Reddy's said it has strengthened its development pipeline across markets, including multiple products related to Covid-19. “In the coming months, this will increase our investment in R&D and accelerate our submissions of new product filings," it said after the second-quarter earnings.

But R&D cost as a percentage of sales is still lower or at the same level as the previous year for both the firms. For Sun Pharma, it was 6.5% in the first half compared with 8.6% a year earlier. Dr Reddy's maintained it at 8.9% compared with 8.8% in FY20.

Way Ahead

Jefferies, however, expects the spends to rebound. "A revival in US generics is likely to increase R&D spend, but as companies have just come out of a long capex cycle, the cumulative R&D plus capex figure will remain in control," the research firm said in its report. The cumulative R&D and capex amount, according to the report, stood at Rs 21,300 crore in FY20.

Manchanda expects the R&D cost to remain below 10% of sales. "8% would be a comfortable zone for most.”

Surajit Pal, research analyst at Prabhudas Lilladher, also sees spending on R&D reviving. “Due to Covid, many clinical trials were stopped due to various obvious reasons leading to lower spends,” he said. “Those restrictions are now gradually removed and R&D costs are expected to go up in coming quarters.”