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U.S. Generic Drug Probe Takes Pharma Stocks Lower; Analysts Say Time To Buy

The biggest sectoral loser on Friday was the Nifty Pharma index, which shut shop at its lowest level in 14 months. All ten constituents were in the red, with Sun Pharmaceuticals Ltd. tumbling to a 28-month low. This after investors reacted to the news of an ongoing U.S. probe on generic drug companies, where the prosecutors may file their first charges by the end of this calendar year. This probe, on an alleged price cartel had begun almost two years ago. The United States Department of Justice (DoJ) is likely to file criminal charges against some generic companies and executives on grounds of collusion to increase prices. Share prices of almost all generic pharma companies like Mylan NV, Allergan Plc. and Pfizer Ltd. crashed in the U.S. on Thursday.

The probe covers multiple firms operating in the U.S. and includes Indian pharmaceutical companies like Dr. Reddy’s Laboratories Ltd. and Sun Pharmaceuticals Ltd. It’s important to note that a lot of companies can be subpoenaed during a probe, to get information but not all may be found guilty. The exact charges as well as the drugs and companies in question are not known yet. There has been an outcry and scrutiny over sharp increase in drug prices in the U.S..

According to a Bloomberg report, Mylan NV and Teva Pharmaceutical Industries Ltd. had received subpoenas; others include Actavis Inc., Lannett Co. Inc., Impax Laboratories Inc., Covis Pharma Holdings Sarl, Mayne Pharma Group Ltd., Endo International PLC’s subsidiary Par Pharma Companies Inc, Sun Pharma and Taro Pharmaceutical Industries Ltd.

Indian Companies Under The Radar

Sun Pharma and its subsidiary Taro Pharmaceutical Industries and Dr. Reddy’s have disclosed in the past that they had received subpoenas from the DoJ. Shares of Sun Pharma have taken the biggest beating with its share price falling as much as 7 percent in intra-day trade to Rs 653.20, which is the lowest since June 2014. Other Indian generic companies which have a higher revenue share from the U.S. market like Lupin, Cadila Healthcare, Dr. Reddy’s Laboratories and Glenmark Pharmaceuticals have also benefited from price hikes.

Sun Pharma claims to be the 5th largest generic drug company in U.S., and it had sales of $2,066 million in the U.S. in financial year 2016. Sun Pharma had in May 2016, intimated the stock exchanges in India about the receipt of a grand jury subpoena by the company’s U.S. subsidiaries including Sun Pharmaceutical Industries Inc. Sun Pharma had then said “the company is of the opinion that the outcome of the above referred inquiry is unlikely to have any material adverse impact on the consolidated operations or consolidated financial results of the company”.

However, it needs to be seen if any of the Indian pharma companies would have a direct impact of the investigation and would get charged eventually as price collusion to jack up drug prices will need to be proven. Analysts believe it could be a good time to buy some of the stocks.

Analysts’ Speak

If the charges are proved, we believe this can lead to a one-time penalty on SUNP (Sun Pharma) and Dr Reddy’s, though it is difficult to ascertain the quantum of penalty at this point due to certain variables (number of drugs probed, calculation of penalty etc). Further, SUNP has stated in the past that the outcome of the enquiry is unlikely to have any material impact on the consolidated operations or financials of the company. SUNP’s stock price has fallen around 20 percent since Aug-16, and we believe at the current valuation of ~20x FY18E EPS (lower end of the average band), the risk-reward is favorable. We recommend adding on any fall. Our TP (target price) is Rs 875.
Jignesh Desai, Religare Capital Markets Ltd.
We do believe that while the generic industry is facing growth challenges in (the) U.S., it is unlikely that players have orchestrated pricing coordination. Our view is that it may be an uphill task for the Department of Justice to prove that these companies have colluded in taking price hikes and the case may take years to reach any conclusion. However, we believe the drug pricing probe does not warrant the 20-25 percent fall in stock prices.
Deepak Malik, Edelweiss Research

It’s a view shared by Deutsche Bank’s analysts Gregg Gilbert, Greg Fraser and Pravesh Khandelwal who are based in the U.S.:

The intense sell-off of many generic stocks large and small suggests that investors are “selling first and asking questions later.” It doesn’t help that there is currently limited investor interest in increasing exposure to healthcare stocks, and even less so for Specialty Pharma stocks. Regardless of the outcome of this matter, and while we can never rule out the potential that some bad behavior has occurred, it is worth considering that the generic industry is a very important enabler of more affordable drugs and is an industry where price deflation is the rule and price inflation is the exception. It is hard to imagine a scenario in which the financial penalties, if any, would end up approaching the ~$8.5bn in market cap that was wiped out.
Deutsche Bank note

Analysts do believe that the U.S. generic business could face de-rating in the near-term given the uncertainty, which is why shares of large cap pharmaceutical companies, with a high exposure in the U.S. took a beating on Friday.

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