UBS Cautions on Slowdown in Indian and U.S. Pharma Markets, Downgrades 4 Stocks to 'Sell'

Global brokerage firm, UBS Securities has raised concerns over the sliding trends in the Indian and US pharmaceutical market. In its latest initiation report, UBS said that the down-slide in the US generic market may have further momentum and growth within the Indian pharma sector has also eased off pace. A steep climb in the sale of unbranded generics also poses an alarm for the sector.

UBS Securities has maintained a conservative call on the sector, having issued multiple 'sell' recommendations on some of the key players in the form of Dr Reddy's Laboratories, Lupin, Aurobindo Pharma, and Zydus Lifesciences. What the house said was the slowdown in both Indian and US pharma markets, which contribute to 70-80% of the revenue of the sector, is an important factor that goes into its bearish call on the space.

"This would translate into reduced growth prospects, as these two markets account for 70-80% of the industry profits," UBS wrote in a report called 'India Pharmaceutical Sector: Trends weakening in India, US'. "Despite the healthy balance sheet, investing in these new growth drivers will take time before the effect is felt.".

Analysts at UBS think the market still is undervaluing the depth of slowdown both in India as well as in the US. In fact, analysts, as put forth, said India's pharmaceutical market is being hurt by a significant rise in unbranded generics. The rise in unbranded generics, driven by the expansion of government's Jan Aushadhi (JA) drug stores to 5% of the market and trade generics that exceed 20%, was noted.

"Manufacturers' margins on unbranded generics are less than half of what they earn from branded products. This growing penetration of unbranded generics poses a threat to profitability," said UBS. The annual growth rate of the Indian market could decline by 1-2% from its base of 8% compound annual growth rate (CAGR) due to increasing JA stores.

In the US, there are some structural red flags, including concentrated distribution channels, potential FDA inspections that can create setbacks, a backlog in abbreviated new drug applications (ANDA) five times larger than annual filings, and 92% of prescriptions already being filled with generics.

"While the market has focussed on price erosion for mature molecules, these only account for 20% of US profits. The approval rate for ANDAs is a much bigger issue," UBS said.

UBS has initiated 'Sell' ratings on Zydus Lifesciences and Dr Reddy's Laboratories, citing that the core profit margins have been overestimated. The brokerage set the price target at ₹850 for Zydus Lifesciences and ₹5,700 for Dr Reddy's Laboratories.

At the same time, Aurobindo Pharma has been placed under a 'Sell' recommendation with a price target of ₹1,333 per share. Analysts at UBS feel the valuations for the company appear over-inflated. This is given the low growth rate and also the modest Return on Capital Employed (RoCE). Similarly, Lupin has received a 'Sell' call. It is supported by a price target of ₹2,250 per share. The firm has already factored in one-off gains expected in FY25 and FY26.

UBS has a 'Buy' rating on Sun Pharma and Cipla with the price target at ₹2,450 and ₹2,060, respectively. Under the assumption that Sun Pharma's revenue from patented products would double in the next four years while picking up the expansion in margin by 650 basis points, this will translate into EPS of 19% CAGR.

Here's what UBS believes in Cipla, for one. It has untapped potential in its US portfolio of injectable and respiratory products. While Cipla and Sun Pharma stocks have already gained 29% and 51% this year respectively, Dr Reddy's, Lupin, Aurobindo, and Zydus Lifesciences have risen between 15% and 67% in the period.