Pharma formulators diverge on strategy for non-prescription businesses: IndRa Report

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Indian formulators seeking growth amid divestment plans by global formulators

India Ratings and Research (Ind-Ra) expects Indian formulators to continue to make investments to grow their domestic non-prescription business through organic and inorganic routes. This would be driven by the need to further diversify the domestic prescription business and strong fundamentals. This strategy is in sharp contrast to some global majors looking for strategic alternatives to exit their mature consumer health business. Investments by Indian formulators are likely to be in consumer healthcare and wellness products, apart from the traditional over the counter (OTC) product categories through new launches, brand extensions and switches from prescription products.

Global MNCs preparing for strategic alternatives: Since 2H17, global majors such as Merck and Pfizer have announced a potential full or partial sale of their consumer health business as well as strategic partnerships for accelerating deleveraging and to focus on the core prescription business. However, potential buyers are opting out of the transactions on account of low single-digit growth globally and elevated valuations which will lead to a higher proportion of debt in the funding mix. GlaxoSmithKline’s buyout of its stake in the joint venture with Novartis International and the potential sale of consumer healthcare nutrition products to fund the same indicate early signs of consolidation in the consumer healthcare space. The non-prescription business includes products in categories such as analgesics, cough, cold & allergy, dermatological, gastrointestinal and lifestyle OTCs such as vitamins, minerals & nutritional supplements and dental products. For global majors these businesses contribute 5-25 per cent to their total revenues, with emerging markets contributing 25-50 per cent from the non-prescription businesses.

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Strong growth levers for domestic non-prescription market: According to Business Monitor International (BMI), India’s non-prescription or OTC market contributes around 14.5 per cent to the total pharmaceutical sales and is expected to grow to $4.2 billion at a CAGR of 8.8 per cent over 2017-2022. The growth is likely to be driven by limited household affordability for frequent clinical visits, convenience of direct purchase and growing preference for self-medication for minor ailments. Furthermore, the growth rate in the OTC segment is expected to be among the high growing Asian peers and would continue to outperform the growth rates in developed geographies.

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Indian formulators’ growing focus on OTC businesses: Over the years, Indian formulators have steadily increased presence in the OTC and consumer segments through organic and inorganic routes, to diversify their domestic generic prescription businesses, while leveraging the established distribution network and sales force of the prescription business. However, the current scale and profitability in the OTC segment are rather insignificant to the overall business risk profile of majority of Indian formulators. Indian formulators Cipla  (Cipla Health) and Cadila Healthcare (Zydus Wellness) have explored spin-offs into separate entities (but continue to hold controlling stake) to allow this business to charter its own course and tap into the growing health and wellness consciousness among the urban population. This has also attracted investments from private equity players to support incremental growth.

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Large Indian formulators have expressed aspirations to build sustainable businesses with a turnover of Rs 10.0 billion-15.0 billion over the medium term to long term. The agency believes Indian formulators will ramp-up presence in the non-prescription business through investments in consumer healthcare and wellness products, apart from the traditional OTC product categories, through brand extensions and new launches. Furthermore, the agency believes the non-prescription business to contribute a solid 15-20 per cent to domestic revenues over the next five years.

Selective interest by Indian formulators for acquisitions: There is a likelihood of selective interest among Indian formulators in the event of a potential sale of select established brands by global majors. The global consumer portfolios under review by Merck and Pfizer also include key common brands in the Indian OTC space for antacids, pain management, probiotic food supplements, depilatory creams and vitamins as well as select prescription brands in cough and cold and other therapeutic segments included as an incentive to the proposed sale process.

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The mature brands in these portfolios contribute 20-50 per cent to India’s revenues, dominated by leadership positions in vitamins, antacids and expectorant/ nasal decongestant sub-segments. While the brands in haematinics and expectorant/ nasal decongestant segment have continued to exhibit above-market growth, the inability to recover from flat-to-low single-digit growth of some leading multivitamin and antacid brands in the trailing 12 months may be a cause of concern.

Switch from prescription to OTCs: Indian formulators have also explored re-launch of prescription products in the OTC avatar such as Sun Pharmaceutical’s Suncros (dermatology), Glenmark Pharmaceuticals’s Kwitz (nicotine gum) and the most recent launch of Lupin’s Softovav (laxative). This strategy is likely to support lifecycle extension for prescription products albeit at a lower price point. Anti-addiction, laxatives, UV protection categories are likely to see incremental interest from other players.

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Traditionally, the potential for abuse and adverse effects due to inadequate label instructions have restrained approval for proposed switches. However, the Indian government in September 2017 announced its plans to expand the basket of OTC medicines by adding around 100 new drugs to the OTC drug list. While the regulation is positive in terms of formalisation of a regulatory pathway, well-managed pricing, product differentiation, product positioning, engaging advertising and retail strategy of formulators pursuing the switch will determine profitability.

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Regulatory interventions such as the ban on fixed dose combinations (March 2016) also have had a disruptive impact on the sale of some of the largest-selling OTC brands sold by Indian and global formulators in India. These included Piramal Enterprises Ltd’s Saridon, Procter & Gamble Hygiene & Health Care’s Vicks Action 500 Extra and Reckitt Benckiser (India) Ltd.’s D’Cold. Although formulators have launched brand extensions without the banned combinations and have gradually recouped sales lost due to the ban, similar adverse regulatory actions may serve as hurdles to the OTC growth story.

Divergent dynamics from prescription products: The OTC segment is different from the broader prescription pharma space, as it has several nuances which are uncharacteristic in nature. These include lesser regulatory restrictions such as the inclusion in the national list of essential medicines that affect the pricing of products in the prescription pharma space, ability to grow brands by advertisement and promotion activities and effective communication, multiple avenues to enhance portfolio breadth by the addition of nutraceuticals, wellness FMCG and other segments and high propensity to grow brands in other geographies. However despite regulatory harmonisation, competitive elements such as significant investments in media campaigns for enhancing consumer appeal or brand recall to drive in-store visibility for user base retention are hurdles to grow sales and profitability.

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A consumer business generally takes about three years to break-even to single-digit EBITDA margins, because of the significant investments required for distribution and sales force; post which, a positive operating leverage coupled with incremental product launches should enable the business to generate mid-teen margins. Established products in the wellness categories can have higher operating margins. Large Indian formulators with demonstrated brand building capabilities and established distribution network can break-even faster and achieve profitability early. The margin and return profile of an optimised non-prescription business is structurally better than an acute prescription portfolio but may significantly be lower than for a chronic prescription portfolio.

FMCG players to maintain upper hand in consumer healthcare: The agency does not expect Indian formulators to outwork established FMCG players in the consumer products arena. Indian FMCG players have demonstrated the ability to develop strong local market knowledge with innovative approaches to gain deep consumer insights, leading to a large diversified portfolio across several product categories and economies of scale to aggressively price products However, the product overlap is likely to be only in certain categories where formulators are likely to have a competitive edge due to better brand pull over FMCG players or portfolio gaps not adequately addressed by FMCG players.