Pharma contract manufacturing and research firms witnessed a disappointing third quarter, raising concerns among investors for a sector that was considered one of the best bets during the pandemic.
The revenue and margin for the Contract Development and Manufacturing Organisation segment saw a year-on-year slump. As a result, most stocks in the category are trading close to their 52-week lows and analysts do not see an immediate growth trigger for the sector.
According to Abdulkader Puranwala, pharma analyst with Elara Capital, it was the exceptional increase in demand during the pandemic that led to unrealistic expectations and stock price run-ups.
The market leader in the CDMO segment, Divis Laboratories Ltd., has been downgraded by several brokerages following its Q3 results. Kotak Securities has revised its ratings from ‘reduce’ to ‘sell’, HSBC has lowered its rating from ‘hold’ to ‘reduce’, and Phillip Securities has changed its rating from ‘buy’ to ‘neutral’.
High Covid base and channel inventory hurt the third quarter performance for most companies in the segment.
During the pandemic, a majority of CDMO companies received large orders for active pharmaceutical ingredients and drugs related to Covid-19 therapies, resulting in exponential sales growth. However, as the pandemic waned, the demand for these drugs declined and their revenue contribution became almost negligible.
Additionally, drugmakers stocked up on excess inventory that was not fully used up, dragging down new orders. It is expected to take a few more quarters for the channel inventory to return to normal.
In its Q3 FY23 conference, Divis Labs reported that raw material prices had gone up and there were pressures on the sales prices of the API. But the company has been optimistic about “growth and also profitability growth” in the coming quarters.
According to analysts, the long-term growth opportunity for the sector remains intact, aided by ‘China-plus-one’ shift and cost benefits. However, investors may need to wait until at least the second half of FY24 to see any upside.
Despite the current setback, these companies are otherwise well-positioned as their revenues are considered sticky, according to Sriraam Rathi, India analyst for pharma and healthcare at BNP Paribas. “Companies do not usually change their suppliers because they require regulatory approvals,” he told BQ Prime. “Thus, they usually stick to the same two to three suppliers.”
While some of these companies are trading below their March 2020 levels, they have not underperformed when compared to pre-pandemic levels, Puranwala said. However, he expects to see further correction in stock prices.
Rathi advised investors to “definitely add good companies when they see further correction”, but also said that investors may have to be patient as this sector “might not generate immediate interest”.
Here’s what analysts have to say about some listed CDMOs:
Divis Laboratories Ltd.
Suven Pharma Ltd.
Gland Pharma Ltd.
Neuland Labs Ltd.
Syngene International Ltd.
Piramal Pharma Ltd.
