''We plan to tap the opportunity in Novel Drug Delivery System'' K. Raghavendra Rao, Managing Director, Orchid

Let's roll back the calendar to the last week of March this year. You are an investor with a lakh of rupees to invest in stocks. And let's assume that you did one of the following: a) Invested in bluer-than-blue-chip Sensex stocks; b) Put the money in Infosys; or c) Wagered it on a handful of mid-cap (less than Rs 1,000 crore) pharma stocks that your smart broker suggested. Let's roll the calendar forward to the start of July. Now, taking stock, who do you think fetched you the maximum return? The Sensex stocks? Fine, the index gained a handsome 22.63 per cent in the three months, but it still wasn't the top performer. Infy? Wrong again-despite the IT bellwether's 34.12 per cent jump. You are probably smiling if you-like many other smart investors-bet on mid-cap pharma stocks. For, in the three months, the mid-cap market capitalisation has soared from Rs 8,844 crore to Rs 14,200 crore. That's a 60 per cent gain-in just three months.

That the larger pharma stocks-like Ranbaxy and Dr. Reddy's-have been on a roll for almost six months now is old hat. What's come as a surprise, though, is the smart march forward of tier-two companies like Orchid, Lupin, Alembic, Nicholas Piramal, and Torrent (See The Top 10 Gainers). Needless to say, for small investors this is a great opportunity to buy into high-growth stocks. Their absolute price, unlike Ranbaxy's or Dr. Reddy's, is still affordable, besides which there's plenty of room for growth. Says Ashit Kothari, Senior Vice-President (Research) at ask Raymond James: ''If you have some appetite for risk, I would say go for mid-caps.''

Boom Spills Over

Until recently, investors in pharma wouldn't look beyond the bigger companies. For good reason. With growth in the domestic market stagnating, only the bigger players were in a position to tap international markets for generics (off-patent drugs) because of their strong R&D and international distribution networks. The smaller players were either stuck in the commodity bulk business (for exports) or had to contend with low-margin generics in non-regulated markets like South America and Africa. So what's got Dalal Street courting mid-cap pharma stocks?

The answer has to do with what's happening 7,000 miles away in the US market. The Food and Drug Administration (FDA) has decided to ease the drug approvals process for generics in a bid to reduce soaring healthcare costs. FDA's revised regulations lower the maximum period that a generic's entry into the US market can be "stayed" (for reasons like patent disputes) to 30 days. The regulation will come into force from August 18, 2003. Besides, the administration intends to speed up review of applications. That is expected to reduce the approval time by at least three months.

What the stockmarket is celebrating is not a mere cutting of the red tape, though. Its eye is on what the move means for India's generic manufacturers-both big and small. The projected market opportunity from drugs going off patent (and thus becoming available for manufacture by a number of generic suppliers) over the next five years is a staggering $60 billion (Rs 2,76,000 crore) and includes such blockbusters as Pfizer's Lipitor (worth $8 billion or Rs 36,800 crore). "Exports of generic formulations is the biggest opportunity for Indian companies followed by bulk drug exports (also known as Active Pharmaceutical Ingredients or APIs), contract research and new chemical entities or NCEs," points out D.G. Shah, Pharma Consultant and Secretary General of the Indian Pharmaceutical Alliance, a consortium of companies like Ranbaxy, Sun Pharmaceuticals, Torrent, Lupin and Alembic. (The common strand for the alliance is its members' high R&D spends and presence in the tougher-to-crack regulated markets of Europe, US, Australia and South Africa.)

Companies seen in a position of readiness to take advantage of the emergent outsourcing opportunity include the likes of Cipla, Lupin, Orchid, and Sun. Cipla-it's not a mid-cap-is expected to grow 20 per cent this fiscal to Rs 1,700 crore on the back of strong export income. It is all set to launch its Budesonide inhalers in Europe, besides which it has tie ups with US-based Ivax and Watson Pharmaceuticals for supply of antipsychotic Zyprexa, which has a $2.7 billion worth of market in the US.

''To thrive post 2005, you have to build intellectual capital'' D.B. Gupta, Chairman and Managing Director, Lupin

On the other side of the Atlantic, Indian companies like Divi's Laboratories have got approvals (in the form of Certificates of Suitability or CoS) from the European Directorate for Quality of Medicines (EDGM), a first step to getting marketing approvals. On the back of a CS bagged last month, the company has projected an almost 20 per cent increase in income to over Rs 300 crore in the current fiscal. The Secunderabad-based Matrix is supplying anti-depressant Citalopram to generic companies in Europe. Orchid Pharma has 3 COS under its belt with the last one given in June 2003, even as it has announced plans to file 12 Abbreviated New Drug Applications (ANDAs) in the US. The ANDAs will allow the Chennai-headquartered company to market generics of drugs going off-patent in America.

In quintessence the smaller Indian companies have finally managed to break into the high-margin regulated markets of Europe and US, and can look forward to reaping the rewards for some years to come. "In the short to medium term, the Indian pharmaceutical industry is expected to post healthy growth rates, with exports being the key driver," according to an industry outlook issued by ingres, a research division of ICRA.

It's A General Upturn

While generics are Indian pharma companies' short-term ticket to riches, things look rosy too on the basic research front-especially in the area of new chemical entities (NCEs). Here, a company not only gets to hone its own R&D skills, but gets royalties and milestone-linked payments from the licencee (usually a foreign drug major). Swiss company Novartis, for instance, has reserved the global rights to Torrent's age (Advanced Glycosylation Endproducts)-breaker compound, which has a huge potential in treatment of heart diseases and diabetes-related vascular complications.

Orchid, through Bexel Pharma, its joint venture in the US, is working on a promising diabetes molecule that will also attack the problem of weight gain associated with the prevailing diabetes treatments. Says Orchid's Managing Director, K. Raghavendra Rao: "I cannot say what revenue this will yield for the company, but similar deals have been done at $20-100 million (Rs 92-460 crore). We also plan to tap the opportunity in Novel Drug Delivery System (NDDS).'' The markets have already rewarded the company, which has plans to launch as many as 14 generic products in the regulated markets beginning 2005, with an almost 200 per cent hike in its share price in the current fiscal.

Torrent has licensed a potentially lucrative molecule to Novartis Samir Mehta, MD, Torrent Pharmaceuticals

Some prominent investors who have chosen to buy into the unfolding success story of this sector include Templeton, which has a stake in Aurobindo Pharma, and Citigroup, which bought a 12.5 per cent stake in TB drug manufacturer Lupin earlier this month, lured by the company's diversification into drug categories like cardio-among the fastest growing therapeutic drug categories in the country-and vitamins. Lupin has also filed five ANDAs, which would allow it to market generics of Cephalosporins (Antibiotics) in the US, and 12 DMFs (Drug Master Files) for selling bulk drugs. New drugs in the pipeline include a much-in-demand anti-migraine formulation, LLL 2011. Says D.B. Gupta, Chairman and Managing Director, Lupin, "If you are a serious pharma player and wish to survive and thrive beyond 2005, you have little option but to build intellectual capital."

There are growth triggers in the domestic market, too, where the long delayed easing of controls on the price of drugs (about 40 per cent of the domestic market is under the ambit of the Drug Price Control Order or DPCO) would not only provide a direct boost to firms whose products fall within its purview, but also further buoy sector sentiment. The local market is also maturing with the focus shifting to drugs for lifestyle-related ailments and away from anti-infectives, which used to dominate the market in the 1990s. According to org, therapeutics in the cardiac and neuro categories are the fastest growing (CAGR of 18 per cent in 1999-2002), followed by dermatological, analgesic, gynae, gastro-intestinal and nutrient (vitamins/minerals) segments.

The local market is also maturing with the focus shifting to drugs for lifestyle-related ailments and away from anti-infectives

But the question that investors want answered is, will the trend sustain? And if yes, for how long? Shahina Mukadam, a pharma analyst at the Mumbai-based Motilal Oswal Securities, feels that the opportunity is robust and forecasts steady growth for the sector. "I don't see major risk in investing." Maybe no major risk but some uncertainty is still there. The contours of the sector will change beginning January 1, 2005, when India will formally recognise product patents, against the current practice of only recognising process patents, which allowed Indian companies to reverse engineer and imitate patented products. Most analysts are predicting a re-rating of MNC stocks as a result (Mukadam has a neutral rating on Aventis Pharma, Merck India, and Novartis India), which could be accompanied by a de-rating of the domestic growth stories.

There is also the risk associated with one-drug wonders like Matrix (for anti-depressant Citalopram) running out of steam. Neither is striking NCEs with any regularity so simple. And as Indian companies battle abroad, they are exposing themselves to a higher litigation risk and product liability typical of regulated markets.

The bulls, however, say that even post 2005, multinationals will tie-up with domestic companies to leverage their research and marketing skills. Besides, while most pharma MNCs in the country are focused only on the domestic market, their Indian peers are looking outwards. The upshot: Concerns notwithstanding, the broad direction for the sector is northwards. The sun is shining on the Indian pharma sector and it is an opportune time to make hay.