By: Ahmed Lakhani
Arif Habib Limited
The pharmaceutical sector has been under pressure since last week. Market capitalization for the sector has dropped by ~8.5% since 1-Dec-14TD, with prices for ABOT, GLAXO, SEARL, FEROZ and HINOON plunging by 17.7%, 7.4%, 10.1%, 11.6% and 14.7% respectively. As per our sources, the news is that the Drug and Regulatory Authority of Pakistan (DRAP) is considering the Average Pricing mechanism. Of the three available pricing methodologies (the other two being Reference Pricing and Cost plus Pricing), the Average Pricing method is the least favorable for the sector. However, the policy has not been finalized and we believe that it is highly unlikely for DRAP to go ahead with average pricing. What might happen is that the policy gets delayed yet again till the easing of political tensions before the finalization of Reference pricing mechanism (being linked to SAARC/ASEAN countries) or Cost plus pricing, with both being positive for the sector.
Brief History of DRAP-PPMA-PCDA Conflict
Pharmaceutical sector has been plagued with the problems associated with an inconsistent pricing policy over recent years. While repercussions of fixed prices were not as severe previously, this was due to lower raw materials cost, lower inflation and a stronger PKR. However, with all this changing for the worse, the issue is now firmly in the limelight, with pharmaceutical companies – represented by the Pakistan Pharmaceutical Manufacturers Association (PPMA) – and pharmacies represented by the Pakistan Chemists and Druggists Association (PCDA), both lobbying against unfair price fixation.
Since the past few months, the issue has been taken up in court against the DRAP to finalize a fair price policy. However, while the court has given numerous ultimatums to DRAP, as well as exercising restraint in terms of deadlines, the DRAP has been unable to come up with a fair pricing policy.
Average Pricing Method – An overview
The average pricing method uses the average of prevailing prices of a certain generic drug, such as Aspirin, which is being sold under different brand names by various manufacturers. For instance if Panadol and Dispirin are the 2 only available brands of Aspirin and being sold for PKR15 and PKR10 per pack respectively, the average fixed price would be PKR12.5/pack. Needless to say, this means trouble for larger companies – MNC’s in particular, with their substantial overheads – while it’s good news for smaller companies, as well as illegal/counterfeit drug producers. Hence, this policy is actually a deterrent for growth of quality products in the sector.
A Word on Ferozesons
Ferozesons Laboratories (FEROZ) has become the talk of the town, with investors queuing up to receive a piece of the action, as the share has continued to rise with unprecedented success (recording a high of PKR 676). This has been possible for FEROZ due to success in becoming the sole licensee to distribute the blockbuster drug, SOVALDI, which is said to have an 80% success rate in curing Hepatitis-C, an illness that is widespread in Pakistan. However, even FEROZ has not escaped the recent price decline seen throughout the sector. We feel that this is unjustified and provides new investors with opportunities to benefit from the discounted prices currently seen (our P/E based Target Price being PKR 928/share, given in our Morning Call dated 27-Nov14). Further, their key earnings driver, i.e. Sovaldi is a life saving drug which doesn’t fall under DRAP policy.
Analysis and Recommendation
While the policy has not been finalized as yet, we do not expect that the DRAP will announce the policy any time soon due to the political scenario. When the policy
does eventually come out, we believe that either reference pricing or cost plus pricing will be the preferred choice. Either policy will allow pharmaceutical companies to increase their prices and subsequently their gross margins.
We believe that the current panic within the sector has actually provided investors with a lucrative opportunity to benefit from discounted prices and make healthy returns as a result.