This document is being provided for the exclusive use of Abhishek Tulsyan at S. P.

Jain Institute of Management and Research

No part of this Report may be published/reproduced/distributed in any form without CRISIL's prior written approval

Profitability of bulk drug players to remain range bound

Indian pharmaceutical companies are present across the entire value chain, from manufacturing API to final formulations. While several companies
sell both formulations and active pharmaceutical ingredients (APIs), many others export APIs and formulations. Even as intermediates and chemicals
form bulk of imports, the value of exports far outstrips imports, which makes India a net exporter. Given its structure, the industry faces several factors
that can impact its profitability. These include:
Geographical factors impacting sales or realisations
Exchange rates of the rupee vis-a-vis other currencies
Regulatory environment
Company-specific factors
We have analysed profitability of bulk drugs exports based on different macroeconomic factors. In 2014-15, profitability of bulk drug players dipped
sharply by 200 basis points (bps) to nearly 17.9%, mainly because operating margin of Jubilant Life Sciences dropped by an estimated 550 bps. The
company received a warning letter for its Spokane facility, which dragged down exports to the US. The company further faced pricing pressures in its
life science ingredients in markets like China. This, coupled with remediation costs, have impacted its operating margin. However, higher growth
reported by companies such as Granules India - whose revenues rose nearly 18% (estimated) - helped cushion the fall in margin.

Bulk drug manufacturers to see stable margin in the near-term

Source: CRISIL Research

P: Projected, E: Estimated
Note: 2014-15 numbers will be updated post release of aggregate set's annual reports

Going forward, pricing pressures could intensify in the generics segment of regulated markets such as Europe, which could pull down realisations of
bulk drugs players. Moreover, increased competition from Chinese companies, especially in more commoditised categories of API, could limit pricing
for Indian API makers. Pricing pressure is thus likely to limit revenue growth from exports.
On the cost front, increase in global regulatory requirements is prompting higher expenditure on facilities and compliance. Moreover, power costs and
costs relating to environmental compliance are also increasing, especially in Andhra Pradesh, one of the largest export hubs. Consequently, we expect
the EBITDA margin to remain rangebound at 17-19%. Many API makers are forward integrating into formulations and filing abbreviated new drug
applications (ANDAs) to tap the lucrative US market and to counter the fall in margins. However, delay in receiving ANDA approvals could lead to
excess idle capacity and add severe financial stress on such companies.

Product portfolio and focus on cost - key to improve profitability

Bulk drug exporters operate in a highly competitive environment. Many products face severe competition as they are commoditised in nature.
Moreover, significant quantities of imported input chemicals and intermediates exposes players to fluctuations in exchange rates. Companies further
face increased regulatory and environmental compliance requirements, which strains their operating margin.
Thus, to boost revenues, bulk drug manufacturers must carefully select their product portfolio and services strategy. For example, supply of high-value,
low-volume molecules (niche generics) is more profitable as competition is limited. In contrast, large-volume molecules face greater competition, which
hits realisations.

This document is being provided for the exclusive use of Abhishek Tulsyan at S. P. Jain Institute of Management and Research
No part of this Report may be published/reproduced/distributed in any form without CRISIL's prior written approval
Similarly, providing custom synthesis services, pre-formulations and entering into supply deals for on-patent drugs offer better prospects due to lower
competition, more stable business models and better pricing realisations. However, such services require highly technical skills and relationships with
innovators.

Product portfolio options for API makers

Source: CRISIL Research

Apart from focusing on the right business mix, bulk drug companies also need to manage their costs, especially raw materials. Raw material costs
constitute 50-55% of operating income for a bulk drugs manufacturer. Chemicals and intermediates are major raw materials required, which could be
either sourced locally or imported. As the share of imports ranges 30-80% of total raw materials used, players are exposed to substantial foreign
currency risks and fluctuations in international prices of methanol, acetic acid, etc as their prices are driven by global petrochemical prices.