Why Indian pharma companies will continue to face a margin squeeze this year

India’s pharmaceutical industry derives close to half of its nearly $50 billion revenue from exports, and has grown at a compound annual rate of 8-9% during the last five years. However, growth for the year ended March 31, 2022 was a tad lower and was largely driven by higher domestic consumption.

Operating margins for the industry at large have been stable around 23%, but 2020-21 was an outlier when margins shot up to more than 25% due to lower marketing, travelling and conveyance expenses because of Covid-19 restrictions. The margin declined in the last fiscal year ended March 2022 and is expected to shrink again this year.

What’s behind the squeeze?

With the one-time gains from lower operating costs getting neutralised due to normalisation of business operations and weaker sales from Covid-related drugs, margins tapered off last year.

In addition, the US generics market witnessed a steep rise in competition and consequent price erosion, which also hit the profitability of local drugmakers in 2021-22.

On the flip side, the adverse impact of price erosion on profitability was partly offset by the depreciation of Indian rupee against the dollar.

The Indian pharma industry is facing multiple issues, starting with rising prices of active pharmaceutical ingredients (APIs), key starting materials and solvents, rise in freight and energy cost, and continued pricing pressure in the US generic market.

Due to supply chain disruptions and continuing lockdown in China because of its zero-tolerance policy, the prices of some APIs and KSMs have increased between 25% and 120% while prices of excipients have shot up as much as 200% since January 2021. The cost of packing material rocketed 25-100%. There has also been a significant upward movement in the cost of power, fuel, coal and thereby freight charges in the same period.

Moreover, with easing of travel restrictions, the US FDA has upped its regulatory inspections of manufacturing facilities. Rising instances of audit observations push up the compliance cost, further denting margins. It also potentially delays launch of products and thereby affects margins.

On the flip side, recently India's drug pricing authority allowed a price hike of 10.7% for scheduled drugs which are under price control, considering the rise in the cost of production. This would provide some support to the drugmakers. The price erosion in the key US market is also expected to moderate, though it will continue to have some impact.

Rating and research agency CARE expects operating margins in the industry to slip below the 20% mark in the first half of this year (April-September). This may bounce back to 22-23% level in the second half. But it would still dent margins for the year to just over 20%.