Macquarie initiates coverage of Divis Labs, Syngene and Solara with a bullish view

Divi’s and Syngene are well placed Pharma companies as outsourcing continues to evolve from a largely cost arbitrage strategy for innovator companies to enhancing R&D productivity and reducing time to market. Outsourcing is increasingly becoming a strategic function in most big pharma companies as they leverage CROs and CDMOs. Despite its highly fragmented nature, the U.S. $150bn+ global pharma CRO/CDMO/CMO (CRAMS) sector has high entry barriers, is highly regulated, has high switching costs, requires deep technical expertise and is a sticky business. Currently, India commands <4% share of the global market, much lower than 16%+ for Chinese CRAMS companies.

As Innovator Company’s look to further diversify their supply chain post COVID-19 and geopolitical tensions, Indian companies offering an attractive blend of lower costs, talent, infrastructure and higher regulatory readiness have an opportunity to garner a greater share.

Global comparison of CRAMS companies suggests that Divi’s and Syngene are in the top quartile on most metrics like growth, margin profile and return ratios. The only metric where Divi’s and Syngene lag their global peers is with regards to higher client concentration risk.

Within Indian API players, look beyond the near-term demand frenzy. Notwithstanding the near-term strength due to channel stocking and supply disruptions due to COVID-19, Macquarie believes that, in a normalised growth scenario, the structural tailwinds for Indian API companies are strong.

Rising need of formulation companies to diversify supply chains, increasing regulatory oversight on API facilities, IP conflicts and competing interests, and geo-political tensions driving import substitution, Macquarie expects Indian companies to benefit. Their analysis suggests that led by import substitution alone domestic API production can broadly double in the next five years.

Similarly, India’s annual API exports, at U.S. $4bn, are significantly lower than China’s U.S. $20-22bn. Even a U.S. $2bn shift from China could result in a 50% surge in India’s API exports. On the flip side, our extensive checks suggest that while the government’s ‘Make in India’ push through the PLI scheme is a step in the right direction, unless incentives are much more lucrative, the scheme is unlikely to result in any meaningful benefit for most listed companies. Within API companies, Macquarie believes pure-play suppliers with a long-term focus and a strong regulatory track record, like Divi’s and Solara, are the best plays on the theme.

CRAMS has an edge over API, while we are cognizant of the structural tailwinds for Indian APIs, fundamentally, CRO/CDMO companies have secular growth trends, superior margins, return ratios and face lower risks.

(Authored by Rahul Kamdar)