Featured API industry reform: high barriers/high investment/high returns

"Featured raw materials have growth potential, and some high-quality companies will usher in considerable return on investment in the secondary market." A few days ago, China Health Media Group China Pharmaceutical News and major securities companies (capitals) jointly launched the "Dialogue·Pharmaceutical Capital" In the "Circle" series of live broadcasts, Zhou Yu, chief analyst of the Pacific Securities Pharmaceutical Industry, deeply analyzed the market situation and policy motivations of the specialty API industry. He believed that in recent years, it has been subject to environmental protection, generic drug quality and efficacy consistency evaluation, related review and approval, and national collections. Under the influence of such policies, the long-term major changes in the specialty API industry are beginning and will enter the “three highs” era of “high barriers, high investment, and high returns”.

Multiple factors catalyze change

What is the reason for the long-term major changes in the specialty API industry? Through combing and observing the policies, Zhou Yu believes that the continuous improvement of environmental protection, consistency evaluation, and related review and approval requirements has increased the barriers of the API industry and catalyzed the supply-side reform of the industry.

In January 2020, the State Food and Drug Administration and other four departments jointly issued the "Guiding Opinions on Promoting the Green Development of the API Industry", proposing the establishment of API green factories, green parks, and green management standard evaluation systems, energy consumption per unit of industrial added value, carbon dioxide The emissions, water consumption, and the emission intensity of major pollutants such as sulfur dioxide, nitrogen oxides, and volatile organic compounds are gradually reduced. Zhou Yu listed relevant environmental protection policies from 2016 to 2020. He believes that whether it is environmental protection policies, the supervision of enterprises by various national and regional pharmaceutical administrations, or the audits of API companies by downstream preparation companies, all have put forward higher standards and stricter requirements for environmental protection and three waste treatment. This has raised the barriers to entry for the API industry, and the surge in environmental protection costs has become a trend. Some small companies are deterred by high costs and gradually withdraw from the market.

At the same time, the consistency evaluation promotes the continuous improvement of the quality of APIs. In 2016, the "Opinions of the General Office of the State Council on Carrying out the Consistency Evaluation of the Quality and Efficacy of Generic Drugs" was released, and the consistency evaluation work of my country's generic drugs is progressing steadily. As of August 1 this year, 1002 product specifications have passed the consistency evaluation, and 100 product specifications have been evaluated by more than 3 companies. my country's quality requirements for the over-evaluated varieties are in line with the US FDA's review and approval standards, which puts forward higher requirements for the APIs of domestic enterprises related to oral solid preparations and injections. Zhou Yu predicted that some API companies with poor product quality control capabilities and relatively backward technology may face the fate of being eliminated.

In addition, the implementation of related review and approval of APIs and preparations will also promote the supply-side reform of the API industry. The holder of the drug marketing authorization is responsible for the quality of the API, so that the quality of the API and the quality of the preparation are no longer "disconnected". High-quality preparations require high-quality, high-stability APIs, and companies lacking technological advantages will find it difficult to gain a foothold.

Zhou Yu vividly compares API companies to "booths". The original supply system and free competition pattern have been changed. Preparation companies can only build connections with two or three "booths", and the upstream and downstream relationships are closer. The price elasticity of API products will also weaken.

Profit shifts to the front

The operating data of the major 43 listed pharmaceutical companies and 27 listed API companies in the capital market show that the net profit growth rate of pharmaceutical companies after deduction has dropped rapidly from 12.49% in 2016 to 3.24% in the first quarter of 2019. The asset growth rate declined rapidly and remained at a low level. The growth rate of fixed assets of API companies increased rapidly from 5.67% in 2017 to 18.71% in 2018 and 16.75% in the first half of 2019, showing a relatively high growth trend.

Zhou Yu analyzed that API companies are expanding faster than downstream preparation companies, and the profits of the pharmaceutical industry chain will shift to the front end.

Under normal circumstances, the most downstream brand manufacturers in the industry are more profitable. However, with the full implementation of volume procurement, the profit margins of manufacturers in the generic drug field have been greatly compressed, and brand advantages have gradually faded with the vigorous promotion of generic drugs. Zhou Yu said that cost control capabilities will become the core competitiveness of future generic drug varieties. High-quality specialty API companies will stand out, occupy a higher market position, and have stronger voice and bargaining power.

Zhou Yu predicts that the production capacity expansion rate of the high-quality API industry may remain at a high level, and is higher than the production capacity expansion rate of the formulation industry. On the one hand, this high growth rate comes from the increased willingness of formulation companies to purchase APIs under cost control. ; On the other hand, it comes from the industrial extension of API companies to the downstream of preparation integration.

The investment cycle of API companies is relatively long. It usually takes 5 to 10 years from the initial project establishment and R&D design reaction route to the final realization of standardized market commercial sales to obtain high returns. Zhou Yu said that the API industry is an industry that gradually achieves high returns, with a relatively long return period. When the fixed asset investment in the API industry starts to accelerate, its high return on investment may take about 3 years. For example, raw material pharmaceutical companies have accelerated their fixed asset investment since 2018, and high returns on performance will gradually be realized in the next 1-2 years.

So, will the price of specialty APIs be affected by the sharp price cuts of preparations? In this regard, Zhou Yu believes that the main reason for the slow increase in the price of specialty APIs from 2016 to 2018 is that the price of upstream chemical products required for the synthesis of specialty APIs has increased significantly, which belongs to imported "inflation", and the future of specialty raw materials Changes in drug prices will come from demand-driven "inflation."

Zhou Yu analyzes from the perspective of "stock" and "incremental" markets: under the influence of volume purchases, the era of high gross profit for generic drugs is over, and the localization rate of preparations and even its raw materials will increase significantly. At the same time, most of the bid-winning companies with volume purchases are domestic pharmaceutical companies. As domestic preparations rapidly replace imports, the demand for raw materials from domestic preparation companies will further increase. In addition, bulk purchases have more impact on the price of preparations, and raw materials as a manufacturing cost item have relatively little impact. Compared with the cost ratio of major international generic drug companies, the manufacturing cost of Chinese pharmaceutical companies is about 24%, which is lower than the international level (about 50%). Zhou Yu predicted that, in the future, the manufacturing cost of preparations companies in my country may continue to rise and approach the international level.

When industrial upgrading is in progress

The growth industry refers to the continuous advancement of technology, the technology application from demonstration to marketization and scale, product sales are growing rapidly, market scale is gradually expanding, industry profits are also growing rapidly, and a large amount of capital is invested to support fast-growing industries. The specialty API industry is a growth industry with technology-driven growth attributes.

Zhou Yu observed that the production technology of my country's characteristic raw material medicine industry is continuously improving, production quality management is accelerating in line with international standards, and industrial upgrading is progressing.

A worker must first sharpen his tools if he wants to do his best. Technology is the core driving force for the high-quality development of an enterprise. Zhou Yu believes that technological progress has opened the ceiling of the industry, and the market share of high-end specialty APIs will increase rapidly. With the initial results of early R&D investment, companies will quickly implement R&D results in fixed asset investment. New plants, new equipment, and new orders will follow one after another, driving the specialty API industry to gradually enter the harvest period, and profits will accelerate.

In addition to the promotion of technology, product line extension and expansion are also stimulating the production capacity of specialty API companies. Zhou Yu took the Indian generic drug giant Dr. Reddy as an example to describe the industrial extension from raw materials to preparations. He said that my country's API companies are changing their roles from a major intermediate supplier to a major global specialty API supplier and even a major global preparation supplier. In addition, the variety of specialty APIs has also expanded from a single variety to multiple related varieties.

Zhou Yu is optimistic about the profitability of specialty API companies in the future. According to his analysis, from 2013 to 2018, the net profits of 11 specialty API companies in my country have shown sustained growth. Since 2013, the specialty API industry has continued to supply-side reforms, the number of varieties obtained DMFs, and the number of overseas audits has continued to increase. The performance of some high-quality specialty API companies has seen sustained and rapid growth, and the industry's growth has been highlighted. For a long period of time in the future, this trend will continue to promote the rapid growth of corporate performance as the existing substantial investment in fixed assets is converted into production capacity.

Dialogue: How to choose the transformation path of raw material pharmaceutical companies

Moderator: Some characteristic API companies are expanding the industry of preparation integration to the downstream, and some companies use their technological advantages to transform to patented APIs and patented drug production and become CDMOs of innovative drugs. Which transformation path are you more optimistic about?

Zhou Yu: The business models of these two transformations are different. The core of the development of API companies is based on products and extending around products, while CDMO is focusing on customers for industrial upgrading. Relatively speaking, the threshold for transition to CDMO is higher, and API companies are more likely to transition to CMO. Both models have their own advantages and prospects.

Moderator: What do you think of some preparation companies considering purchasing API companies for integrated development?

Zhou Yu: The policy is forcing the transformation of generic drug companies. The above approach is one of the directions. However, the production of APIs requires more professionalism and accumulation, and requires high management and technical capabilities, which cannot be achieved overnight. If downstream preparation companies have the ability to directly acquire API companies, it is also a good way to break through.

Moderator: In a cyclical and price-volatile industry such as bulk APIs, are there any companies that have done a good job in transforming into specialty APIs?

Zhou Yu: Some companies are expanding into intermediates or specialty APIs, and some are doing innovative research and development. However, pure bulk API companies may be more in the stage of fighting costs. In the future, their product prices will be greatly affected by the market and need to be transformed.