India Ratings and Research (Ind-Ra) has maintained a neutral outlook for the Indian pharmaceutical sector for FY23. Ind-Ra expects the Indian pharmaceuticals market (IPM) to grow 6%-8% YoY in FY23 (FY21: 5.1% YoY; 1HFY22: 27.7% YoY) and a muted performance in the US generic market due to a mid-to-high single-digit price deflation (FY21: negative 1.2% and 0.9% in 1HFY22 YoY).

The Indian active pharmaceuticals ingredient (API) suppliers witnessed weak growth during 1HFY22 (FY21: 19.2% YoY), due to a high base and inventory stocking in FY21 on account of Covid-19-led disruption in supplies of key starting materials. While the agency expects the API business of Ind-Ra selected companies to report high single-digit growth in FY23 due to a demand uptick, the overall revenue growth for them is also expected at 9%-10% YoY, given their optimised operating costs which will lead to a healthy EBITDA margin performance (20%-21%) in FY23 (FY21: 22.9%; 1HFY22: 22.6%). Higher capex in lieu of the Production-linked Incentives (PLI) scheme will restrict the quantum of free cash flow generation during the year.

Ind-Ra has also maintained a Stable Outlook for its most of the rated pharma issuers for FY23, expecting limited rating movements in the sector. The agency has upgraded ratings on 12 companies in its pharma portfolio since April 2021, on account of a continued improvement in the business and financial profile, strong EBITDA to operating cash flow conversion, a healthy uptrend in return on capital employed and a strong performance in the India business.

Like in FY22, the agency expects the rating actions in FY23 to be driven by company-specific factors United States Food and Drug Administration (USFDA action, operating profitability and business visibility). Ind-Ra has observed fewer facility inspections from the USFDA in lieu of the pandemic, and hence expects a significant increase in USFDA inspections in FY23. Ind-Ra continues to monitor its rated portfolio and any material deviation in the credit metrics from its expectations could result in a rating downgrade.

Most large pharma companies rated by Ind-Ra belong to high investment-grade categories. Large players are adequately capitalised to make bigger investments to adjust for the ongoing fundamental shift in market opportunities.

Ind-Ra expects the mid-single-digit pricing pressure in the US generic market and healthy growth in the domestic pharmaceutical market to continue well into FY23. Cost-cutting measures remain a priority for Indian companies. However, interim disruptions such as high raw material costs and logistic expenses will put pressure on the level of free cash flow generated. With the significant improvement in the free cash flow generated in the near term, M&A activities will continue to provide inorganic push in FY23.

Ind-Ra does not expect the sector’s liquidity to face a major risk, despite similar maturities levels in FY23 and FY24. Large pharma companies generally have large cash balances, which typically account for 14%-16% of their revenue. Furthermore, most companies have sufficient headroom under debt covenants and diversified funding sources. The interest coverage of large pharma players is likely to increase with scale and margin expansion. Ind-Ra expects large pharma companies to continue with their healthy debt-funded capex and research and development programme, given higher visibility in terms of sales growth and profitability.