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India remains an important country for the US for import of pharmaceuticals with it featuring in the top-10 overall exporters to the US and among the top-4 in pharma. Pharmaceuticals is the third-largest imported commodity in the US and the second-largest category in imports from India. Pre-covid, the frequency and number of inspections of manufacturing plants in India by USFDA had increased significantly with growing ANDA filings, especially for complex products. We expect this trend to return with the environment normalising. However, it remains a double-edged sword since, pre-covid the inspections were followed by a number of observations, OAIs (official action indicated) and warning letters. High price erosion in US generic markets among other macro factors has already pushed sector valuations into a trough; the rise in USFDA inspections with adverse outcomes could further delay recovery from these levels.

* USFDA inspections to the fore; pending ANDAs pile up: India is one of the largest suppliers of generic drugs to the US market; additionally, fourth-highest pharma imports to US are from India (~US$9bn in CY21). Pre-covid, India underwent highest USFDA inspections (~14% of the total in FY20) outside of the US. Increased inspections were not only due to more ANDA filings, but also change of filings towards complex products, which require more scrutiny. These inspections were followed by observations / OAIs / warning letters, which kept impacting pharma supplies to the US. Inspections during the pandemic were only for critical drugs, but the environment is now normalising and the frequency of USFDA inspections is increasing. All this while, companies kept filing ANDAs resulting in a long list of products awaiting approval. Our coverage universe has an average of 86 ANDAs pending for approval. Hence, USFDA inspection remains a double-edged sword for Indian companies. A clean chit from USFDA would provide opportunity for product approval and launches, but an adverse outcome could delay the same, further affecting growth.

* Increased conversion of inspection to warning letter/OAI causes concern: Before covid, the USFDA had issued a total of 220 warning letters in FY20 vs an average of ~150 p.a. between FY15-FY20. The jump is in the number of ‘non-US’ countries – to 70 from a 5-year average of 52. China and India top the list of recipients, together receiving ~47% of total warning letters for the non-US segment in FY20 whereas the average between FY15-FY20 was ~60%.

* Early trends: Most Indian companies have been waiting for USFDA to begin plant inspections. However, early trends point that these inspections are ending with high number of observations (nature of the observations remain unknown). Based on precedents, these observations would delay product approvals and launches denting growth prospects for the companies. Sector valuations have reached a trough following steep price erosion in the US market due to high channel inventories among other macro causes. Adverse outcomes to the USFDA inspections could restrict valuations at these levels for extended periods.

* Prefer companies with higher India sales, clear FDA status and pipeline of complex generics: US generics market is expected to remain under pressure due to continuous price erosion, delay in launches and uncertainty about USFDA inspection outcome. We believe India domestic business provides better growth visibility and margin sustainability. In the US, companies with clean FDA record and pipeline of complex generics would prove to be a better choice despite price erosion. Top picks: Alkem, JB Chemicals, Dr Reddy’s.

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