R&D Costs: Who Will Benefit In Pharma?

The Union Budget 2012 has yet again disappointed the pharma sector by not providing the much required inclusion of the non-in-house R&D expenses like land, building and clinical trials. It has however granted five years’ extension to the existing Clause 35(2AB) which gives 200 per cent weighed income tax exemption on the R&D costs incurred.

The Indian pharma companies in the last decade have provided good opportunities for the investors due the generic drug opportunities across the world. Besides, the coming days will belong to those companies which will be discovering new molecules as well as challenge the top drug patents. To do so, however, one needs to invest heavily in R&D. The process related R&D activities are also important for the operating performance of a firm.

We have collected information related to the R&D expenses of the top Indian pharma companies to find out which are the most likely companies to gain from this development. What we found from the data is that Dr Reddy’s Laboratories (DRL) is the only company that spends over 10 per cent of the total income on R&D activity. Lupin is another company which has shown impressive growth in its R&D expenses. We believe that both Lupin and DRL are the two companies that are most likely to benefit from the extension of 35(2AB) in the coming days. Both the companies may also plan to scale up their R&D activities to gain additional tax benefit as well as work on new products. Lupin, on an YTD basis, is up by 12 per cent while DRL is up by 6 per cent during the same period.

The R&D expenses of Cadila Healthcare at 6.5 per cent of the total income also look good to us. That apart, Piramal Healthcare, Sun Pharma, Glenmark and IPCA Laboratories will also be beneficiaries of the tax exemption on R&D expenses.

Ranbaxy and Biocon, on the other hand, have reported decline in their R&D expenses in CY11 and FY11 respectively. We expect that the R&D expenses will be the key for their growth since both the companies are facing some unresolved issues. Ranbaxy’s two manufacturing plants are currently facing an import ban while Biocon’s deal with Pfizer has come to an end. We believe that Ranbaxy will increase its R&D activities as it will gain from the off-patent products in the export market while Biocon will gain from a speedy launch of insulin analogs.

Investors should note that it takes a long time to discover new molecules and monetize them. Given this fact we would prefer Lupin and DRL as investment-worthy companies as they are already spending more money on R&D.

# Ranbaxy’s figures are for the calendar year CY11 and CY10.