We had indicated to stay invested last quarter as it was an optically weak quarter, and the same has played out. Offtake of Revlimid resulted in revenues growing to Rs. 1,221 Crores (vs. Rs. 475 Crores QoQ) and profits expanding to Rs. 407 Crores (vs. Rs. 133 Crores QoQ).

Rationale for staying invested- 

• Strong product pipeline: 
  • The company is preparing to launch Risdiplam (Evrysdi) in the Indian market, pending a decision from the Delhi High Court regarding Roche’s injunction. It has decided to price the product at a fraction of the cost of other players (Rs. 15,900 vs. 2 lacs+).
  • NATCO and Mylan Pharmaceuticals Inc. have settled their U.S. patent dispute with Novo Nordisk regarding generic Ozempic (Semaglutide). NATCO and Mylan are collaborating on developing generic Ozempic products, but the settlement terms are confidential. Semaglutide is used in the treatment of diabetes and aids in weight loss. The patent for Semaglutide in India expires in March 2026. In other countries, such as Canada, Brazil, and Saudi Arabia, the patent is set to expire between 2026 and 2027.
  • It also has some drugs in its pipeline which will materialize in the next few years. 

• Scale up and profitability in Crop health Sciences (CHS) segment - In FY25, CHS delivered Rs. 60 Crore in revenues and was loss-making, including an impairment charge taken in Q4FY25. Management expects to achieve revenues between Rs. 160-170 Crore in FY26 and reach breakeven. Post FY26, it is expected to start delivering profits.
• Cash Cushion, Acquisition, and Monetizing Opportunities - The Company has ~Rs. 3,500 Crore in cash and bank balance. Management commented that they will likely complete an acquisition targeted towards increasing their manufacturing or distribution base in the US. Natco has more than 400 acres of land parcel near Hyderabad; it monetized ~15 acres for Rs. 115 Cr and will sell additional land parcels over the next 4-5 years at the right realization if needed. 
• Early Stage Investments and R&D efforts- Natco is ahead of the curve and invests in multiple opportunities, some of which may yield significant returns in the future. 
  • NRC-2694-A is an orally administered small-molecule tyrosine kinase inhibitor discovered and developed in-house; it is being tested for the treatment of Head and Neck cancer.
  • eGenesis - Invested Rs. 68 crore in a biotechnology company focused on xenotransplantation by developing safe and effective human-compatible organs for transplant.
  • Investments to the tune of Rs. 31 Cr in Cellogen Therapeutics (gene therapy-based treatment), Eyestem (cell therapy for eye treatment), and Stero Therapeutics (novel therapeutics for rare diseases). 
• Valuation- Natco is currently trading at a P/B of 2x and has Rs. 3,500 Crore in cash and bank balance. Ongoing businesses including export business ex-Revlimid, domestic revenues, API business, and CHS segments will continue generating positive cashflows. 

Guidance and uncertainty- Management estimates a possible dip in revenue by 20% and profits by 30% due to geopolitical uncertainties, pricing pressure in its core product portfolio in the US, and increased R&D expenses. This guidance doesn’t factor in positives from domestic launches (Risdiplam + Semaglutide). 

Moneyworks4me opinion:

Given Natco Pharma's strong product pipeline, the expected turnaround of its CHS segment, its significant cash reserves for strategic growth, and its investments towards R&D, we believe the company is well-positioned for long-term growth. While some near-term market dynamics exist, the fundamental strength and promising catalysts outweigh them. Therefore, we recommend clients to HOLD their positions, allowing these strategic initiatives to fully materialize and deliver continued value.

Optically weak quarter, Revlimid sales have seasonality. 

Segmental performance-

• Export formulations segment took a hit as there was no off-take of Revlimid in current quarter. Off-take depends on how much Teva procures from the company, based on its inventory levels and volume market share. As per the agreement, Natco is allowed to increase its market share every year (up to a maximum of 33% of volumes until CY26). We believe management’s commentary that sales will recover in Q4FY25 and the following quarters, after which pricing should be monitored.
• Among other segments, domestic formulations business (Rs. 96 Cr in Q3) declined marginally at 3% YoY and 6% QoQ while API business (Rs. 67 Cr in Q3) grew 44% YoY and 34% QoQ. Crop Health Science, a new segment the company entered a few years ago, has grown 7% YoY/QoQ to Rs. 15 Cr.

Approval of 2 Abbreviated New Drug Application (ANDA)-

• Final Approval for Generic Bosentan (PAH Drug) in the U.S.
  • It has received final approval for its generic version of Tracleer® (Bosentan tablets for oral suspension), used to treat pulmonary arterial hypertension (PAH) in children aged 3 and above.
  • Lupin Pharmaceuticals, Natco’s marketing partner, will handle the product’s U.S. launch. Natco believes it holds exclusive First-to-File rights, granting it 180 days of market exclusivity. However, launch details remain confidential.
  • The drug had estimated U.S. sales of $11 million for the 12 months ending Sep’24.
• Approval for Generic Everolimus (TSC Treatment) in the U.S.
  • It has received approval for its generic version of Afinitor Disperz® (Everolimus tablets for oral suspension), used to treat certain brain tumors in patients with Tuberous Sclerosis Complex (TSC) aged one year and older.
  • Breckenridge Pharmaceutical, Natco’s marketing partner, plans to launch the drug immediately in the U.S. market.
  • The drug had estimated U.S. sales of $112 million for the 12 months ending Sep’24.

Product pipeline – Company has a strong pipeline of drugs, including major molecules like Semaglutide and Pomalidomide. Semaglutide targets both diabetes and weight loss, with settlement and litigation outcomes impacting its launch timeline.

Financial Resilience through Cash Reserves: With over Rs. 2,000 crores in cash as of Sep’24, Natco is exploring acquisitions to strengthen its portfolio.

NATCO Pharma Ltd (Natco) is a well-established player in oncology segment (cancer related) with brands catering to diseases including breast, bone, lung and ovarian cancer. It is a vertically integrated player, targeting niche molecules placing emphasis on R&D, operating in domestic and export markets. Compared to other pharma players, this focused approach where barriers to entry are high and customers are stickier aids the company. 

It has made its mark across all 3 business segments, namely finished dosage formulations (FDF), active pharmaceutical ingredients (APIs), and Contract Manufacturing Business.  In contract manufacturing, Natco is targeting growth in Crop Health Sciences (CHS) business with state of the art manufacturing facilities for both technical and formulations manufacturing.

In export formulation, its business model is to challenge innovators drug patent (niche Para IV/Para III filings/First to file) and capture large market of generic version of such drugs. Management has shown capability of navigating complex legal and regulatory challenges to do the same. Natco mainly sells FDF in the US, India, Canada, Brazil, and over 50 other countries.

They have nine manufacturing places across India and two research centres in Telangana. 

Para IV/FTF Business Model

In the United States, a pharmaceutical company must submit a special application to the FDA (Food & Drug Administration) known as an ANDA (Abbreviated New Drug Application) to introduce a generic drug. There are various categories of ANDAs, each with a specific purpose:

1. Para II: This type is submitted when the original drug's patent has already expired.

2. Para III: This is used when the generic company intends to wait until the patent of the original drug expires before selling its version.

3. Para IV: This is filed when a generic company thinks that its product doesn’t violate any existing patents, or it believes the original patents are invalid or not enforceable.

When a Para IV filing is made, the original patent holder has 45 days to respond, potentially by suing the generic company. If this happens, the FDA can delay the approval of the generic drug for up to 30 months or until the patent dispute is resolved, whichever comes first. The outcome of the legal case or a settlement then determines if the FDA approves or disapproves the ANDA.

A key aspect here is that the first generic company to make a Para-IV filing and successfully navigate the patent litigation is granted a 180-day exclusivity period. This period, known as First-to-File (FTF), allows the generic company to be the first to market their version of the drug, potentially capturing a significant market share.

Natco, entering the US market around 2010, has performed notably well by focusing on specialized opportunities and achieving several firsts in this area.

Blockbuster opportunity in Export formulations

Revlimid (Lenalidomide molecule) is a prescription medicine, used to treat adults with cancer/multiple myeloma. Natco Pharma along with Teva Pharmaceutical Industries settled the Paragraph IV litigation related to Revlimid with Celgene (part of Bristol-Myers Squibb -BMS). Other companies have also stuck deal with BMS such as Sun Pharma, Zydus Cadila, Cipla and Dr. Reddy’s Laboratories. But here, Natco has advantage as terms of its agreement are drastically better than peers. 

While management guided that Q3FY24 will have muted sales of Revlimid, the same will keep on growing in coming years. As per agreement Natco is allowed to increase its market share every year (maximum at 33% of volumes till CY26). Usually in blockbuster drugs, major threat is price correction post patent is over. In case of Revlimid, major price correction in US market from these levels is not expected. Apart from US market, Natco can even gain foothold in other markets (via its subsidiaries in Brazil and Canada) for Revlimid. 

Historically, export formulation segment has grown at 13% CAGR, catering to 3 major markets namely US, Brazil and Canada. 

Domestic business back on track

In domestic formulation business, three key business segments have been oncology (64% contribution), pharma specialty, cardiology & diabetology (C&D). Majority of launches in India are first time branded generics. It has promising pipeline of ~40 innovative molecules for future growth in specialty business. While domestic sales have been muted in last few years, H1FY24 run rate shows signs of being back on track. 

Crop Health Sciences (CHS) segment scaling up

This division was established by leveraging the company’s core pharmaceutical expertise in chemistry, patent knowledge, and a strong commitment to quality. In their CHS portfolio, there are different chemicals and biological solutions to control insects, diseases, and weeds in crops. 

In the past year, they introduced two pesticide formulations, NATGEN and NATERRA, using Chlorantraniliprole (CTPR), and combination products named NATVOL and NATLIGO. These products work as versatile foliar (liquid spread on leaves) insecticides suitable for various crops. In India, they anticipate the market size for CTPR combination products to be ~Rs. 2,000 crore. Furthermore, they've been marketing pheromone-based mating disruption products tailored to manage the pink bollworm, a significant pest in cotton farming.

Their main goal is to create unique molecules for both the Indian and global markets. Additionally, they're interested in forming partnerships with other businesses (B2B) for these products. Company has 8-10 more products in the works, scheduled to be released in the next two years.

Management

V.C. Nannapaneni- He has over 42 years of experience in the pharmaceutical industry. Having spent more than a decade in the US, he has worked in various pharmaceutical companies. His educational qualifications include Bachelors and Masters Degrees in Pharmacy from Andhra University, Vishakapatnam. Additionally, he holds a Masters degree in Pharmaceutical Administration from the Brooklyn College of Pharmacy in the United States.

Currently, he is involved in general management responsibilities and also oversees the New Drug Discovery program of the company. This indicates his role in both overall leadership and the strategic development of new pharmaceutical products for the company. 

Rajeev Nannapaneni- has worked at Merill Lynch and Natco Systems LL.C in USA. He joined the company in the year 2000. He has got wide experience and exposure in General Management, New Business / New Product Development in India and for International markets. He holds B.A degree in Quantitative Economics and also B.A in History from Tufts University, Boston, USA. This academic background, coupled with his professional experience, contributes to his role and responsibilities within the company.

Concerns: There could be two areas where company might face issues, higher than expected price erosion in Revlimid and domestic business not ramping up. 

Opinion- Natco pharma has a differentiated business model - 

(a) Targeting niche and complex chemistries, intricate production processes or innovative methods of delivering drugs, 

(b) With capable management who have strong execution history, 

(c) Challenging innovators for complex generics and

(d) Focus on diversifying revenues through entry into CHS (expect ~Rs 180 Cr+ in FY24 with levers to grow ahead). 

Good results.