Generic Drug Makers to Benefit from Health Care Reform

Japan's brand drug makers are facing difficult challenges. The country's baby boomers – the cohort born between 1947 and 1949 – are starting to retire in numbers this year. With an aging population and limited financial resources, Japan's government is seeking to reduce ballooning spending by its national health care insurance system. Some consolidation in the industry is inevitable, as already evidenced by the recently announced merger between Tanabe (4508), and Mitsubishi Pharma.

One sector within the drug industry that should benefit from the new regulations aimed at cost-cutting is generic drugs. Since April 2003, co-payments for individuals in Japan's health care insurance system have been lifted from 20% to 30%, making consumers more sensitive to their healthcare costs. In the U.S. and many European countries, the generic drug market is well established, but Japan is behind as much as 20 years. On a unit basis, generics represent only 10% of Japan's drug market, against 40% to 50% in the US and Europe.

Source: Bando-Yakuhin
Note: Red bars are for units; blue bars are for local currencies


In addition to issuing various "guidance," the government has published regulations to promote wider use of generic drugs. These include price revisions in 2002 to provide additional incentive payouts to insurers for generic drugs, and last year's change in the prescription format to allow pharmacies to change to generics when pre-approved by a doctor.

Japan's generic drug industry is highly fragmented; there are about 200 manufacturers, mostly small, privately owned companies. The expanded market opportunities bring more competition, not only among generic firms but from entry by the big, name-brand pharmaceutical companies. Consolidation in this segment is inevitable. While there are a limited number of publicly traded generic drug companies, the leading names may offer investment potential because (a) by acquiring smaller competitors, the leading companies will post higher growth; and (2) they also are acquisition candidates for Japan's brand drug makers as well as large overseas companies.

Already, there are signs of foreign interest in this segment; specifically, several Indian generic drug makers announced they will enter the Japanese market to exploit their price competitiveness. Also, this year stock-swap acquisitions by overseas companies will be allowed, making purchase and investment easier for U.S., European, and Asian companies, many of which are better capitalized than their Japanese counterparts.

There are only a handful of publicly traded companies in Japan that focus on generic drugs. Their stocks trade at PEs of 20 to 25, about the market average. In addition, a few of the brand pharmaceutical makers get a good portion of their business from generics. Elmed Eisai, a subsidiary of Eisai (4523; ADR:ESALY), boasts the top reputation among medical professionals. Sawai (4555) seems the most reputable among independents; it's also the market leader and is increasing production volume by purchasing a plant owned by Schering Japan.

Nichi-Iko (4541) is aggressive in M&A and tie-ups; it has formed an alliance for itemization and standard-making with Towa (4553), another leading generic company, and Sawai. The company has had to revise its earnings expectations upward several times in the past few years. Towa is known for aggressive direct sales to pharmacies, which may be attractive to overseas companies entering the Japanese market.