FDA Adapting To Expansion Of Generic Drugs

 |  Includes: AGN, HSP, MYL, NVS, PRGO, TEVA
by: Morningstar

The global expansion of the generic drug industry and the flood of applications for drugs losing patent protection have led to a backlog of drug approvals for the resource-constrained Food and Drug Administration. While new generic drug bioequivalency and stability requirements will raise the bar for approvals, a new generic user fee program and agency reorganization should enable the FDA to reduce the drug backlog. We don't think the large generic drug manufacturers, such as Teva Pharmaceutical (NASDAQ:TEVA), Novartis (NYSE:NVS) subsidiary Sandoz, Mylan (NASDAQ:MYL), Watson Pharmaceuticals (WPI), Hospira (NYSE:HSP), and Perrigo (NASDAQ:PRGO), will have any significant issues navigating new FDA requirements.

The FDA must adapt to the changing generic drug industry. The globalization of the pharmaceutical supply chain, a multitude of new international generic manufacturers, and the increasing complexity of drugs have amplified the oversight responsibilities of the FDA. The agency is reorganizing and putting in place new operating procedures for coping with the generic drug global supply chain. While some of the FDA's changes should increase generic manufacturer costs and drug approval times, we think industry efforts to increase resources and streamline the approval process at the agency should eventually reduce the large backlog of generic drug applications. In general, we think the largest generic drug manufacturers will be able to smoothly transition to new FDA requirements on generic drugs.

Over the past decade, globalization and the large number of U.S. branded drugs coming off patent have led to a rise in abbreviated new drug applications, or ANDAs, for generic drugs. ANDAs swelled to nearly 800 in 2005 from 300 in 2001 and have consistently been between 800 and 900 every year over the second half of the past decade. Additionally, the U.S. pharmaceutical market has become more reliant on international suppliers. The FDA expects nearly 24 million drug product shipments into the United States in 2011, a nearly fourfold increase from a decade ago.

The agency also estimates that about 40% of drugs consumed in the U.S. are manufactured outside the country and 80% of the active pharmaceutical ingredients come from abroad. The international drug supply chain incorporates nearly 130,000 importers and 300,000 manufacturing sites in 150 countries. Meanwhile, the addition of new FDA staff has not coincided with the agency's rise in responsibilities. Currently at about 1,850 full-time employees, the number of personnel at the FDA has remained relatively flat over the past decade. These factors have largely contributed to the current backlog of nearly 2,000 ANDA applications.

An agency reorganization and a new fee program should increase the pace of generic drug approvals. The FDA is taking measures to alleviate pressure on the agency while also raising the bar for ensuring safe and effective generic medicines. To match the demands of the global manufacturing environment, it is creating four new offices. The Office of Drug Security, Integrity, and Recalls will address supply-chain issues, threats, and integrity. The Office of Manufacturing and Product Quality will manage manufacturing compliance, market surveillance, drug shortages, and consent decrees. The Office of Scientific Investigations will handle quality systems and international regulatory collaborations. The Office of Unapproved Drugs and Labeling Compliance will enforce unapproved drugs, quality of compounded drugs (drugs made by pharmacists), fraud, and collaborations with the Centers for Medicare and Medicaid Services.

The FDA will alter its operating procedures as well. It plans to implement operating recommendations from McKinsey consultants and improve its quality management system. The industry also awaits the passage of the Generic Drug User Fee Act, which will allow the FDA to collect fees on submitted generic drug applications and approved manufacturing facilities. The GDUFA agreement negotiated between the FDA and the Generic Pharmaceutical Association will allow the agency to increase its financial resources in exchange for shorter generic drug approval times. The FDA plans to implement GDUFA in October 2012. We estimate the GDUFA fees will be relatively low.

The FDA is raising the bar to ensure safe and effective generic medicines as the industry grows. Corresponding with the increase in ANDAs, warning letters for international drug quality issues climbed to 19 in 2010 from 2 in 2005. The FDA also noted that drug shortages have risen considerably over the past few years, especially in sterile injectable drugs, which accounted for 74% of all shortages. Further, the FDA said 54% of the shortages in 2010 resulted from poor product quality and manufacturing practices, while 21% resulted from capacity constraints.

The agency is implementing a quality-by-design process, which steers generic drug manufacturers toward a greater understanding of manufacturing and quality-control measures. The FDA will require generic drug manufacturers to begin reporting all bioequivalency studies to the agency (currently companies only report passing bioequivalency study results). Any failing bioequivalency studies will require a manufacturer explanation for the outcome. Additionally, the agency will be releasing draft guidance requiring larger and longer drug stability tests, which could increase generic drug development costs and delay drug approval times.

Large generic drug manufacturers should easily adapt to new FDA requirements. Although new bioequivalency and stability requirements will increase generic drug application times and development costs, we think the largest drug manufacturers will easily adapt to the new standards. We don't think the new requirements will have much effect on our profitability forecasts and fair value estimates for the large-scale operators, such as Teva, Sandoz, Mylan, and Watson, thanks to their existing quality-control measures, operating processes, and economies of scale. Small players and new entrants will probably be most affected by the changes. Despite higher application costs and longer application preparation times, requirements for faster drug approval times and reduction in the ANDA backlog should be a net benefit to the industry by enabling manufacturers to get their products on the market faster.