3 reasons why pharma's 'underperformer' tag at markets could change soon

Resolution of supply chain issues, defensive buying and index inclusion are triggers

The Pharma sector has been an underperformer on the stock exchange during the last bull run. While the Nifty 50 has returned 45 per cent in the last 12 months and 5 per cent in the last 30 days, the Nifty Pharma index has returned 19.5 per cent and minus 5.6 per cent, respectively. This trend could change over the next three months, for several reasons.

The Nifty Pharma Index is being extensively reworked. As of September 30, it will track a total of 20 stocks, selected and weighted on the basis of free-float market capitalisation. That doubles the population from the current 10 stocks. 

This, inevitably, means rebalancing on the part of mutual funds, index watchers and the Pharma sector Index ETFs. It may also mean some speculative buying from traders, who will ride any momentum that develops.

The Pharma sector has seen overall year-on-year expansion of both topline and the bottomline in the Q4, 2020-21 and Q1, 2021-22. The sector has always been considered a strong defensive holding. This is due to high forex earnings, and it is usually not affected by cyclical factors.

Investors do watch for two red flags. One is possible legal trouble due to Intellectual Property-related cases. The other is adverse reports from the US FDA (Food & Drug Administration), which regularly inspects export facilities in India (and elsewhere) for hygiene, quality control, etc.

In Q1FY21 however, Pharma had major issues due to global supply chain disruption. The import of Chinese APIs (Active Pharmaceutical Ingredients) were taken out of the equation due to the pandemic, which was centred in Wuhan province where most of China’s APIs are manufactured. China holds dominant market share in the global API market and India imported approximately Rs 17,500 crore worth of APIs in FY20.

Local lockdowns and transport issues also led to disruptions in the manufacturing processes for Indian Pharma, and in transportation to markets. Pharma has also been hit by margin pressures. The largest market, the US, is seeing lower drug prices. However, the Q1FY22 performance suggests the supply chain issues have been sorted out, although US margin pressures remain.

As investors turn slightly cautious with the stock market seeing churn and profit-booking at Nifty's 16,500 levels, the Pharma sector could attract defensive buying. This is especially true of the new stocks that will become members of the Nifty Pharma Index.

The new members would be decided on the basis of several different criteria. Apart from being in the F&O list, the index members would be chosen on the basis of averaged six-month free float market cap. So it’s technically impossible to give a definite list yet.  

However, the probable candidates include stocks like Gland Pharma, Abbott India, Laurus Labs, IPCA Labs, Pfizer, GlaxoSmithKline, Syngene International, Sanofi India, Ajanta Pharma, Natco, Alembic Pharma and Glenmark, etc. Several of these may also be included in the F&O list. While Gland and Laurus have excellent YTD returns of above 65 per cent and Ajanta has returned 37 per cent, the others have been underperformers. We could see a trend reversal across this space.