Growth in domestic market likely to provide booster dose for pharma stocks

The pharma sector, once considered a safe bet, has been trailing the benchmark indices for four years in a row

The Nifty Pharma was the second biggest gainer among sectoral indices, rising 10.4 per cent on Tuesday. In addition to the market rally, analysts believe it will be among the few sectors to post strong revenue and profit growth in the March 2020 quarter.

Besides domestic demand, there could be higher export orders — not just for Covid-related drugs but also for other formulations. The sector, once considered a ‘safe bet’, has been trailing the benchmark indices for four years now. In CY19, for example, even as the benchmarks delivered 12 per cent returns, the health care index declined over 9 per cent — a 21-percentage point difference.

Since the start of CY20, however, the sector’s fortunes have changed. Recovery in domestic sales growth, stability in revenues (against the sharp drug price erosion earlier) in key developed markets, a depreciating rupee, and attractive stock valuations are expected to help the sector outperform its peers.

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Some of the gains are reflected in the health care index, which has risen marginally by 1.3 per cent in one month. In comparison, the benchmarks have witnessed a dip of 20 per cent.

Analysts at CLSA believe earnings of pharma firms are relatively secure in a vulnerable market. It is the only sector where brokerages have revised their earnings estimates upwards for the coming year. The key trigger is the trajectory in the domestic market, which has been growing upwards of 10 per cent, thanks to an uptick in pricing, and healthy volumes. Growth was driven by both the acute and chronic segments.

 

 

CLSA believes the industry has strong growth drivers — rising penetration of medicines, increasing affordability, and growing incidence of chronic disorders such as diabetes, cardiac, and oncology therapies.

After two months of single-digit growth, the figure touched 12 per cent in February for the sector, led by price hikes. Analysts expect the current double-digit growth rates to sustain, which will help boost the top line and domestic operating profit margins of pharma firms. While multinationals get almost all their revenues from India, Sun Pharma, Lupin, Cipla, and Cadila Healthcare get about 40 per cent of sales and over half their earnings from domestic operations.

 

In the US, too, analysts expect steady profitability in the next couple of quarters. Antique Stock Broking’s Kunal Randeria is positive on the US market as drug shortages are near five-year highs.

Further, he adds India is relatively well-placed to scale up due to the lower impact of Covid-19. This will help firms supply more to the US and EU. He also highlights that if shortages increase, plants under the USFDA’s Warning Letters could see exemptions for certain products.

The brokerage believes companies with a strong domestic franchise and growing US business with pipeline visibility are unlikely to disappoint on the earnings front. 

Moreover, valuations have turned attractive. Most pharma stocks are available at valuations lower than five-year averages. An­tique highlights Cipla and Dr Reddy’s in the large-caps and Al­kem in the mid-cap space as its top picks, while CLSA prefers Sun Pha­rma, Cipla, Cadila, and Abbott India.