Domestic funds exiting pharma stocks on valuations

However, FIIs have been raising their stake in these scrips

Foreign institutional investors (FIIs) have been increasing their stake in the health care segment, while domestic funds (DIIs) have been reduced theirs’.

In the March quarter, health care attracted the second largest inflow across sectors from FIIS, at $702 million. And, it also saw the largest of outflows by domestic investors, at $472 million. At the end of the March quarter, FIIs had increased their holding by 50 basis points on a sequential basis to 26.4 per cent; DIIs had reduced theirs' by 60 bps to 6.7 per cent (see chart).

Four of the past five quarters have seen this divergent trend — FIIs largely buyers and DIIs emerging as sellers in health care.

The rise in FII limits in select stocks and profit-taking by DIIs are key reasons. Over recent months, the FII limits have been increased for Lupin, Glenmark Pharma and Aurobindo Pharma. In fact, at $353 mn, Lupin got nearly half the overall FII inflow into the sector.

There has also been a churn in the DII portfolio from defensives towards cyclicals. Fast moving consumer goods and health care companies saw the highest outflows on a sequential basis by domestic investors in the March quarter. Unlike FIIs, domestic investors are significantly overweight on capital goods, oil and gas and public sector banks, says Motilal Oswal Securities.

“Domestic funds are more optimistic about the recovery. They believe cyclicals are highly undervalued and once recovery starts, these stocks will give good returns. Since pharmaceutical stocks have gone up quite a bit, they have booked a bit of profit from defensives such as pharma,” says Daljeet Singh Kohli of IndiaNivesh. FIIs, he says, want to first see some change on the ground; they don’t see many good options in cyclicals, with some of these burdened by debt, he adds.

There is also a view in the market that the valuations are still high, despite the fact that product approvals by the US Food and Drug Administration have come down dramatically. Either approvals come in or valuations correct but neither is happening, says an analyst. “DIIs have cut their exposure to pharma, given the higher valuations and are moving to sectors where valuations are more supportive; it is a cyclical shift. Globally, FIIs are more comfortable in the health care space,” says Vikas Khemani, president and chief executive, Edelweiss Securities.

Analysts say FIIs are looking at the long-term story and initiatives of Indian pharma companies to transform themselves into global entities, with a focus on niche pipeline, geographic expansion and research & development.

Abhishek Sharma of IIFL says domestic investors have been major buyers of pharma companies in the 2010-2014 period and some funds still have major exposure here. Of late, there has been some profit-booking due to a sharp run in the price and in valuations as compared to the 2012 levels.

While the health care space has been one of the best performers over recent years, valuations have also moved up substantially. From 18.7 times the one-year forward earnings estimates in FY12, the valuations had peaked at 27 times at the start of FY15, before correcting to 24 times at the end of that financial year, in end-March.