FY17 could be a better year for pharma majors

With most concerns priced in, investors may start bottom-fishing as valuations look reasonable

As pharmaceutical majors grappled with the US Food and Drug Administration (FDA) on compliance, concerns on their growth in the world’s largest pharma market and thus, their overall growth increased. Sun, Lupin, Dr Reddy’s, Cadila and even Cipla and Aurobindo, all are facing  FDA ire.

Among recent developments include the second set of observations for Lupin’s Goa plant, indicating increased risks of further action by the FDA. If that happens, approvals for many limited-competition products filed from the facility (a key revenue contributor) can get delayed. Additionally, analysts at Kotak Securities in their March 18 note said they saw a possibility of 10 per cent downgrade to Lupin’s FY17 consensus EPS (Rs 71, a growth of 45 per cent over a year) due to lower sales of anti-diabetic generics, Glumetza. Not surprisingly, Lupin’s stock is down 17 per cent in the past week. Sun’s US revenues have also seen softness due to limitations with the Halol plant and delay in ramp-up from other facilities. Additionally, though IMS data suggested Sun’s recently launched oncology generics drug, Gleevec, has gained 52.6 per cent market share in the US, analysts at Nomura in a note this month said data did not fully capture the entire market and, hence, its market share might be lower than reported by IMS.

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The recent government ban on many fixed-dose combination (FDC) drugs also raised concern on business growth for certain companies. However, domestic majors (except Lupin) do not figure in the list of top 10 drugs by sales. While many companies have taken interim stay orders from courts, in the case of an unfavourable order, the impact for Lupin and Sun will be only Rs 0.2 and Rs 1.8 per share, respectively, estimate Karvy’s analysts.

Given the series of negative news flow, pharma stocks have fallen sharply in the past 6-12 months and lagged broader markets in March, too. Most are trading 25-33 per cent lower from their peak levels.

While clearance of FDA-related issues is the single most important trigger for growth, analysts say companies are taking corrective measures. As clarity emerges, it could provide triggers. While they say the worst seems behind, there are positive developments, too.

Sun Pharma, for instance, will see synergy benefits accruing from its acquisition of Ranbaxy starting FY17-FY18.

Dr Reddy’s, with the acquisition of UCB’s product portfolio, has seen its India sales grow 33 per cent in February, whereas its niche US portfolio as injectables also faces limited competition. Completion of the Gavis acquisition should drive Lupin’s US growth. Further, with companies having multiple production facilities, they are likely to seek site transfers from the FDA for new launches. Site transfers allow companies to undertake manufacture and export of approved drugs from other FDA-compliant plants.

Though currency headwinds could emerge, for now, the Bloomberg consensus estimates suggest earnings of top companies (except for Dr Reddy’s and Cadila) will grow upwards of 20 per cent in FY17 and by over 17 per cent (except Glenmark) in FY18. And, with valuations cheaper  (FY17 estimated PE ranges 16-20 for most companies), analysts advise long-term investors can accumulate selectively on dips.