Pharma, IT needn't be good contra calls

Wait for some more time before taking a plunge

There are only two sectors, pharmaceuticals and information technology (IT), which have disappointed investors in the past year. In a year when the National Stock Exchange’s Nifty 50 is up 17.2 per cent, and all sectoral indices have given positive returns, pharma and IT sectoral indices, which have declined with 11.3 per cent and 10.6 per cent, respectively, stand out like sore thumbs.
 
While pharma and IT mutual fund schemes have done better by falling much less, that is, -3.68 per cent (pharma) and -5.11 per cent (IT), it is still disappointing for investors who are seeing a bull run even in small-cap stocks.
 
Over a 10-year period, things are quite different. Amid the trio of defensives — fast moving consumer goods (FMCG), pharma and IT — FMCG funds have returned 19.49 per cent, pharma funds 14.80 per cent and IT funds 6.84 per cent annually, according to data from Value Research. Except IT funds, the other two have done better than the Nifty (8.63 per cent a year) over the same period.
 
While the FMCG sector’s good run has continued, pharma and IT companies' fortunes have gone downhill. So, does it make sense to invest in there? Investment advisor Arun Kejriwal says it isn’t. “In these two sectors, all companies are suffering from some problems or the other. Also, one does not know when things will improve. I would rather wait for a few months to get a better outlook before I invest as a contra call,” he says. 
 
The argument against taking contra calls against these sectors, say experts, is the problems that they are facing haven’t gone away. For example, the IT industry is facing a political pushback in the US, its major market. A recent Nomura report has pointed out that while IT companies are trading at near historical discounts to other defensive sectors like FMCG, valuations are not cheap enough to ignore structural issues or external risks. Going forward, the brokerage house is cautious on margins of IT companies, given the rupee’s appreciation and the need to change onsite staffing. “We expect FY18 to start off slow and see risks from structural issues and external risks to outweigh cyclical improvements,” says the report.
 
Pharma is going through similar pains, as the industry is under significant pressure due to increased scrutiny from US Food and Drug Administration (USFDA). Leading companies like Sun Pharmaceutical, Lupin and Wockhardt are all finding themselves in some trouble or the other with the regulator. While reports suggest some fund managers are beginning to take contra calls on this sector, many others  are still unconvinced.

 
“The pharma sector has been consistently facing problems from the regulator — a much deeper problem. The industry needs to take a serious look at its quality issues,” said a fund manager, who did not wish to be named. There are pricing pressures as well.
 
A study by Evaluate Pharma recently estimated there would be a $390 billion drop in global pharma sales over the next five years, following pricing pressure and greater scrutiny on drug pricing in the US. While the impact on Indian companies is yet to be quantified, as the sector is the biggest supplier of drugs to the US, it is obvious that they would be hit.  “I would wait for another six months at least to buy stocks or funds in this sector. Yes, there is a chance that there might be some turnaround in their fortunes because of steep falls, but even if I buy at 10-15 per cent higher than current prices, it is worth the risk,” says the fund manager. 
 
“It would be wise for investors to build a portfolio of stocks in IT and pharma sectors across large and small-caps through a systematic investment plan, rather than lumpsum buying,” says Nilesh Shah, MD, Kotak Mutual Fund.