Steady outlook and higher returns triggers for companies refining their strategy
The Nifty Pharma index has been one of the major underperformers, declining over 11 per cent since the start of 2022. In contrast, the benchmark Nifty50 has risen 5 per cent during the period. Even as pharma stocks have disappointed investors, brokerages believe domestic pharma companies would be a better bet going ahead than those with a high exposure to the US market.
The reasons for this investment argument are higher regulatory and pricing pressures in the US market and the recent bounce-back of the Indian pharmaceutical sector. Sun Pharma’s Halol facility in Gujarat recently received an import alert notification from the US Food and Drug Administration (USFDA). The facility, which was already under scrutiny, was re-inspected and slapped with the highest penalty (import alert) for not conforming to good manufacturing practices. This facility accounted for 10 per cent of Sun Pharma’s US revenues and 3 per cent of its consolidated turnover.
Among the listed entities, Glenmark Pharma is another drug maker which received an import alert for its facility in Baddi, Himachal Pradesh.
Such instances of import alert, according to Motilal Oswal Research, have significantly intensified the regulatory risk of the India pharma sector’s ongoing base business in the US market. In addition, the brokerage’s Tushar Manudhane and Sumit Gupta highlight that unsuccessful USFDA compliance leading to official action indication/warning letter have adversely impacted the prospective business of Indian pharma companies focusing on US generics. Further, the timeline for the escalated USFDA action has shortened considerably, adding further risk to the US generics business.
Besides higher regulatory pressures, increased price erosion over the past few years, cost escalation due to higher raw material costs, increasing working capital needs, and more competition for the same drug in new filings have compounded the pharma companies’ worries.
Given the headwinds in the US market, most brokerages are positive on companies in the domestic pharma space. Nomura Research’s Saion Mukherjee and Aneesh Deora say that growth for domestic formulation makers will be driven by price increases, patent expiries, seasonal demand and acquisitions. They expect steady domestic growth and low costs to support earnings.
A domestic growth recovery is seen as one of the key triggers for India-focused players. After muted 3 per cent growth in October, the domestic pharma market posted robust 14.5 per cent year-on-year growth in November. Barring a few therapies, most key segments reported double-digit growth rates.
According to Aarti Rao and Maulik Varia of Anand Rathi Research, “most therapies have picked up pace in the past four to five months”. A ramp-up, they say, has been seen across sub-chronic and chronic therapies such as cardiac, anti-diabetes, dermatology, gynaecology and antineoplastics. “Demand in acute therapies (excluding Covid 19-related products) are also picking up momentum.” The brokerage has maintained its positive view on chronic therapy-focused companies like Ajanta Pharma, JB Chemicals, Eris Lifesciences and Torrent Pharma.
The focus of pharma companies will increase on the domestic market and companies are expected to scout for opportunities inorganically with surplus cash from Indian operations, say Rashmi Shetty and Zain Gulam Hussain of Dolat Capital. “With cash flows and profitability in the US relatively weak, the Indian pharmaceutical market is once again gaining prominence and focus. The last two to three years have seen companies shifting gears and focusing on the home turf, which offers steady growth, much better working capital and cash flows, and higher return on capital employed.” Its key picks are Cipla, JB Chemicals, Ajanta Pharma, Indoco Remedies and Suven Pharma.
The pharma majors’ preference of India and less regulated markets and the higher growth in these geographies is also reflected in valuations. While export-oriented pharma majors are trading at valuations last seen a decade ago, at around 19 times their FY24 earnings estimates, those for domestic focused companies are richer at 26.5 times, says Nomura Research. Given the valuation comfort, its top pharma picks are Zydus Lifesciences for its improvement in India growth, potential upside in the US and reasonable valuation, and Lupin, which has a favourable risk-reward ratio and could be a turnaround story.