A Democrat victory could hurt pharma sector: Ampersand Cap

A: The risk reward in the near term, in our view it is balanced because the market has obviously run ahead of the recovery in the second half whether we call it discretionary demand or the capex cycle in terms of the public capex cycle revival. In our view the risk rewards looks to be balanced; obviously there is a big event tonight and tomorrow, so we need to play that out. However, from earnings point of view and recovery point of view, we are turning more selective in terms of the sectors we like - like cement, specialities, non banking financial companies (NBFCs) and so on.

Ekta: Just wanted to get some perspective on how serious this election outcome could be for the pharma space because we saw huge fall on Friday, we are seeing stocks correct in today’s trading session as well albeit selectively. Your sense in terms of whether there is going to be an earnings revision on the downside simply because there could be a change of dynamics in the US industry when it comes to generic drug pricing?

A: A lot of it is already playing out as we speak and in fact a Democrat victory is actually going to be slightly more negative for the kind of drug price control and other controls which might set in, in the US. We need to watch it. I think the bulk of the de-rating which has happened in the sector over the last one-one and a half year, partly captures it. However, there are risks to the sectors till in terms of what the new regime would bring in terms of various controls which might be there in the place. So, instead of focusing on victory of Donald Trump, I think it is the question of Democrat victory which actually could be more negative and that really is the key and that really is the concern right now.

Having said that, I think the de-rating has been ongoing and has been ongoing for various other reasons not necessarily because of elections. So, we might be nearing the end of that. We are still not calling it an end and we are not advising or clients to dabble into pharma as yet. However, I am pretty sure over the next two to three months we would reach that point.Prashant: Why you like Bajaj Auto?

A: I think the key reason for us to recommend it to our clients is the fact that the two or three new launches which are scheduled in Bajaj Auto would continue to lead it to increase the market share in the domestic market. So, the thesis here is purely domestic and the new premium models which they are launching and essentially going up the ladder in terms of value chain which they have. That really tide up with the fact that the exports, we think there is much less negative from here on and the fact that the stock has underperformed, all put together I think makes it a compelling buy within the sector where although the stocks have done really well.

Most of the good news is priced in most of the other stocks and we are seeing some of that in the price movements of the other stocks which have been the leaders so far. We think Bajaj Auto could be the leader over the next 6 to 12 months in the sector.  Ekta: From the auto space there is a lot of fervour on Tata Motors today on the back of a possible pound depreciation aiding EBITDA and earnings going forward. Your thoughts, have you done any work on that?

A: Tata Motors, obviously given that the Jaguar Land Rover (JLR) numbers and the new models which are coming up are doing well and that there is an expectation of those doing well. I think stock might continue to do reasonably okay within the sector. However, I think in terms of the preference we would clearly be Bajaj Auto ahead of all the others in terms of the auto sector per se.

Prashant: When you look at these currency moves and very meaningful, I was saying this earlier that from the time that JLR was bought by Tata Motors the pound is down 35 percent - that is from 2008 to now and the pound is down 20 percent since the Brexit. We have seen large moves in other currencies as well the Yen for example. When you look at currency related impacts on specific stocks, as an analyst how do you pencil changes in numbers because essentially you have to make a prediction that currencies has structurally weakened and they will stay at a certain level. So, how is one able to do that?

A: There are two levels of impact on the currency one is the obviously immediate impact on the balance sheet if it is a dollar denominated debt is there I mean that is the easy part. The profit and loss impact is the next level of impact which could also be transient in the sense the sometime the pricing is able to adjust to the currency movements. However, I think the most difficult part and which is where one needs to evaluate things like Tata Motors is that if the currencies depreciates or appreciates whether that increases or decrease the competitiveness of that particular sector for example if rupee depreciates sustainably and what it does to the IT services, competitiveness in an environment when the IT spending is not doing well then obviously that is a big help.

So, there is no simple answer to it, the easier answers are the impacts on the balance sheet debt and the immediate impact on the margins and so on in the profit and loss (P&L) in the next one year or so, but the lasting impact of the currency is what drive the re-rating, for example we have never seen and I can’t recall any time when just because of the currency depreciations or the INR depreciation the IT services sector has got re-rated from a PE multiple point of view. That has never happened.

What really determines the sustainable re-rating of any stock or sector is whether the currency depreciation is going along with the thesis that helps you to get market share in an industry which is growing. So, that is what is kind of critical in companies like Tata Motors for example where a case can be made out of pound depreciation which is sustainable rather than transient phenomenon. Whereas in IT services for example INR depreciation would give a temporary relief if INR were to depreciate. However, if the global demand in environment doesn’t improve and if the INR is depreciating because of the global risk environment turning worse then it won’t lead to any advantage to the company in terms of getting higher topline growth in dollar terms.Watch accompanying videos for more details...