It's common to hear people refer to India as the 'pharmacy of the world', however, back home, the pharmaceutical sector has failed to evoke the same traction within the stock market. The sector has long remained an underperformer, barring the period of the COVID boom.
Pharma companies were plagued by a high base effect, increasing price erosion, and soaring input costs in 2022, which took a toll on their margins and resulted in a slump in stock prices. The Nifty Pharma index eked out 11.4 percent negative returns last year, a sharp underperformance compared to the Nifty 50's around 4 percent rise.
Nonetheless, something changed this year as the Nifty Pharma index, though still down around one percent in 2023 so far, has fared better than the headline Nifty 50, which has lost over 2 percent.
"With the waning of headwinds such as expensive valuations, price pressures and an unfavorable base effect, basically the primary causes for the sharp downturn in 2022, margin pressure is seen easing for pharma companies. This is what drove the improved performance by the sector," said Yadhu Ramachandran, research analyst at Geojit Financial Services.
Thanks to these changing dynamics within the sector, coupled with a resilient domestic demand, most analysts on the Street have been compelled to take a relook at the pharmaceutical pack. Several analysts now anticipate the sector to be on the cusp of a turnaround to be seen in the coming years.
Multi-decadal story?
But aside from expectations of improving margins, what has changed for the industry, so much so that analysts now expect pharma to witness a break away from its years-long stagnancy and shine?
Alok Dalal, research analyst-healthcare at Jefferies, believes that the domestic and outsourcing pharmaceutical markets are structural multi-decade stories. "The $27 billion domestic pharma industry has structural growth drivers in place and is set to achieve low double-digit growth in the coming years. Increased spending on medicines as the population starts to age in the coming decade and a rising share of chronic ailments such as cardiac, diabetes and cancer should help sustain double-digit growth," Dalal told Moneycontrol.
He expects big companies and brands to become bigger as consolidation gathers pace in this sector. Another analyst at a domestic brokerage, who did not wish to be named, concurs and believes a positive surprise in the form of flourishing domestic demand for acute medicines like those for spring flu, air pollution and post-COVID side-effects, has placed the sector on a better growth trajectory.
In addition, the analyst is of the view that in uncertain times, pharma stocks witness defensive buying as they become the flavour of the market. Couple that with the correction in most stocks last year bringing valuations to pre-COVID levels and making way for a good price point for investors to enter these counters, the analyst said.
Growth drivers in place
The analyst mentioned earlier anticipates the price hikes taken by the National Pharmaceutical Pricing Authority (NPPA) for the second straight year to support overall growth, even if volumes fail to catch up. Along similar lines, Dalal also sees operating margins of pharma companies improving in FY24 on the back of price increases in India, new launches in the US, stable pricing for US generics and favorable trends in input prices on a year-on-year basis. However, he also noted that this would be partly offset by remedial activity for certain companies facing US Food and Drug Administration action and the ongoing field force addition in India.
Another underlying trend is expectations of outperformance by small and mid-cap pharma companies instead of their large-cap peers. The optimism is largely because of their high exposure to the domestic market, a segment where analysts see maximum growth.
Drugmakers leading the race
Alok Dalal's favourite bets within the pharma space include Syngene International, Zydus Lifesciences and Sun Pharmaceutical Industries. The large-cap major Sun Pharma as well as Torrent Pharma and JB Chemicals are also among the top bets of the analyst mentioned earlier.
Dalal likes Sun Pharma's specialty pipeline ramp-up along with its strong positioning in India and emerging markets as it ensures sustainable double-digit revenue growth and a best-in-class margin profile. For Dalal, Sun Pharma looks well-placed to achieve faster than industry growth in India and emerging markets while global specialty sales should reach $1 billion by FY25E.
"Visibility beyond FY25 to sustain double-digit growth comes from the recent acquisition of Concert and two pipeline products in psoriatic arthritis and atopic dermatitis space. The stock also trades at an attractive PE valuation of 25x/20.8x FY24/25 earnings," he said.
He also finds Syngene at an inflexion point amongst other outsourcing names. The company's capital expenditure of over $400 million over the last few years has begun bearing fruit with the company's recent big contract wins. This, according to Dalal, is a testimony to Syngene's capabilities and provides visibility on improved asset utilisation.
As for Zydus Lifesciences, deriving around 40 per cent of its revenue from the stable domestic market where it has a presence in the prescription and consumer business is its major upside trigger. "Cushion to earnings from the domestic market, stable pricing trends in the US, key facilities under US FDA compliance and a strong US pipeline bodes well for the core earnings of Zydus," Dalal said.
Disclaimer: The views and investment tips expressed by experts on Moneycontrol are their own and not those of the website or its management. Moneycontrol advises users to check with certified experts before taking any investment decisions.
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