Brokerage firm Nirmal Bang Institutional Equities believes the risk-reward ratio for pharmaceutical companies in its coverage has turned favourable, largely due to the deep discounts in their valuations, along with expectations of a margin recovery in the sector.
Despite the challenges faced by the pharma industry in FY22-23, such as slowdown in growth, price erosion, and increased FDA scrutiny following Covid, Nirmal Bang believes the sector is poised for a rebound.
Factors such as rising raw material costs and a higher Covid base were key contributors to the sharp correction experienced by the sector in FY22-23.
On the cusp of a turnaround
With a subdued performance in FY22-23 behind us, Nirmal Bang anticipates a rebound in domestic growth in the pharma sector, with double-digit growth in FY23-24 as the base normalises. Additionally, the brokerage expects price erosion in the US market to cool off from double-digit levels to single-digit levels.
"On the margin front, cost inflation is normalising, and companies have, to a great extent, passed on the burden of additional costs, largely in branded markets," the brokerage wrote in its report.
However, the risk of regulatory scrutiny is expected to intensify in the coming financial year and on that account, the brokerage firm prefers companies that are heavy on branded generics and have the least exposure to US generics.
As for companies with higher exposure to the US market, Nirmal Bang sees sustained pressure on valuations.
Margins will improve
Pharmaceutical companies are likely to experience a recovery in margins, thanks to the easing of raw material cost inflation and a reduction in price erosion in the US market.
The price increases implemented by most companies to counter the effects of cost inflation, particularly in branded markets, are also expected to bolster margins in FY23-24, according to Nirmal Bang Institutional Equities.
Furthermore, Nirmal Bang forecasts continued growth in the US market in FY23-24, driven by Revlimid's increased market share compared to FY22-23. The launch of key products like Spiriva, Advair, and Transdermals are also expected to support growth further.
Compelling valuations
The brokerage firm has a "buy" call for 10 of the 17 pharma companies in its coverage universe, as the recent correction in the sector has made valuations attractive. The company had a "sell" recommendation for only one company.
In the large-cap space, Nirmal Bang chose Sun Pharma, Torrent Pharma, and Cipla as its top picks, while Eris Lifesciences, JB Chemicals, and Ajanta Pharma were the preferred bets within the small and mid-cap space.
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