Here's why it’s time to take note of small and mid-cap pharma stocks

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In the pharmaceutical sector, large-cap companies have often stolen the spotlight off their small and mid-cap peers. Still, with the dynamics changing in the healthcare space, it seems that now is the time for small and mid-cap pharma companies to rise to prominence.

Optimism for small and mid-size pharma companies is running high as analysts believe these companies are on the verge of witnessing a turnaround and may finally catch up on growth with their large-cap peers.

What's behind the optimism?

A greater presence in the domestic market coupled with strong growth triggers are the major upside triggers for small and mid-cap companies.

In addition, a second consecutive year of price increases in the range of 10-12 percent – seldom seen earlier – is another upside trigger in their favour.

Improving prospects for chronic as well as oncology and dermatology portfolios have placed small and mid-size companies on the growth path.

Smaller pharma companies are curtailing their investments in the US market, a segment that faces headwinds in the form of heightened regulatory scrutiny, delayed approvals, increased competition and price erosion. As the small and mid-cap companies focus more on the domestic market, they also remain unaffected by price erosion and other external shocks.

Reduced US presence

Ajanta Pharma, Alembic, and Torrent Pharma have announced their intention to decrease their investments in the US, the world’s largest pharmaceutical market. Ajanta Pharma said it will exercise caution in spending for its US business.

Alembic plans to cut its research and development expenditure for the US and delay some high-risk projects. These announcements are in line with Torrent Pharma's decision last year to close a liquid manufacturing plant in the US.

The increased focus on the domestic market is aimed at deriving higher growth. A teaser of that trend was seen in the performance of the Indian pharma market in March. JB Chemicals & Pharmaceuticals, FDC, Alkem, Alembic, Cipla and Ipca were the top performers as they grew 25-35 percent in March, according to brokerage firm JM Financial.

Moreover, the Indian pharma market grew 19 percent in March and 16 percent for the fourth quarter on year, driven by higher acute therapy sales and a low base effect. According to analysts at JM Financial, the trend is only expected to improve.

Major outliers

When it comes to choosing companies that can lead on growth parameters, analysts remain divided. However, two clear favourites emerge – Ajanta Pharma and JB Chemicals & Pharmaceuticals.

Deriving a higher share of revenue from the domestic market is a major positive for these companies. Aside from that, according to Mitesh Shah, research analyst at Nirmal Bang Institutional Equities, expansion in the insulin segment is aiding margins for JB Chemicals.

“Overall margin improvement and top-line addition through the dermatology segment ensures that growth for the company will remain strong for the next two-three years," Shah said.

Another analyst said a little more correction in JB Chemicals will make a better entry point and risk-reward for investors.

For Ajanta Pharma, its strong revenue visibility, pricing power in key markets of India and Africa, and expectations of margin improvement are among factors cited by analysts that will drive growth.

After struggling with margin pressure in the past few quarters due to capital expenditure, forex volatility and high freight costs, analysts anticipate an improvement in margins to become visible. In addition, the stock's reasonable valuation also makes it a perfect candidate to march into a bull ride.

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