Should you invest in pharma sector?

Pharma industry in India

• India’s pharmaceutical industry is now the largest provider of generic drugs globally, supplying over 50% of global demand for various vaccines, 40% of generic demand in the US and 25% of all medicine in UK. Generic drug is a copy of a branded drug and has the same dosage, quality and performance characteristics
• The strategically important sector contributed $37 billion or 1.5% to India’s GDP directly, with another 3% coming indirectly. The industry also has a global reach and is a net foreign exchange earner of more than $10 billion annually. 

Challenging times in last 5 years 

• The last few financial years had been difficult for Indian pharma companies. The industry had been contracting due to price declines by 8-10% for generic drugs in the US markets for the last five years in a row.
• The companies were also facing a lot of challenges due to USFDA violations. 

However, FY20 has registered a flat growth and FY21 could see a 5% growth, according to forecasts. Analysts are now very bullish on the sector and say that earnings could double in 4 to 5 year period. 

Robust rally in pharma sector

While the ongoing pandemic has led to a steep correction in stocks of other industries, pharma companies have rallied by up to 70% since the lockdown was announced on March 24th. The table below shows the handsome gains made by some of the drugmakers since the lockdown began.

What has led to this massive rally?

• Low investor risk appetite: Pharma stocks are seeing a lot of traction, as investors’ risk appetite has gone down substantially. 
• Improvement in USFDA compliance: These pharma firms have been improving upon their compliance with the US Food and Drug Administration (USFDA) norms by adopting good manufacturing practices. The ongoing Covid-19 pandemic has also increased the dependency on Indian generic drugs as the US drug regulator cleared four Indian facilities within a short period of ten days in April. 
• Strong earnings growth: While the profitability of all other industries have been impacted, these firms have reported relatively robust Q4 results. The revenues of Sun Pharma, Dr Reddy’s Lab and Aurobindo Pharma grew by up to 16% in Q4FY20. The net profit of Dr Reddy’s (124% growth), Lupin (34%) and Aurobindo Pharma (45%) have also been very robust, leading to heightened investor confidence.

Prospects going forward

• The sector seems poised for growth in the near future. Despite the huge gains made over the last two months, the valuations continue to remain reasonable. Stocks of Sun Pharma, Lupin and Glenmark are still trading at more than 50% discount to the 2015 peaks while DRL, Cipla, Aurobindo Pharma, Torrent Pharma and Cadila are 10-15% away from touching their record high levels of 2015. 
• The pressure on pricing, especially in a highly competitive market like the US, is prompting companies to reduce costs. By calibrating R&D budgets and streamlining therapy segments, Indian generics makers have taken all steps to remain low-cost producers globally.

Our VGQM model has a Buy rating on Cadila Healthcare, Divi’s Lab, Dr Reddy’s and Torrent Pharmaceuticals.

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