Sailesh Raj Bhan
Reliance Mutual Fund
Investors need to bring down their return expectations from pharma stocks to 15% from 20-25% clocked in the last five years, said Sailesh Bhan, Deputy Chief Investment Officer, Reliance Mutual Fund.
Since 2008, the weight of the pharma sector in the sensex which used to be 3% has moved up to 12%, this has given huge return to investors and has also reflected in the outperformance of the sector.
Strong returns in the last 4-5 years have created a high multiple base for a lot of companies and the markets are pricing in their ability to repeat that kind of growth. This appears challenging, which has led to a derating of the sector, especially for companies which are oriented to international markets.
Earnings outlook has slowed down on the international side, due to regulatory reasons where approvals are slow or simply due to the fact that the base is large for them to rapidly grow in international markets, unless there is an existing portfolio. The stock price correction seems to be over and is now consolidating at these levels. Investors should bring down return expectations to 15% from 20-25%.
USFDA's observation on plants of various Indian pharma firms has been one of the main reasons for the fall in stock prices. The problem arises if these are repeated and if they have got anything to do with data integrity. Every letter issued by the FDA to a company is different. Since investors do not have the content of the letter at the time of news flow therefore, it is perceived significantly negative, which often leads to a sharp correction in price. Good Indian companies come out of it strongly since their processes are strong and they take one more step to take the compliance a level higher. It is a coincidence that all these FDA issues have come together, which stresses the investors.
The health ministry's has ban on sale and manufacturing of 344 fixed dose combinations, may not be significant on an industry wide basis. The turnover of this category is only 1-3%. However, there could be company specific issues.
While choosing between Indian Pharma firms with cheap valuations or MNC’s at expensive valuation - the business, distribution, capability and advantage of a company plays a major role. For example, in the domestic market, there is an unlimited opportunity for good companies. The market opportunity will last for many years to come. The domestic pharma industry has born recently. The market is expected to grow due to the rise in awareness and detection but the cost of the medicines is low due to low income. The export price has reached a good threshold and is the second opportunity. The ANDAs companies have filed, the US generics markets. Once approved it will lead to significant opportunities in the US and European markets. The third opportunity is the contract research and manufacturing companies which are suppliers to global pharmaceuticals.
Ten years ago, Indian companies did not have scale to acquire which they have now and they can add cash to the business which can add up to the portfolio. Acquisitions are way to go as they cut down entry time to new markets. The sector has seen high M&A activity in last few years and pricing is not cheap. So, companies need to be careful while going for acquisitions.
* As told to The Economic Times Apr 05, 2016