Pharma stocks see turn in fortune
After underperforming for three years, healthcare scrips have got the bounce back on multiple tailwinds

Brokerages are getting bullish on pharmaceutical stocks after the recent rally and have raised price targets of bluechip pharma stocks. They expect pharma earnings to grow 22 per cent year-on-year in the current financial year, thanks to easing US FDA restrictions, moderation in price fall and product launches lined up for the upcoming quarters.

In an update on the sector, HDFC Securities said, "We believe FY19 may see a gradual comeback for large-cap pharma companies, driven by actual and likely regulatory resolutions, moderating price erosion and several product launches across generic and specialty categories in the second half of FY19.”

Due to the negative impacts of regulatory clampdowns, channel consolidation in the US and increased competition, earnings of US-focused Indian pharma companies dropped 30 per cent during FY18. Despite the all-too-visible business challenges, they persisted with higher R&D activity (related to complex generics and specialty business), which aggravated the pain. As a result, the Nifty Pharma Index has corrected about 30 per cent over three years leading to FY18 after clocking 30 per cent compound annual growth rate (CAGR) of during FY11-15.

It seems the stocks have bottomed out and they currently enjoy a favourable base.

The NSE Pharma Index was up 0.88 per cent on Wednesday.

VK Sharma, head-private client group & capital market strategy, HDFC Securities, said, “ The Pharma Index had risen 10 per cent in the past four sessions, giving the market and the Nifty a helping hand. On Wednesday among the Nifty constituents, Dr Reddy was the biggest gainer, rising 2.9 per cent, followed by Cipla that rose 2.6 per cent and Lupin gained 1.79 per cent.”

Easing of pressure from the US drug regulator, as the warnings and restrictions earlier imposed are being taken off, is cheering the market sentiments on the pharma stocks, he said.

A few days back Sun Pharma got a big relief from the US FDA, which will enable faster approvals for its products. In almost 15 days, due to positive developments such as regulatory hurdles getting cleared, the stock has appreciated by 18 per cent, says Sharekhan.

Purvi Shah, pharma analyst, Sharekhan, commenting on Sun Pharma, said, “Sun Pharma Halol plant received EIR (establishment inspection report) resulting in regulatory hurdles being cleared. This is a big relief and the next step is getting a letter from the US FDA for closure of the warning letter, leading to faster product approval. With better product mix and cost-control measures, we see a scope for margin expansion in the next two years.”

“ Post Q4FY2018 management conference call we had upgraded our recommendation on Sun Pharma, we continue to maintain our buy recommendation with a revised price target of Rs. 625,”Shah said.

What has changed for drug companies, according to HDFC Securities analysts, is that (a) US price erosion is moderating now, (b) the companies now have a diversified manufacturing base, (c) research & development cost as a percentage of sales has topped out and (d) lucrative product launches in FY19/FY20 are scheduled.

“Also (because of ) a favourable base due to GST and US tax impact, we expect earnings to grow 22 per cent YoY in FY19. Valuations are still attractive for key stocks,” HDFC Securities said.

Price erosion has been ever-present in the generics business; however, it has historically been in the range of 5-6 per cent versus the double-digit decline witnessed over FY16-18. Except Glenmark, all major players have seen moderating price erosion during 4QFY18 and have guided for stable single digit price decline ahead, HDFC Securities said.

Three years ago, 50 per cent US revenues of most Indian pharma majors were contributed by two plants. Since then, they have added plants and diversified filings across multiple facilities. Lupin has seven formulation plants now; Sun Pharma has built one more injectible plant while the Mohali plant has also received clearance from the US FDA. Others have also scaled up the manufacturing base both in numbers and capability. This has significantly reduced concentration risk from future regulatory adversity.

R&D spend for the  companies has increased from Rs 7,200 crore in FY15 to Rs 10,600 crore in FY18. Most of them have guided for flattish R&D spend in FY19. HDFC Securities expect R&D spend to remain in the range of 8-9 per cent of revenues over the next two years for most companies.

Absence of niche product launches in the US was a key reason why Indian companies did not perform well over FY16-18. But the filing pipe looks rich and mature enough now. FY19 can be a breakthrough year in terms of niche product opportunities.  New launches in inhalers, bio-similars, trans-dermals and niche injectibles are expected to start from FY20, the brokerage said.