NEW DELHI: A likely flash of brilliance may not just be enough for this sector to win over analysts.
Pricing challenges remain, but the good part is regulatory environment is improving for the pharma sector. The industry is expected to make an earnings rebound in the June quarter — up to 50 per cent surge in net profit — largely driven by a low base and rupee tailwinds.
If analysts are to be believed, this sector is up for a gradual comeback in FY19, but the current valuation may not be that compelling to go long-term bullish on the space.
50% spike in Q1 profits?
Edelweiss Securities expects the sector to report a jump of 17 per cent in revenues and nearly 50 per cent in profits. Motilal Oswal Securities, whose pharma universe bounced back in January-March following four consecutive quarters of double-digit earnings decline in 2017, is seeing 44 per cent profit growth.
Phillip Capital sees its pharma universe reporting 42 per cent YoY growth in earnings on a 12 per cent rise in revenues growth. This brokerage noted that the ANDA approvals rate in the three months to June improved to 200, from 112 in the preceding quarter, even as the quarter witnessed only a few new launches by domestic drug makers.
The brokerage is positive on Biocon, Cipla, Divi's Labs, IPCA Lab and Sun Pharma, and negative on Glenmark and Lupin as far as quarterly earnings go.
The earnings recovery hinges on bottoming out of pricing pressure in the US market, but the worst, insofar as earnings are concerned, is over for the healthcare sector, Motilal Oswal Securities said.
Large cap drug makers may take a lead, thanks to regulatory resolutions, moderating price erosion and new product launches in the second half of the financial year, said HDFC Securities. The brokerage is expecting pharma stocks under its coverage to report first double-digit revenue growth in six quarters.
Pricing pressure looms
In case of price erosion, analysts feel that significant price erosion may happen only for drugs where there are fewer than three manufacturers. Besides, they feel that the government many bring in more life-saving drugs under the DPCO (Drug Price Control Order) ambit ahead of state and general elections.
"Lowering drug prices by adding drugs to DPCO is expected to gain a favour of citizens during the 2018 state and 2019 general elections. The impact of adding new drugs to DPCO is to lower both the revenues and profits of pharma companies whose drugs may be added to DPCO," said Karvy Stock Broking.
Regulatory issues easing
The recent favourable inspections at Sun Pharma's Halol plant, Cadila's facility and Dr Reddys Medak, Srikakulam SEZ and UK facilities demonstrate that the worst in terms of regulatory issues is over, said Edelweiss Securities.
Rupee depreciation
During the June quarter, the rupee depreciated 3.8 per cent against the dollar and 12.7 per cent against the euro. It though appreciated against three BRICS currencies Russian Ruble, Brazilian Real and South African Rand, which could influence the EM market growth for the firms.
A 1 per cent depreciation of the rupee against the dollar has a benefit of average 1.1 per cent on Ebitda even as hedges and interest payments may trim some of the benefits, BofA-ML said on its coverage stocks.
M&A activity to pace up
Karvy expects that the drug makers may resort to divest ANDAs or businesses that lack core competence.
"We strongly believe that divestitures, mergers and acquisitions would be the key driver of growth for the large generic pharma companies in India and the US. Timing of mergers and acquisitions may be uncertain, but will be primarily driven by the level of competition and valuations," it said.
Valuations
The valuation premium pharma stocks have enjoyed in the past over the benchmarks is falling, but analysts largely have mixed views on whether the time is ripe for investors to invest in the sector.
"Consensus downgrades during the June quarter was 7-8 per cent for FY19/20E earnings. The sector trades at 18 times rolling one-year forward earnings, implying a 10.4 per cent premium to Nifty versus 42.5 per cent a year ago," Edelweiss said. The brokerage expects Dr Reddy's, Cipla and IPCA to do well.
According to Sharekhan, many frontline stocks are still trading close to their long-term average valuations following sharp downgrade in earnings estimates for the past six quarters. It prefers Biocon, Cadila, Cipla and Sun Pharma as investment options.
What to look at
Updates regarding FDA, key product approvals, management commentaries and the exchange rate would be key in deciding earnings upgrades or downgrades, stated Sharekhan.
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