Despite fall, muted FY18 outlook will keep pharma stocks under pressure

Led by a steep fall in the Sun Pharmaceutical stock, which was down over 10 per cent, the BSE Healthcare Index fell about 2.5 per cent on Monday. With this correction, the index has shed 21.6 per cent since its 52-week high, while Sun Pharma, the largest constituent of the index, has dipped 41 per cent from its one-year high of Rs 854. Monday’s correction is due to a muted revenue outlook from the Sun Pharma management. The company expects a single-digit decline in FY18 revenues, which took the Street by surprise.  

While pharma stocks have fallen quite a bit, analysts believe any bad news — be it on the regulatory front (US FDA plant inspections), delay in approvals or pricing pressures on the current basket of products — could lead to further correction in the range of 5-10 per cent. The top five companies in the pharma space, which used to trade at 22-25 times one-year forward earnings, are now available at 17-18 times. In this context, the price movement will depend on commentary from Aurobindo Pharma on Tuesday, especially on pricing pressures and product approvals.  

Ranjit Kapadia of Centrum Broking, believes a 10 per cent decline from the current levels will take valuations to attractive levels and investors can start accumulating large-cap pharma stocks with a holding period of at least two years. 

What has compounded the woes of the large-cap generic companies is the fact that there is pricing pressure in India as well and with the goods and services tax (GST) implementation around the corner, and destocking issues, the June quarter performance could be as bad as the March quarter. 

Most companies are focusing on specialty drugs and complex generics, which have higher entry barriers, to turn the tide. But, the higher research and development (R&D) on these products will take time to bear fruit, with stocks expected to languish in the near-term. 

Cadila Healthcare 

The stock was up two per cent on Monday, as the company’s March quarter (Q4) numbers were one of the few to meet analysts’ expectations. The management commentary indicating resolution of issues at the Moraiya plant by Q2FY18 is a key trigger for the stock. The company, which has the largest Abbreviated New Drug Applications (ANDAs), at 198, among Indian pharma companies, said for 20-25 ANDA approvals for FY18, which include limited competition products. But, this hinges on the FDA nod for its Moraiya plant. Given the triggers, most analysts have upgraded their financial estimates for the company. Edelweiss Securities analysts believe the company could achieve best-in-class US growth among peers, which will drive strong earnings growth over FY17-19. 

Cipla

While the company’s Q4 performance was impacted by the one-time write-off in subsidiary Invagen and provision in a biosimilar subsidiary, given its small base, it is relatively insulated from the severe price competition in the US market. The disappointment for the company was the India business, where revenues fell four per cent. With weak operating profit margins in the quarter, analysts at SBICAP Research believe the FY18 outlook remains muted, with the management not providing a confident outlook for significant improvement in profitability.  

Dr Reddy’s

A 19 per cent fall in US revenues due to higher pricing pressure and competition in the US business dented the company’s performance in Q4. The company plans to launch 15 products in FY18 in the US market but analysts believe there could be delays, given regulatory issues. Centrum Broking has revised its FY18 and FY19 earnings estimates downwards by 10 per cent and nine per cent, respectively, due to delays in obtaining ANDA approvals and pricing pressure in the US market.

Lupin

Erosion in the US base business led to revenues coming in below estimates and higher R&D expenses impacted operating profit. Analysts at Emkay highlight the bleak earnings outlook for FY18 due to high US base business price erosion, as well as loss of value in the generic version of diabetes drugs Glumetza and Fortamet. They’ve lowered their earnings estimates by 9-12 per cent over the next two years, mainly due to US pricing pressure, and believe there are further downside risks, given uncertainties over growth in India and Japan. 

Sun Pharma 

The Sun Pharma forecast best captures the uncertainty and sharp fall in generic prices in the US and muted outlook due to this erosion. It was the dip in US sales which led to the seven per cent revenue decline and the nearly 800- basis point fall in operating profit margins. While Q4 was a forgettable quarter, more worrisome is the delay in the Halol plant resolution, which the management believes may not come through in FY18 as against Street estimates of a resolution in the September quarter. 

 
Analysts expect the US business to fall eight per cent on an annual basis over the next couple of years.



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