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Pharma index set to post its biggest monthly gain in 21 years amid Covid-19

Pharma stocks got a new lease of life as coronavirus pandemic got a tighter grip on the country in April, with the S&P BSE Healthcare index set to post its biggest monthly gain in 21 years. Investors flocked to pharma stocks on expectations of these companies aiding the development of a vaccine to counter the pandemic and a rush to safer investing options in uncertain times.

The S&P BSE Healthcare index has rallied nearly 26.9 per cent thus far in April 2020, on a strong rally in stock such as Sun Pharmaceuticals Industries, Cipla, Lupin, Aurobindo Pharma and Glenmark Pharmaceuticals. In comparison, the benchmark S&P BSE Sensex has gained 11 per cent during this period. On the other hand, the Nifty Pharma index, which surged 30.8 per cent thus far in April, is set to post its record the biggest monthly rally since January 2001. The last time the S&P BSE Healthcare index saw a similar rally was in March 1999 when it had surged 31.5 per cent in a month.

“With supply-side risks mitigated as China KSMs (key starting material) resume and disruption risks easing amidst improved business continuity, the pharma sector finds itself positioned to grab opportunities in the COVID-19 environment,” suggest analysts at Edelweiss Securities.

For the January – March 2020 quarter (Q4FY20), analysts expect the sector to report a strong earnings growth mainly due to panic buying of medicines and other healthcare products in the domestic market, international orders for drugs like Hydroxychloroquine, Oseltamivir etc (although only couple of weeks of March) & other essential medicines to fight COVID-19 and the related demand for respiratory, antiviral and other chronic drugs.

According to analysts at K R Choksey Shares and Securities, most Indian pharma companies saw a spike in export orders, which coupled with favorable currency movement (appreciation of 5.9 per cent & 3.6 per cent in USD/INR and EURO/INR during the quarter) will positively impact the topline growth.

That said, analysts do caution against the rich valuation the pharma index and the stocks are trading at.

“Indian companies are less involved in the innovation of complex products, while global players have an edge over them in terms of experience and innovation. Nifty pharma Index trades at 21x one-year forward P/E versus 23x 10-year average, the peak of 30x (CY-15), and low of 20x(CY-19). Even with a low valuation, the sector struggles with earnings growth due to unrelenting FDA concerns, volatile earnings, and domestic market price regulation,” wrote Surajit Pal, an analyst tracking the sector at Prabhudas Lilladher in a recent co-authored report with Tausif Shaikh.

That said, there is an increased perception among investors that the US FDA will take a lenient stance on inspections going forward, led by Covid-19/shortages, and this warrants a multiple re-rating. Even though pharma is the preferred defensive play for Jefferies, they maintain that inspection outcome by the US FDA will continue to be determined on a case-by-case basis led by facility/inspector. This, according to the research and brokerage house, remains a risk for the sector. For now, the US FDA has halted all inspections globally due to the coronavirus pandemic.

“Pharma is a defensive play during Covid-19. We also expect multiple plants across companies that are under waitlist to clear in the next 12-18 months. Our earnings estimates factor clearance of most plants by mid-FY22. This is a risk for companies with plants under warning letters.” said Piyush Nahar, an analyst tracking the sector at Jefferies.

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