Pharma sector likely to bounce back in 2019 after three years of slump

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After three years of under-performance, the pharma market could bounce back in 2019 on stable pricing, better domestic growth and reasonable valuations. 

The BSE Healthcare index, which lost 6 per cent in 2018, had registered positive returns for investors back in calendar year 2015 with returns of 15 per cent. 

The muted returns last year was driven by lower net profit due to limited big-ticket launches in the US coupled with price erosion in the base business of majority of generic drug majors. Though the rupee depreciation did help offset some of the weakness, imports of drug intermediates and pricing pressures dented their overall performance. 

The near term trigger for the stocks has been the comments by Teva, the world’s largest generic maker, that the worst in terms of aggressive pricing is over for the sector. 

The drug maker’s statement on price stability has led to an uptick in prices of the pharma index. While the broader markets are flat, pharma has gained about 2 per cent over the past week. 

An analyst at a domestic brokerage indicated that there has been a pricing uptick in the US market in recent months and the double-digit pricing erosion, which has been the case in the past couple of years, have come down. 

Nitin Agarwal and Sumit Singhania of IDFC Securities, in a recent report, believe that the progressive improvement in business outlook across most companies in 2019 will be driven by normalisation of price erosion in the US and expected pick-up in new product launches on relatively depleted US sales base. Larger Indian generic players get between 30 per cent and 50 per cent of their revenues from the US market and an uptick in pricing and volumes will reflect on their revenue growth.

What should help the companies is implementation of cost-cutting measures across their research programme as well as sales/general administration expenses. The analysts expect a meaningful pick-up in net profit growth over FY19-21 versus muted growth across most companies over FY15-18. 

The other trigger is outlook for the Indian market. The domestic segment has been posting decent performance in recent quarters and analysts expect a steady 11 per cent growth in the December quarter. 

The recent decision by the courts setting aside the ban on a fixed dose combination drug of Wockhardt, coupled with five-year protection for patented drugs are positives for the domestic market.

 

The near-term trigger for the pharma stocks would be the third quarter results. Analysts believe that a weak rupee, lower generic price erosion and cost cutting will help companies improve their year-on-year performance in the quarter. Amey Chalke and Eshan Desai of HDFC Securities, said, “This will be the second consecutive quarter with positive sequential growth in the US business, aided by softening of pricing pressure, exit of many US-based companies from commodity products and the presence of a flu season.”

With improvement in earnings growth, analysts expect valuations, which are currently in the reasonable 20-27 times its FY20 estimates, to become more attractive. 

While most analysts favour multinational pharma companies which have been outliers within the pharma space with outsized returns in 2018, among Indian companies, Aurobindo Pharma and Biocon are the top picks.