Brokerages are betting on pharma stocks with India focus: Analysts

While domestic growth is pegged at double digits, recovery in the US may take a couple of quarters

The only sectoral index that managed to end in the green despite the mayhem on Friday was the BSE Healthcare — with a gain of 1.2 per cent. Investors are betting on the health-care space to be the beneficiary following a worldwide alert on the new Covid variant, Omicron. Within the pharmaceutical space, brokerages are betting on domestic-oriented pharma companies as compared to larger generic players, which are witnessing multiple headwinds in the US market.

Domestic operations of Indian companies stood out on the growth parameter in the September quarter. Even as overall YoY sales growth for the sector was 7 per cent, the Indian domestic business grew at 12 per cent. While JB Chemicals posted the fastest domestic formulations growth of 39 per cent over the year-ago quarter, IPCA’s performance stood out on both YoY and sequential bases, with growth of 30 per cent and 14 per cent, respectively. Alkem Laboratories and Sun Pharmaceuticals were the other notable performers in the domestic market, registering 26 per cent growth YoY.

There are multiple reasons for the Indian market doing well in a weak quarter. Analysts led by Bhavesh Gandhi of YES Securities say that a combination of strong acute seasonality, lingering base effect (becuase Q2 last year did have some impact on domestic ex‐Covid sales) and a bit of push from Covid-related drugs/supplements (largely antibiotics and vitamins) led to robust growth in the domestic business.

While anti-Covid medications saw a sharp drop in the current quarter, they can make a comeback if the impact of the new strain is stronger than expected. Glenmark Pharma, Dr Reddy’s Laboratories, and Cipla, among others, stand to gain in that scenario. Analysts believe that on a normalised basis, the domestic formulation market will grow in double digits, aided by a higher patient footfall, better chronics growth, and elective surgeries.

Even as price increases remain the single-largest contributor to growth in India and companies have pricing power, larger generic players are struggling to grow in the US market/international markets, resulting in a hit to sales growth, as well as margins. Given the huge channel inventory across geographies, including the US, and medications closer to expiry, there has been destocking leading to sales at discounts and sharply reduced prices.

Barring a few, most companies posted a decline in sales on a YoY basis, leading to a 2.3 per cent fall on an average. Analysts at Prabhudas Lilladher Research say: “The US market remains highly competitive, resulting in a weak performance. Higher pricing pressure, supply disruption, and the absence of meaningful launches have majorly impacted growth of the American business.” Besides, the recent US FDA inspections have largely led to observations that will peg back the launch plans of Indian companies. A sharp rise in raw material prices, supply disruption, lack of container availability, and higher freight costs have hit gross and operating profit margins. Barring a couple of companies (Sun Pharma and Biocon), most pharma majors reported a decline in operating profit margins YoY, with an average fall of over 100 basis points, according to Motilal Oswal Research.

Most brokerages believe that the pressure on sales in the US will remain at least until the end of FY22, impacting both sales and profitability of larger generic companies. Rahul Jeewani and Punit Pujara of IIFL Research say: “Given that the next round of key US product launches for Indian generic companies is expected only in H2CY22, we believe the narrative for the US-focussed generic companies will remain weak over the next two-three quarters. Consequently, we prefer India-focussed formulation companies, such as JB Chemicals and Alkem, which continue to outperform market growth in India.”

Among larger companies, Cipla remains the top pick of most brokerages and was the biggest gainer in the Nifty50 stocks on Friday, surging over 7 per cent. In addition to strong growth in the domestic segment (40 per cent of revenues), launches in the US are expected to keep revenue growth and its margin on a higher trajectory. Within the multinational pharma pack, which are a pure-play on the domestic pharma growth, Abbott India and Pfizer are the major picks.