 "Pharma: Strong pill in medium doses")
The valuation discount between the large caps and mid caps existed given strong product pipelines, high earnings visibility, strong balance sheets and healthy return ratios for large cap pharma companies.
However, given the growth prospects and the yawning valuation gap, analysts believe that select mid caps could give better returns going ahead. Says Kapil Bhatia, Assistant Vice President, Systematix Capital, “While large caps have traditionally grown at a faster pace, as mid caps companies expand global reach and improve their therapeutic mix, they are likely to catch up or exceed the growth rates of their larger peers.”
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Large caps currently trade at valuations of 20-25 times their FY15 estimates while mid cap companies are valued between 8-14 times, a discount between 44-60 per cent. This is likely to reduce going ahead. Says Ranjit Kapadia at Centrum Broking, “Improving margins and profits on the back of higher sales volumes and market share gains in the domestic market should help mid caps to bridge the valuation gap.”
In fact given the performance of some midcaps over the last fortnight the Street is already discounting some of the positives. Stocks such as Unichem Lab, Aurobindo, Biocon and Torrent Pharma have touched their 52-week highs. However, given the increased risk associated with midcaps, Hitesh Mahida of Fortune Research says that investors who wish to take exposure to mid cap names should opt for ones with robust business models, differential product pipeline, strong balance sheet and attractive valuations.
Aurobindo Pharma
The stock has been making new 52 week highs, hitting Rs 310.50 on Wednesday. Despite the gains it still remains one of the cheapest stocks in the pharma space. The company is trading at 8.1 times its FY15 earnings estimates and is still at a discount to mid-cap average P/E multiple of 14.2 times and large cap average of 17.8 times as per Bank of America Merrill Lynch Research (BofAML).
The company after resolving FDA related issues sometime back is now on a strong wicket in the US post re-launch of cephalosporin class of drugs from Unit VI (one of the affected facilities) and market share gains by products launches in last 12 months. The ramp-up in injectibles capacity at Unit IV and at least three injectibles launches in next 30 days (all in shortage list of USFDA with market size of $68-80 million bolsters its prospects. Analysts at Edelweiss believe that sustainable operational performance will restore confidence over execution, resulting in valuation rerating. Notably the company has the largest pipeline of products (250 plus filings including approved and pending approval) in the US.
Sarabjit Kour Nangra at Angel Broking estimates net sales to grow at 17.4% CAGR over FY13–15 while BofaML analysts estimate a 21 per cent growth with 580bp margin increase on improving product mix and higher share of formulation. BofAML analysts add that with the investment cycle behind it and increased capacity utilization along with strong free cash flows, expect balance sheet to improve considerably, resulting in a re-rating. Bloomberg consensus by analysts polled in November’13 shows a target price of Rs 355.
Biocon
The Biocon stock has been touching its 52-week highs over the past week post a recent drug approval as well as growth prospects of its biosimilar portfolio. The company got a go-ahead from India's drug controller to market the breast cancer drug Trastuzumab. The drug, a biosimilar version of Roche's Herceptin, has been developed jointly with Mylan and is estimated to have a market size in India of $21 million. The innovator product sales for its biosimilar portfolio being co-developed with Mylan are pegged at $34 billon globally.
The company with sales of $414 million in FY13 is looking at more than doubling the same to $1 billion by FY2018. While the domestic pharma business (14 per cent of revenues) is growing at 30 per cent annually and listing of its contract research subsidiary Syngene could unlock value, the bigger trigger is the opening up of the regulated markets to its biosimilars post patent expiries of key drugs in CY15.
The stock which trades at 13 times its FY15 estimates (35 per cent discount to large pharma companies) has not priced in any upside from biosimilar products, according to analysts at IIFL. The research firm estimates that Biocon will grow its earnings at annual rate of 24 per cent over FY13-FY16. Given the longer time frames for biosimilar approvals, investors with a timeframe of 2-3 years should consider investing in the stock.
Torrent Pharma
This mid cap pharma stock too has caught the investors’ fancy touching its highest in over a year on Tuesday. Analysts at IIFL believe that the company which is one of its top midcap picks has a strong business portfolio with the highest growth potential. More than 60 percent revenue comes from the emerging markets and more than 70 percent of domestic revenue comes from higher margin specialty business. Not surprising that the company in domestic markets remains unaffected by traders stir in the country and as per trade body AIOCD data grew 13.3 percent in October’13.
For the US markets, Torrent is focusing on accelerating its filings to 10-15 ANDAs each year. It currently has 23 pending approvals and 31 under development including large generics and niche products. It is also likely to launch one product on exclusivity in the US during December 2013. This strong pipeline is likely to drive Torrent’s US and European growth, observes Perin Ali at Edelweiss.
A low base and high number of product launches will keep growth in the US above 30 per cent for the next three years, say IIFL analysts. They predict that the given the high contribution from growth markets, growing revenue base as well as strong free cash flows, the stock which is trading at a discount of 20-50 per cent discount to large cap pharma could rerate over the medium term.