You Shouldn't Follow India's Super Investors Without Checking This First... - The 5 Minute WrapUp by Equitymaster
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You Shouldn't Follow India's Super Investors Without Checking This First...

Mar 16, 2018

Kunal Thanvi, Research analyst

Hyderabad is a city famous for its software parks and of course, Biryani.

But over the years, it has also emerged as a major centre for the Indian pharma industry. I was in the city a few days ago, to meet the management two niche pharma companies.

Unfortunately, there was no chance to enjoy the local Biryani. I had to visit both companies on the same day, so my schedule was tight. Maybe next time...

With the US FDA breathing down its neck, it's safe to say the Indian pharma industry is not enjoying achhe din.

But I wanted to dig deeper.

You see, despite the cloud of uncertainty hanging over this sector, I've noticed something positive.

Many of India's super investors have started betting on some of these companies.

With the help of my trusted smart money indicators, I checked for super investor activity.

The Sherlock Holmes in me comes alive in these situations! I always want to know what they're buying...and this time was no different.

My findings were crystal clear. The smart money has entered some niche pharma companies.

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I wanted my Smart Money Secrets subscribers to be in on this action.

So, for the last ten days, I've been working on the pharma sector...ably assisted by my colleague, Sarvajeet Bodas.

A famous super investor has bought into a Hyderabad based pharma company that's in the middle of a change in its business model.

At first glance, the story looked very good. Besides, the stock is down about 50% from its peak. That made it even more attractive.

Now, some of you may have heard me at Equitymaster conference talking about why I choose the sidecar that I want my subscribers to get into. I spoke about what I do when I find a stock that a super investor has bought.

I try to destroy the case for buying that stock. I look for disconfirming evidence.

Looking for Disconfirming Evidence!

In other words, I try to find all the reasons why I can reject that stock.

Why?

Well, if the stock survives my assault, I can move ahead and consider it for recommendation.

Now as I said, I liked this pharma company which had a very good story. The management was...

  • Changing the business model
  • Re-structuring the business internally
  • Shifting focus from low to high margin products
  • Prioritising value over volume
  • ...and more

But when I looked at the historical numbers, a pattern emerged...

Numbers Don't Lie
  FY98-02 FY03-04 FY05-09 FY10-12 FY13-17 9MFY18
Net Profit Margin (%) 3.18 -0.69 4.01 -0.27 4.50 1.7
Source: Ace Equity

The numbers tell a very different story. Every five years, this company takes a hit and profitability goes for a toss.

The management as well as our super investor believe that it's different this time.

I don't agree. The company's 20-year history has given me a lot of disconfirming evidence.

After a two-hour long meeting with the management, I got all the information I needed to connect the dots. I discovered the management is indeed trying to transform the business, but in the interim, they've made the business model very risky. They expect a lot of good things to happen but they don't have any timeline for it.

That's why the Smart Money Secrets team rejected the stock. If more clarity emerges in the future, we may take a re-look at it.

But not at the moment.

There's no need to take any unnecessary risks. No matter what happens to the stock price in the short-term, I'm committed to choosing the right sidecar for my subscribers.

I wish I could've recommend the other pharma company I met. It's a worthy candidate...but the stock is just too expensive.

The next Smart Money Secrets recommendation will be out very soon. It's not a pharma stock. I believe, my team and I have identified a better choice.

If you're a premium member of Smart Money Secrets, you can expect the report on Monday, 19 March.

Chart of the Day

Is this the right time to buy pharma stocks?

There was a time when almost every stock in the pharma sector was considered to be a safe stock. You could just pick the top 5-6 companies from this sector and expect to make decent returns over time.

In fact, it was termed as defensive sector. However, in last two years things have changed a lot. There is enormous uncertainty in the industry.

Uncertainty regarding price erosion in the United States as well as hostile US FDA visits, have changed a once defensive sector into a risky sector.

However, we believe this could be point of consolidation in the industry i.e. with stricter norms, lower margins, and pricing pressure, the industry may see many exits and acquisitions. This could lead to relatively fewer but higher quality players.

BSE Healthcare Index Down 26% in Three Years

We believe, if you can pick a niche company with good financials and strong management, this is a good time to consider pharma stocks.

Regards,
Kunal Thanvi
Kunal Thanvi (Research Analyst)

PS: The best investors in India do all the hard work required to pick the right stocks - all you need to do is watch what they are doing. To follow India's best super investors, click here...

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