Is It the Right Time to Buy Pharma Stocks Now? - The 5 Minute WrapUp by Equitymaster
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Is It the Right Time to Buy Pharma Stocks Now?

Sep 12, 2018

Sarvajeet Bodas, Research analyst, The 5 Minute Wrapup

It's been fifteen months since we launched Smart Money Secrets.

My team and I have recommended sixteen stocks so far (15 buy recommendations and 1 buy at lower level recommendation).

If you scroll through this list of recommended stocks, you'll will notice something interesting - there are no pharma stocks.

That's not something that happened by chance. I have consciously stayed away from this sector.

It is not that I haven't met the management of any pharma company. In fact, Sarvajeet and I met a couple of them earlier.

But I didn't recommend them because there was no clarity.

If you go back in time a bit, between 2005-2015, the US generics market was the most important driver of growth and profitability for Indian pharma companies.

Back then, it was all about figuring out when a drug was to come 'off patent' and then quickly making a cheaper generic version.

That era is over. Now, the dynamics of the generics business is changing.

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There is price erosion due to consolidation at the distributor's level in the US. Earlier, there were eight distributors. Now, this came down to just three. With this, the distributors now have a better bargaining power.

Also, improved pace of approvals by the USFDA has resulted in rising competition as well as pressure on pricing.

Apart from this, the absence of niche product launches, in the US, was another important reason for their poor performance in the last couple of years.

Since 2016, the BSE-Sensex is up 45%. The BSE-Healthcare index on the other hand, fell by more than 5% during the same period.

What Lies Ahead for Pharma Stocks?

This quote from Marilyn Monroe aptly describes the situation Indian pharma companies are in-

    'Sometimes when things are falling apart, they may actually be falling into place.'

It became imperative for pharma companies to identify new engines of growth and invest more in innovation.

According to IQVIA, a pharma consulting and research company, the largest proportion of new medicines launched in the last five years has been speciality drugs.

Going forward, speciality medicines will drive spending in developed markets.

Indian pharma companies have been investing in their global speciality business for the last few years.

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Through this initiative, the pharma industry is trying to gradually move up in the value chain.

However, this will entail significant front-ended investments. The corresponding revenue will accrue over a period of time.

Think of it as short-term pain for long-term gain.

Similarly, pharma companies are learning to cope with FDA inspections better. They are improving incrementally. Earlier, they didn't know which areas they needed to improve as per strict USFDA standards. Now they know.

Not to mention, the recent tariff cuts by China on Indian medicines that will open up another major overseas market for the Indian pharma companies.

Last but not least, the pharma companies earn a majority of their revenue in foreign currency. With the rupee falling to 72, investors are looking for businesses that earn revenue in US dollars.

So, is the pharma sector poised for a comeback? Is the worst over?

I believe so.

FY18 was a tough year for pharma companies. But FY19 is shaping up well. And I expect FY20 to be even better.

Although there will some challenges ahead, the recovery is on in full swing and I am excited!

In fact, as I wrote to you last week, Sarvajeet and I will be travelling to meet a pharma company.

If all goes well, this could be my first pharma stock recommendation to Smart Money Secrets subscribers.

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Chart of the Day

2018 has been an eventful year, to say the least. The Sensex touched all-time high of 38,990 last month.

The rupee touched an all-time low of 72.74 yesterday. The crude is going up and gained around 13% in 2018.

The midcap and smallcap indices are feeling the heat. They are down by about 9% and 13% respectively. Whereas, the Sensex is the outperformer with an increase of 12%.

I thought it would be an interesting exercise to see how sectorial indices are performing in 2018.

Here's the result.

Pharma and IT Outshine Their Peers

BSE IT index is up whopping 41% in 2018. The BSE Healthcare index also did well and is up 8.5%.

Over the last three months, the BSE Healthcare index rose by 24%.

Whereas, the BSE Auto and the BSE Oil & Gas indices were down 8.6% and 9.1% respectively.

With the rupee breaching the 72 mark, IT and pharma are outperforming all other indices.

In the near term, the rupee being under pressure could benefit export-oriented businesses.

My last month's Smart Money Secrets recommendation will benefit from the rupee depreciation.

The company derives around 65% of the revenue from exports. The icing on the cake is the company's focused entry into the B2C segment, which provides it a long runway for future growth.

I believe, the potential upside in this stock is 79%.

If you're a Smart Money Secrets subscriber, read the detailed report here.

If not...you can get the report by signing up here.

Regards,

Kunal Thanvi
Kunal Thanvi (Research Analyst)
Editor, Smart Money Secrets

PS: Kunal Thanvi, editor of Smart Money Secrets, is the Sherlock Holmes of investing. He is on a mission to reveal the top picks of India's best investors to you. For clean, high quality stock recommendations that won't put your wealth at risk, subscribe to Kunal's Smart Money Secrets.

PPS: Ajit Dayal, our founder, will be talking at the Indian Merchant Chamber, Churchgate on the Lehman Crisis on the 15th of September 2018. Those of you who are interested in attending this event can sign up here.

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