Pharma : Is the price upswing justified? - Views on News from Equitymaster

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Pharma : Is the price upswing justified?

Sep 11, 2003

2003 has been a very good year for India per se and the stock markets in particular. The Sensex, which was hovering around the 3,300 levels during the beginning of the year, has now crossed the 4,400 mark. Unlike other bull runs that the market had experienced in the past which were sector specific (like software in 2000), the current upswing has been across all sectors. Pharma stocks were one of the key gainers during this period. This is evident from the following graph.

As can be seen from the above graph, Rs 100 invested in the CNX Nifty 100 would have yielded Rs 127, while a similar amount invested in the BSE Healthcare Index would have grown to Rs 152. Moreover, if we consider the run up in the two indices from April 2003 onwards (the time since the current rally started), the CNX Nifty 100 has gone up by 43% while the BSE Healthcare index has gained 65%! Even among the pharma stocks, it was the mid-cap stocks that really stole the show as can be seen from the following table.

Mid-cap pharma stocks upswing...
Sep 2, 2002 (Rs) Sep 3, 2003 (Rs)
CADILA HEALTHCARE130.2292.0124.4%
FULFORD (I)112.6243.0115.9%
AUROBINDO PH225.8460.5104.0%
GERMAN REMEDIES284.0472.366.3%
GLENMARK PHARMA240.0377.957.5%
KOPRAN LTD.40.860.447.9%

As can be seen from the above table, midcap pharma stocks grew at a much higher rate than the BSE Sensex. So to what extent is this upsurge in pharma and midcap stocks price justified? Lets find out.

Absence of product patents has helped Indian companies specialize in the manufacture of generic drugs. The generic market in the US was US$ 40 bn in 2001 and is estimated to rise to US$ 90-95 bn by 2012. Moreover, drugs worth US$ 55-65 bn are expected to go off patent in the next 5 years. Further, with pressure to reduce health care costs, the US government has passed regulations to speed up approval procedure for generic drugs and also include generics in its Medicare policy. In view of India's expertise in the generics market, this could translate into strong growth for the Indian pharma companies. Ranbaxy and Dr. Reddy's have recognized this growth potential for generic drugs in the US and other regulated markets and are focusing on the same.

Another avenue of revenue for Indian companies is outsourcing. Indian companies can enter into contract manufacture of bulk drugs as well as formulations. Indian companies with their expertise in drugs manufacture and large number of US FDA approved manufacturing facilities (India has the maximum number of US FDA approved plants outside the US) are the key positives working in India's favour. Nicholas Piramal, Wockhardt and Cipla have taken major initiatives on this front. Many smaller pharma companies such as Matrix Laboratories and Divi's Laboratories have also shown strong growth on the back of drug manufacturing contracts. Indian pharma companies can also capitalize on low cost of operations and availability of highly skilled scientists. Over that, the presence of a large number of patients with ethnic diversity at a much lower cost will help India become an ideal destination for clinical trial and research.

Adding to the above positives, the growing domestic health insurance market is expected to drive domestic demand post-2005. Moreover, the fact that most of the WTO members have agreed to a draft agreement for the supply of essential drugs to the least developed countries has opened another avenue of growth for the medium-sized Indian pharma companies. Thus, while few will question the strong growth potential that beholds the Indian pharma companies, not many will be able to justify such a steep rise in stock price.

Potential of discovery research, contract manufacturing, contract research and the WTO agreement were listed as the reason for this upswing in pharma stock prices. However, the fact that Indian companies had outsourcing opportunities going forward was known for a long time. So why has the realization about the same drawn up only now? Another concerning factor was that even if one company received a US-FDA approval, all the stocks in the sector saw a sharp rise in price. Thus, an approval for Ranbaxy resulted in a stock rise across all the stocks in the sector. Even the mid-cap stocks that had little or no prospects of even filing an ANDA registered a rise in their prices.

Although some of mid-cap pharma stocks hold good potential going forward, investors need to understand that considering their size, there is an inherent risk involved in buying these stocks. Investors, thus, need to exercise caution while investing in these stocks. The key to successful stock picking is investing in fundamentally strong companies with a good track record. Finally, a few words of advice, 'Behind every stock is a company - research it'.

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