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Who’s the fairest of them all? - Views on News from Equitymaster
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  • Sep 14, 2002

    Who’s the fairest of them all?

    Valuations of the Indian pharma sector have undergone a sea change in the last couple of years. MNC pharma companies, once darling on the bourses, went out of favour with investors in mid-1999 as better growth opportunities became visible for Indian pharma majors.

    The earnings multiple in the recent past clearly suggested that investors were ready to pay a premium on companies, which had successfully reduced their dependence on domestic markets and were successful in entering the fast growing export markets.

    These companies grew at a faster clip, invested in creating intellectual property and were to a certain extent successful in monetising R&D to varying degrees. Leaders of this group are Ranbaxy and Dr Reddy’s. On the other hand, companies solely dependent on the slow growing domestic market commanded a lower valuation. For example, though Sun Pharma consistently outperformed its peers in terms of growth and profitability in the domestic market; it used to trade a discount to peers. This was largely on account of the fact that the export strategy of the company was unclear and revenue streams singular. As is evident from the charts below the out performance in case of Dr. Reddy’s and Ranbaxy is far higher than in case of Cipla and Sun Pharma.

    MNC pharma companies have been losers in terms of sales growth and consequently market capitalization over the last two years. While Indian Pharma companies market capitalization soared around 180% in the last two years, MNC market cap was down around 8%.

    Valuations across the sector are again in the process of re-alignment. On one hand, the disappointment to Dr. Reddy’s on the research front and several instances of delay in generic approvals have compelled investors to wake up and realize the need to align the risk associated with growth. Post the slide in Dr. Reddy’s; pharma stocks have remained more or less range bound the last couple of months.

    MNCs, on the other hand, have been quick in responding with most companies intensively restructuring their operations in a bid to bounce back. There was almost a ‘V’ shape recovery in the operating margins of several MNC majors. Having sensed a recovery in margins of these companies, market capitalization of these stocks are already making a partial comeback. However, the key question on the mind of investors is once things are set right and restructuring achieved, where would the growth come from?

    Investors, for the moment, seem to be at crossroads. Going forward, investors are likely to chase growth, coupled with clarity on future earnings. In the ensuing tables we have provided comparative forward valuations of Top Indian and MNC pharma companies.

    Domestic Pharma – Valuation comparison
      Dr. Reddy's Ranbaxy Cipla Sun Pharma
    CMP (Rs.) 865 885 940 578
    P/e - 02 14.4 37.5 24.6 16.3
    P/e -03 E 14.2 17.1 16.7 14.2
    Mkt Cap (Rs m) 66,173 103,103 56,400 26,993
    Mkt Cap/ Sales (x) 4.4 3.6 4.4 4.0

    To conclude, the success in the US / European generic and drug discovery space is likely to continue to be the key drivers for the Indian pharma majors. The P/E multiple of Indian pharma companies are expected to remain higher compared to their MNC peers in the short run on the back of sustained earnings growth. Further, paybacks from investments made by several domestic companies to get an exposure in the International markets are also likely to add to the optimism. However, sooner than latter, investors are going to demand a strategy post 2005 before continuing with premium valuations to these companies. On the other hand, post restructuring, visibility of growth is likely to be the key driver for the MNC pharma companies.

    MNC Pharma Companies – Valuation comparison
      Glaxo Novartis Pfizer Aventis
    CMP (Rs.) 365 238 432 365
    P/e - 02 37.6 13.2 21.3 12.6
    P/e -03 E 18.9 11.5 15.2 12.2
    Mkt Cap (Rs m) 27,010 7,616 11,880 8,395
    Mkt Cap/ Sales (x) 2.5 1.6 2.2 1.5



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