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Sensex V/s Pharma V/s Software

Sep 16, 2004

Looking at the behavior of the Indian stock markets in the last one month, one gets a feeling that it has again proved to be the proverbial conundrum, something extremely difficult to predict in the short term. Shrugging off the twin demons of inflation and rising interest rates, the BSE-Sensex has notched up an impressive 9% gains in a matter of a month. Still impressive was the performance of two of the most promising sectors in the Indian corporate space - pharma and software. While one would not want to hazard a guess on the position of the index in the medium to long term, one can predict with reasonable confidence that these two sectors are in for some good times ahead. Let us find out the reason behind this optimism.

The strong performance of pharma index relative to the Sensex can be attributed to the strong growth prospects that pharma companies offer in times ahead. However, the main constituents of the pharma index like Ranbaxy, Cipla, Dr. Reddy's, Glaxo and Nicholas Piramal are all rising for different reasons. While the heavyweights, Ranbaxy and Dr Reddy's, are rising on account of investors' expectations of global opportunities that exist for Indian companies in the US and European markets, Glaxo and other MNC pharma companies have participated in the bull run on expectations of arising benefits of the new patent regime post-2005.

In the analyst meet last week, Ranbaxy talked about its vision for the year 2007 of reaching US$ 2 bn in revenues. The path chosen for the same is pretty clear and the company might attain this ambition as it did with its previous target of US$ 1 bn in 2003. The management seemed quite confident of its products in the US generics market and said that it will continue to file 20-25 ANDA's (abbreviated new drug applications) every year going forward. This has given the markets some confidence about the success of Ranbaxy going forward. The effect of this confidence can be seen with Dr. Reddy's as well, which has also rallied considerably in the past month. While Dr. Reddy's has reported a streak dismal performance in the past few quarters, we believe that the worst might get over for the company after another quarter. The company, which has invested hugely in R&D activities, may launch certain non Para IV products in the US in the next few quarters. Most of the incremental R&D expenses that Dr. Reddy's have made in the past few quarters have gone into increased ANDA activities.

Another drugs major, Cipla has run up more that 40% in the last two months on expectations of high growth prospects in the bulk drugs segment. Cipla has tied up with some US generic majors like Ivax, Watson and Parr for supply of bulk drugs for about 140 generics products of these companies. Apart from that, the company is focusing on new product launches in the domestic market. The company has grown faster than the overall domestic market growth in the first half of the current year.

While stocks of Indian pharma companies are gaining ground on positive news from the exports front, MNC pharma companies have been gaining because of opportunity available to them post 2005 when process regime gives way to the patent regime. Companies such as Glaxo, Pfizer, Aventis and Novartis, which have strong pipeline of patented products, are likely to gain most from the new patent regime. However, the quantum of gains and the timing of the same will depend upon the affordability and acceptance of costly drugs by the Indian patients.

With, very low penetration levels of medicines in the country and changing life style, we can be sure that in coming years the growth of the pharma sector may change its trajectory and go on a higher growth path. Apart from that, the cost competitiveness of the Indian producers can be a great advantage for them in the international market.

Stocks from the other knowledge driven sector, software, have also rallied significantly in the last one month with the IT index churning out a return of 13% compared to 6% from the Sensex. The major players in the Indian software space - Infosys, Wipro, TCS and Satyam as well as niche player like Geometric Software, Hughes Software and i-flex have outperformed the market in the last month. And this seems a result of rising investors' optimism about increased outsourcing businesses to these companies.

Even though global majors like Cisco and Intel have revised their second half guidance and have indicated cautious times ahead, investors continue to favour technology stocks in the Indian markets. Internationally, companies are accepting the global delivery models of the Indian software vendors and have shown increased eagerness to outsource their IT requirements to Indian companies. Thus, as outsourcing becomes mainstream and billing rates stabilise further, Indian software companies can look forward to improved times ahead.

However, here we would like to caution investors from considering all companies in the IT sector 'insulated' from the turn of events outside their realm. We believe that going forward, demand for technology solution from global clients is likely to be concentrated among a few players. These could either be the large software and services vendors or small niche players. This is because the demand for technology is likely to be more guided by the 'Return on Investment' factor, i.e., how much of cost saving or return on investment can be obtained by clients from their IT spending.

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