2003 is now coming to an end. From hovering around the 3,300 levels at the beginning of the year, the Sensex has come a long way. However, an important aspect of the current rally has been the fact that it has been a broad based one, across all sectors and companies. Infact, the mid-cap stocks (on a broader scale) have outshone the larger companies. Pharma sector mid-cap stocks also played a key role in the mid-cap rally on the bourses. With this backdrop, we conducted a poll by asking the following question, 'Is the recent rise in mid-cap pharma stocks warranted?' The results were as follows.
Out of the total respondents, majority (58%) were of the view that the recent price upswing in mid-cap pharma stocks is warranted, while 40% held a contrary view. To get a better perspective, of the extent to which the mid-cap pharma companies have outperformed, take a look at the following table.
Stock price movement at a glance...
As can be seen from the above table, during 2003 (to date), the BSE Healthcare Index has outperformed the Sensex. Moreover, in the pharma sector, while the biggest gainer (Aventis) amongst the large-cap pharma stocks gained 118%, its mid-cap counterpart (Matrix) gained a whopping 624%. Many of the other mid-cap pharma stocks like Lupin, Aurobindo and Cadilla also managed to outperform their larger peers. So what really is the reason for this sharp increase in the stock price of mid-cap pharma companies?
To understand this, let us first evaluate what has changed for the pharma industry per se and the midcap pharma companies in particular during 2003.
The domestic pharma sector started the year on a bad note owing to the VAT fiasco followed by the slowdown in the domestic pharma industry impacting the performance of pharma companies. Further, although the prospects in the domestic markets were depressed, the international market opened new avenues of growth for the Indian pharma companies. The biggest opportunity is the rapidly growing US generics market. However, given the high R&D expenditure required to be incurred for getting US regulatory approval and intense competition, only large pharma companies like Ranbaxy and Dr Reddy's Laboratories are in a position to capitalize on such opportunities.
The other big opportunity awaiting the Indian pharma companies is in the form of 'Outsourcing'. Outsourcing can be in the form of contract manufacturing or contract research. Some of the companies in the field of contract manufacturing of bulk drugs are Matrix Laboratories, Divis Laboratories and Nicholas Piramal, while Torrent Pharma and Aurobindo pharma are the key players in contract manufacture of formulations. These companies can capitalize on their US-FDA approved plants and manufacturing expertise and become the partner of choice for MNC companies.
On the other hand, as far as contract research is concerned, although this avenue has not yet been exploited in a big way, many companies like Divis Laboratories are contemplating an entry in this field. This apart, many mid-cap pharma companies have also entered into co-marketing agreement with MNCs. Cadilla Healthcare has taken a lead in this field and has entered into an agreement with German company, Schering, for the marketing of latter's drugs in the Indian market.
Finally, the recent WTO agreement on the supply of essential drugs to least developed countries could also usher in new streams of revenues for mid-cap pharma companies. Moreover, the revival in the domestic markets coupled with the low per capita consumption of medicines in the country as compared to the world average, signal good growth prospects for the pharmaceutical industry going forward.
Thus, not many would doubt the long-term prospects of the pharma companies. However, this does not justify an across the board rise in pharma company's stock prices. This is because not all companies will be able to capitalize on these opportunities. For example, only large companies with a good R&D set up will be able to develop new drugs or compete with global generics companies in the US generics market. This apart, only those companies that have manufacturing expertise and US-FDA approved plants will be in a position to win outsourcing contracts.
Moreover, investors also need to realize that investing in mid-cap stocks is inherently risky owing to their small size. Hence, ascertaining the management quality and vision of the company is of paramount importance before investing in mid-cap stocks. This apart, the business segment in which the company is operating and its growth potential in that segment also needs to be evaluated. Finally, investors need to understand that although the mid-cap pharma stocks could be the next multi bagger, they could also be the latest entrants to the vanishing companies list. Hence, research well before investing.