Pharma Stocks: Is a Re-rating on the Cards?

It's said that there is a bull market in some part of the world.

In fact, if you look at the Indian stock market, there is always a bull market in some sector or another.

You just need to find it, investing in it, and stay put during times of underperformance. The former is relatively easier compared to the latter.

That is precisely what value investing is all about.

My next statement might confuse the conventional 'buy and hold' investor...

There is a notion in the market: BUY good quality businesses and FORGET about them. Well, I believe buy and hold doesn't work. Forget the cyclical sectors, it doesn't work even in FMCG. The only constant theme in the market is sector rotation.

2003-2007 was the era of infrastructure and real estate stocks. The bust which followed due to the global financial crisis led to the sharp rise of pharma and FMCG stocks.

Post Covid, it was the chemical and diagnostic spaces which was the darlings of the market.

However, in 2022, when things normalised, the abnormal valuation of these sectors reverted to mean as earnings slowed down.

So the focus shifted to value from growth, where the public sector gained favour.

Stocks like NTPC, Coal India, Power Grid, etc, attracted strong interest from both the retail as well as institutional investors. In fact, the barometer of PSU sector which is the Nifty PSE index is close to an all-time high.

In the stock market, every sector is cyclical no matter how 'defensive' it is perceived. Pharma and FMCG which are touted as defensives and 'safe' also have an element of cyclicality in them.

The question is how do we find out which sectors are likely to get in flavour?

The simple answer is valuations, and the more complex answer is industry trends.

Let's discuss the most unloved sector right now and how its fortunes can change.

Pharma - The Most Unloved Sector of 2022

Let me take you back to 2009...

India's exports of branded generics grew by 16% CAGR from FY09-FY15. The domestic market continued its steady growth. This led to higher earnings and margin expansion.

Companies like Lupin and Sun Pharma went for acquisitions in their ambition to fund growth. The stock prices zoomed as the valuation multiples re-rated.

The right time to invest was 2009-2010 when export business was looking promising. The 6-year period from 2010-2015 led to strong outperformance of the pharma sector compared to the Nifty.

This was mainly due to...

1. Strong revenue and profit growth.
2. Re-rating of valuation multiples led by the strong growth.

Stocks like Sun Pharma, Lupin, Biocon, Strides, IPCA Laboratories, to name a few, gave stellar returns during that period. After all, pharma was a sector where nothing could go wrong.

Well, there was something wrong. The problem was in the valuations of these stocks.

How can the price to book value of the top ten companies in the pharma sector be 6.5 times? Well, contrary to public opinion, pharma too was a cyclical sector with margins peeking out in 2016.

While margins were on an uptrend till FY16, the stocks peaked out before it was reflected in fundamentals a year later. The smart money knew the era of margin expansion was ending.

The point of this exercise was to show why valuations are so important to find the end of a cycle.

From a fundamental perspective, the decade from 2010-2020 for the pharma sector was split in to two halves.

First Half (2009-2015) - What Went Right

• Booming export growth due to new opportunities
• Steady domestic business
• Rising valuations
• Domestic facing sectors were weak as recovery was underway post 2008.

Second Half (2016-2019) - What Went Wrong

• Pharma companies acquired overseas companies at exorbitant valuations on assumption of high export growth.
• R&D expenses were at their peak. Most of the free cash flow was burnt in R&D.
• However, exports slowed down on pricing pressure in the USA along with vendor consolidation.
• Valuations were too high and had to de-rate on slowing growth.

The NSE Pharma Index made a top in October 2015, the index as of March 2023 was at the same level. No returns for 7 long years.

The question to be asked now is, 'Where are we in the cycle?'

Top Pharma Companies	Price/Book	5 year Profit growth
Sun Pharma	4.5	-1%
Lupin	2.6	Loss
Dr Reddys	3.9	11%
IPCA	3.6	35%
Cipla	3.3	23%
Aurobindo Pharma	1.3	3%
Biocon	2.8	3%
Glenmark Pharma	1.5	-1%

Source: Screener

The combination (subject to fundamentals) should be lower price to book and lower 5-year profit growth. This will indicate higher room for upside when profits eventually come in.

In the last cycle, valuations peaked at 6-6.5 times and at the bottom, the sector was a strong buy at 2.5-3 times.

Look for these criteria when considering the top pharma companies in India.

Warm regards,


Aditya Vora
Research Analyst, Hidden Treasure