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Pharma stocks rise sharply this week on cheap valuations

LiveMint logoLiveMint 15-09-2017 Isha Trivedi

Mumbai: Pharmaceutical stocks, which have been among the worst performers in the current year, rose sharply this week on the back of renewed investor interest in the sector owing to cheaper valuations.

Heavyweight Sun Pharmaceutical Industries Ltd jumped 11% so far this week as broking firm Credit Suisse upgraded the stock to “outperform” from “neutral” and most other brokerages remained positive on the company.

Hyderabad-based Divi’s Laboratories Ltd was the biggest gainer, rising 23% so far this week, on reports that the company’s manufacturing unit, which is under import alert, is undergoing an inspection from the US drug regulator.

Lupin Ltd, Dr. Reddy’s Laboratories Ltd, Aurobindo Pharma Ltd and Glenmark Pharmaceuticals Ltd rose 4% each.

The BSE Healthcare Index gained 5% so far this week, while it is down 21% since the start of 2017.

Shrinking growth in the US, the biggest market for many Indian pharma companies, due to price erosion and regulatory issues, and increasing price restrictions in domestic market have been weighing on pharma stocks over the last two years.

The benchmark Sensex index has gained 21% so far this calendar year, but pharma stocks have underperformed.

“The Indian pharma sector’s valuation multiples have contracted over 25% over the past 2 years. Moreover, earnings forecasts are accounting for most of the risks and challenges. This, in our view, is an opportunity to accumulate stocks from a long-term view,” brokerage firm JM Financial said in a report dated 13 September.

“We expect earnings to pick up over the medium term, with PAT (profit after tax) recording 10% CAGR (compounded annual growth rate) and a 170bps (basis points) improvement in average RoCEs (return on capital) over FY17-FY20, as companies move up the value chain, with a ramp-up in the launch of complex generics and specialty products, focus on growth in emerging and other developed markets and volume-driven growth in the attractive branded domestic market,” JM Financial said.

Vishal Manchanda, analyst at Nirmal Bang Securities, said fundamentals in the sector remain the same, but valuations have come down. There are potential triggers around the corner which can revive growth for select large-cap companies, and with sufficient liquidity available and various other sectors looking overpriced, investors are turning towards pharma stocks.

At the current price levels, many analysts are positive on the Sun Pharma stock due to its potential to monetise its specialty drugs pipeline.

According to data from Bloomberg, out of 44 brokerages that track Sun Pharma, 20 have a “buy” rating and 10 have “hold” rating on the stock.

In a note dated 13 September, Credit Suisse said the specialty pipeline is likely to boost the profit of Sun Pharma to 20% CAGR during FY19-22. Also, US price erosion risk for the company is expected to be lower at mid-single digit, while the industry faces higher risk.

“Sun has already invested $600 million in seven specialty assets. Our proprietary analysis shows peak sales of these assets should be $700 million. Increasing contribution of specialty addresses growth concerns in generics and helps Sun revert to 20% profit growth trajectory. Strong free cash flow (over $500 million) should help acquire more assets and deepen presence in chosen specialties. Monetisation has already started with two drugs in the market, and the lead derma drug MK-3222 should be launched next year,” Credit Suisse said.

JM Financial said the historical premium that Sun Pharma enjoyed has disappeared. From a historical high of 29x in March 2015, Sun is currently trading at FY19 price-to-earnings multiple estimate of 20x, which is well below its 5-year range and at the lowest premium compared to its large-cap peers. “With limited downside risks to current earnings estimates and significant key risks having played out, we find the stock’s risk-reward attractive at these levels.”

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