Pharma stocks for defensive bias or to gain from weak rupee? Must read this

How is the health of your portfolio after the recent selloff in equities?

If you are planning to give your portfolio a defensive tweak in view of the multiple headwinds ahead, pharma is definitely one space to look at. Pharma is also in focus as a sharp drop in the rupee this year has turned investor focus on export-heavy businesses.

But one needs to be selective and cautious. Select names from this sector such as Merck, Valiant Organics, Albert David and Kilitch Drugs have rallied between 60 and 110 per cent so far this year.

With a 0.74 per cent dip on a year-to-date (YTD) basis, the Nifty Pharma index outpaced the benchmark index which slipped more than 1 per cent during this period. That’s primarily because stocks like Sun Pharma, Ipca Labs, Aurobindo Pharma, GlaxoSmithKline Pharmaceuticals, Biocon, Divi’s Labs, Pfizer and Abbott India gained between 5 per cent and 33 per cent on a year-to-date basis.

But stocks like Orchid Pharma, Mangalam Drugs, Avon Lifesciences, Wockhardt, Morepen Laboratories, Indoco Remedies, Ajanta Pharma, Laurus Labs and Cadila Healthcare fell between 12 per cent and 75 per cent during the same period.

Most brokerages have since become cautious on the sector ahead of September quarter earnings. There are expectations that the pharma sector will report weak operating performance for Q2 on account of sustained pricing pressure in the US and high base of US generics business, muted domestic business growth on account of high base led by GST-led channel refilling and increased raw material cost due to supply disruption from China.

“Even after the rally in the past few months, valuation multiples of some of the pharma companies under our coverage are still close to their long-term average multiples due to de-rating in the past two years. Though the risk of earnings downgrade still persists, given the near-term challenges, we see an opportunity to invest in select quality names,” brokerage Sharekhan said in a report.

“We continue to maintain our cautious view on the sector and recommend selective stock picking. During Q2 of FY18, after GST implementation, pharma companies had re-filled the channels via inventory push. Given the volatility in the US market, we prefer domestic-focused players,” IDBI Capital Markets said in a report.

The brokerage believes margins of pharma companies are likely to be under pressure, as most of them import Chinese active pharmaceutical ingredient (API) and intermediates, whose prices have increased substantially due to supply constraints.

“With few major launches in the US, depreciating currency across the emerging markets, including rupee, against the dollar QoQ, we expect moderate growth in exports. Most emerging market currencies had a weak performance against the US dollar, which appreciated 4.7 per cent QoQ in Q2FY19. We expect gain from appreciated dollar to get passed on to adjust price erosion in US generics over time,” brokerage Prabhudas Lilladher said.

With the implementation of the goods and services tax (GST) during the first quarter of FY18, a large part of sales was reported in Q2FY18 and that base effect will ensure lower-than-expected growth in Q2FY19 for India formulation businesses.

“With the disadvantage of a higher base in domestic sales in Q2FY18, we expect average domestic sales growth (YoY) to be more than 8-12 per cent in Q2FY19E. We expect domestic formulation market to continue to be challenging, especially for the companies which are highly dependent on acute therapy drugs. It would be more challenging for large Indian pharma companies due to large base and strong restriction on churning out of new combination drugs,” said Prabhudas Lilladher.

For stock-specific investors looking for some pharma names in their portfolio, IDBI Capital Markets has ‘buy’ rating to Cipla and Dishman Carbogen Amcis with a target price of Rs 483 and Rs 321. However, it has ‘reduce’ ratings on Merck India and Sanofi India.

Prabhudas Lilladher has a ‘buy’ ratings on Aurobindo Pharma, Eris Lifesciences and Ipca Labs with target prices of Rs 909, Rs 849 and Rs 642, respectively, while Sharekhan prefers Biocon, Divi’s and Sun Pharma.