Pharma stocks were the first to rally after Covid but have underperformed the markets since then. In the last two years, Nifty Pharma declined 5.6 per cent against Nifty-50 gains of 21.8 per cent. But green shoots of recovery are visible in the last one-month as Nifty Pharma gained 8.4 per cent compared to Nifty-50’s 3.8 per cent return. Investor focus may be back on the segment as India sales continue their momentum and US sales growth, riding on niche products, may overcome generic deflation in the short run. The news flow from the leading companies is also positive and the sector is poised well heading into the last results season for FY23.

The strong domestic growth potential was masked by high comparable base in India and even in emerging markets. In the last one year, Covid portfolio sales in the base year resulted in weak year-on-year growth numbers. India and EM sales which should now have a lower Covid contribution in the base year, should allow for real growth to be reflected in numbers. The companies should report 10-12 per cent YoY growth without any disruption aided by branded presence and passing on the high RM costs. US generics product mix, led by a higher proportion of limited competition molecules, should post growth in the short-term overcoming the double-digit price erosion in base portfolio. But on the US regulatory front, US FDA inspections will continue to be an overhang for the industry.  

The top five by market cap, have managed to beat Nifty-50 in the last one month led by Divi’s (16 per cent) and Dr. Reddy’s (11.7 per cent). Sun Pharma, Cipla and Zydus Lifesciences have also returned 6 per cent, 5 per cent and 8 per cent respectively in the last month. Amongst mid-cap pharma companies, Aurobindo, Lupin, Torrent and Biocon, only Aurobindo recovered 25 per cent (from a significant decline of 60 per cent from peak in May-2021) while others have returned between 2-4 per cent in the last month.

Positive undercurrents

The news flow at the top is encouraging as well. On the M&A front, Sun Pharma and Dr. Reddy have announced M&A news that found good reception in the markets. In early March, Sun Pharma completed the acquisition of Concert Pharmaceuticals for $576 million, which includes a Phase III asset for treatment of Alopecia Areata - a hair loss condition. The tally of Sun’s assets which can generate $500 million per year now include Ilumya and the recent addition. In late February, Dr Reddy announced a $90 million deal (upfront plus contingent of $15 million) to acquire the US generics portfolio from Australia based Mayne Pharma which should add 10 per cent its US portfolio. There have been hints of slowing US generic price erosion in Q3FY23 results discussion and the investor community will be monitoring if it carries into the fourth quarter.

The domestic market, including the price control segment, should report strong growth led by pricing. Apart from higher raw material prices, the high WPI inflation should aid price pass through for the industry which has 11-12 per cent of domestic portfolio under price control.

US FDA plant inspections continue to impact the segment, the latest being Cipla’s Pithampur plant in February. The quarter results discussion should highlight the delay to be expected in the respiratory front.

On the product front, the trajectory of generic Revlimid after one or two quarters of initial launch will be a key monitorable for the companies that have launched (Natco, Dr Reddy, Zydus Lifesciences, Cipla and Sun Pharma amongst the many). How the companies stick to their volume quotas (as per agreements) and the impact on pricing should be a learning curve for all stakeholders.

Q4FY23 expectations

In Q4FY23, revenue growth of 10-15 per cent YoY, and margin expansion by 100-200 bps is expected for the industry as cost pressures ease along with favourable forex movement (USD/INR). Divi’s, leading the research outsourcing segment, reported a weak Q3FY23 on loss of Covid business. The recovery expectations are strong as the stock recovered 9 per cent on Friday last week based on recovery in exports. On valuations, Sun Pharma is trading at 25 times FY24 earnings in line with historical range of 25 times and others are trading between 18-20 times FY24 earnings which is slightly below historical range.