The year 2020 suddenly saw pharma stocks turn into fund managers’ blue-eyed baby. From a low earnings and valuations base, pharma stocks witnessed large gains from January 2020. As of October 16, 2020, the S&P BSE Healthcare index’s returns increased 48 per cent.
Asset Management Companies (AMCs) are mirroring the same trend in their returns. As per data from Value Research as on October 16, 2020, under equity-oriented MF, the category of sectoral pharma fund has gone up by 18.83 per cent in last three months and the returns were up by 64.27 per cent in last one year. Fund managers are spotting this growth as a major opportunity.
Nine AMCs are offering pharma funds. They all favored Cipla, Divi’s Laboratories and Dr Reddy’s Laboratories after analysing their stock portfolio. Eight AMCs have stocks like Alkem Laboratories, Apollo Hospitals, Lupin and Sun Pharmaceutical, amongst other common pharma scrips.
IIFL Wealth Hurun India has came up with a report on India’s Top COVID-19 Pharma Entrepreneurs List 2020, which reveals top ten companies working on vaccines or drugs include Cipla, Divi’s Laboratories, Dr Reddy’s Laboratories, Alkem Laboratories, Lupin and Sun Pharmaceutical, among others. No doubt fund managers are bullish on these stocks.
As key pharma companies have laid a sharp focus on capital efficiency, visible improvement in the domestic and export markets should reflect in the form of higher earnings growth. Experts believe this has led to a massive re-rating of the sector since March 2020.
“The last one-year returns are a function of the sharp re-rating of the PE multiples as the sector is likely to post higher growth in profits coupled with superior return ratios. This largely captures the 50 per cent return and given the Price to Earnings (PE) re-rating, the performance of the sector would be in line with the overall broader markets,” says V Srivatsa, Executive Vice President & Fund Manager - Equity, UTI AMC.
In recent times regulatory challenges, competition, pricing pressures, and large R&D budgets left the Indian pharma industry in the lurch.
The sector endured a strong bull run from 2009 till 2015. A major lull followed from 2016 till 2019.
S&P BSE Healthcare index data showed double-digit annual growth of 23 per cent in 2013; 47 per cent in 2014; 15 per cent in 2015. However, between 2016 and 2019 returns were negative. January 2020 saw a rebound.
The COVID-19 crisis resulted in a shift of thrust towards healthcare and better diagnosis. It has bolstered demand in the sector.
“Pharma is a relatively secular sector with many diversified revenue streams. Further, India has over 27 crore people over the age of 50 who are primary consumers of pharmaceuticals. This, along with global outsourcing and manufacturing opportunities, are the two biggest drivers of growth,” points out Sailesh Raj Bhan, Deputy CIO - Equity, Nippon India Mutual Fund.
Since 2016, pharma companies have faced multiple headwinds in terms of decline in exports due to customer consolidation in developed markets and US plant compliance issues.
At present, exports are rising thanks to demand from the US market, currency depreciation and stable pricing. Growth outlook, however, is subdued.
“The pharmaceutical industry has been recovering after witnessing severe pricing pressure in the export markets. In the last many quarters, export growth has been around 8-10 per cent,” says Vrijesh Kasera, Fund Manager, Mirae Asset Healthcare Fund, MiraeAsset Mutual Fund.
In its research report on healthcare, Motilal Oswal Financial Services remains upbeat on COVID medicines that are driving the overall growth in Indian Pharma Market (IPM). “Growth in IPM recovered sharply to 4.5 per cent Year-on-Year (Y-o-Y) in Sep’20 versus a decline of 2.2 per cent Y-o-Y in Aug’20,” notes the report.
Tanmaya Desai, Fund Manager for SBI Healthcare Opportunities Fund at SBI MF explains, “The domestic market contributes 30 per cent of Indian pharma companies’ revenues. Exports account for 70 per cent. Exports, primarily to the US, is the biggest demand driver as businesses are by and large normalising.”
Edelweiss Securities in a report, Pharma & Healthcare Preview, notes that despite revenue challenges, the sector is likely to report high teens earnings growth during second quarter of 2020-21. The broking firm expects healthcare sector revenue to grow by 38 per cent quarter-on-quarter (Q-o-Q) as life returns to normal. Indian pharma companies like Dr Reddy’s Laboratories and Lupin would see around a 6 per cent Q-o-Q export led growth from new product launches.
A leaner cost structure and substantial investments in the past have started to yield results. It is expected to help maintain earnings growth momentum.
“Sector valuations on forward earnings basis is around 26x, equal to the last 10-year average and at around 26 per cent discount to the earlier peaks. Hence, we believe that the valuations will remain reasonable,” says Kasera.
Non-pharma healthcare, like hospitals and diagnostics stocks, are also expected to gain as they are witnessing demand growth. Higher government spending on healthcare and relaxations in the regulatory process has aided these companies.
“Over the long term, we broadly think non-pharma healthcare like hospitals, diagnostics, and wellness, which are under-represented in the index, would increase their weight,” explains Mahesh Patil, CIO – Equity, Aditya Birla Sun Life AMC.
A boost in insurance penetration also indirectly affects the sector. As insurance penetration improves, one can expect an increase in surgeries and resultant pharma demand.
“Many elective surgeries are postponed since out of pocket expenses in India is over 60 per cent of overall medical spending. Ayushman Bharat program, the world’s largest health assurance program launched two years ago, is an important step in that direction,” says Patil.
Sectoral funds generally have a higher risk-reward ratio compared to diversified mutual funds that invest across different sectors.
“Any sector opportunity that still has some cyclical element due to shifts and valuations is good. Investors with more than five-year horizon should look at mutual funds in a sector-specific category,” points out Bhan.
For investors who have the conviction that a sector or a theme will do well in the coming years but are unsure about the companies to invest in now have the option to buy sectoral funds.
“Sectors and stocks run in cycles. Pharma stocks have run up quite a bit, almost 71 per cent since April lows, ignoring the March lows. However, there is still some scope for pharma stocks to do well. But systematic investment plans in pharma funds is a preferred mode of investment,” explains Deepak Jasani, Head - Retail Research, HDFC Securities.
Equity mutual funds witnessed outflow for three consecutive months. In September, it was Rs 734 crore, against Rs 3,999 crore in August. Banks, consumer non-durables, finance, software, pharma, and petroleum products were the top six sectors where equity MFs invested their funds till September 2020. With the recent uptick in pharma space, this is the right time to invest in equity pharma funds, given the promising future it holds.