Dicey near term, stay selective; long-term outlook positive
Q1FY2016 result expectations
Consecutive quarter of muted revenue growth: For Q1FY2016, most of the pharmaceutical players in our universe are expected to show a reasonable performance mainly due to a high-base effect, adverse cross-currency movement and fewer product approvals for the regulated markets. Divi’s Laboratories (Divi’s Lab; strong growth in contract manufacturing), Glenmark Pharmaceuticals (Glenmark Pharma; the US market saw seven abbreviated new drug application [ANDA] approvals in this quarter, so revenue stream may be better) and Torrent Pharmaceuticals (Torrent Pharma; a strong growth in Europe and Latin America) are likely to see a robust growth as compared with other companies. Whereas in the case of Sun Pharmaceutical Industries (Sun Pharma), the consolidation of Ranbaxy Laboratories (Ranbaxy) has resulted into higher growth (Sun Pharma result is not comparable on a Y-o-Y basis).
Earnings likely to consolidate, unlike past quarter no exclusive products: On an aggregated basis, the net sales of our pharma universe are expected to post a 4% growth, excluding Sun Pharma (including Sun Pharma, a 10% decline) on the back of an 8% growth in the domestic business and a 15% growth in the exports business. The operating profit margin is likely to contract by 478 basis points YoY while the net profit of the universe is likely to remain flat YoY for Q1FY2016 (including Sun Pharma the decline will be 10% YoY). The profit growth for the quarter will be led by Cadila Healthcare, Divi’s Lab, Glenmark Pharma and Cipla, while Lupin, Ipca Laboratories and Torrent Pharma will see a decline in profit.
Issues in near term but a healthy growth outlook for long term: The past few quarters have seen a fewer number of product approvals in the USA, as the US Food and Drug Administration (USFDA) has been busy overhauling the drug review process. Meanwhile, the ANDA filings by the generic players kept piling up and currently, on an average, nearly 40% of the ANDAs filed are yet to be approved by the USFDA. This has moderated the growth in the US market (the US market is the largest contributor to the revenues of our universe) for most of the players. However, we expect a large chunk of the pending ANDAs to unfold in the next few quarters and that will help revive the growth rates. Also, the growth is likely to be driven by the domestic market, which is witnessing a robust volume growth, and the introduction of new drugs. Therefore, while we are positive on the long-term prospects of the sector, a few of the front-line players may see headwinds in the short term.
Relying on the long-term prospects, most of the pharma companies have been successively re-rated over the past few quarters and that has led most of the front-line players to trade at a significant premium to their respective historical average multiples. On an aggregated basis, our pharma universe is trading at 27x its FY2016E earnings (vs 15x Sensex earnings) as compared with its historical average of 14-20x (on one-year forward earnings basis). However, we expect the premium to sustain due to an improving product profile and increasing reach of the Indian pharma companies. We advise staying selective in this space.
Preferred picks for this earnings season: Cadila Healthcare, Cipla and Divi’s Laboratories
Subscribe for free email updates to get daily free stock market tips and make money like professionals.