Pockets of Pessimism

banner-octIndian Pharma: Fat pitch in sight, get ready for a hard swing!

It may seem odd to talk about a fat pitch when Nifty is at a striking distance from a five digit mark (sorry, struck and gone well past that mark is another matter). It is no secret that Sensex has been soaring to stratospheric valuations on surging liquidity from both domestic and foreign investors. If anything, stocks are simmering at frothy levels for a while now. Yes, this is true for much of the sectors where it is a story of trumpets blaring amid ever-rising list of multi-baggers. But that hasn’t stopped the markets to punish prices in certain select pockets to seductive levels on growing uncertainties in the short-to-medium term. If one looks around for sectors where drums are beating amid plunging stock prices, it is unlikely that one would return empty-handed.

No prizes, of course, for guessing the sectors that have been the laggards in this bull run. It is widely known that the top stocks that have spectacularly soured the sentiments are from the infamous group of three sectors, namely IT, Telecom and Pharma. While all of them are going thro’ sectoral short-term setbacks, on measure of mis-pricing relative to long-term business fundamentals, Pharma seems to be more promising.

In a rare instance of unfortunate coincidence, confluence of factors have miraculously come together to conspire a deadly blow to the fortunes of pharma industry. The sector that helped India to build global prominence is suddenly facing huge set of headwinds on account of following developments:

  • Increased regulatory scrutiny (Increasing cases of warning letters and import warnings from US FDA).
  • Consolidation of distributors in US resulting in pricing pressures for generics
  • FDA’s increased focus on fast-tracking drug clearances leading to more competition in generics and hence putting pressure on prices.
  • NPPA (National Pharmaceutical Pricing Authority) bringing more drugs under price control in domestic market.
  • The risk of dictum from Indian govt. on generics prescription in the local market.
  • To top it all, GST hiccups couldn’t have come at a worse time i.e. destocking and delay in restocking in domestic formulations.

Very rarely, such a series of setbacks suddenly surround a particular sector and cause stock prices to get mis-appraised in a disproportional degree. Pharma is going thro such a painful period in this so called perfect storm. Are these setbacks structural or cyclical? If anything, FDA’s vigorous vigil will play a vital role in streamlining the quality process which is positive in the long-term to achieve bigger business scale in generics. Similarly, accelerated drug clearances by FDA, while putting pricing pressures, will also help small and medium players to gain faster access to US generics. In our recent meeting, CEO of one of the promising mid-tier pharma companies, echoed this long-term view. Moreover, much of the domestic challenges listed above should not dent the long-term prospects for the sector, except the dictum of generic prescription, which many industry insiders don’t see it coming given the practical challenges in implementation. With govt. going slow on this, the noise around it has subsided significantly.

As someone wise said, great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to be mis-priced manically. Pharma seems to be offering that classical value opportunities to those who have lots of patient capital. More so with small and mid-cap pharma (stock specific, of course) where relative undervaluation can give additional kicker.

Happy Value Investing!

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