Pharma Index Surges Over 19% This Year
Pharma pack shines in an upbeat market, DAM Capital's Nitin Agarwal helps us understand the rationale behind the strong upmove. #BQLive
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00:00 Hello and welcome to BQ Prime. I'm Monal Sanghvi and our guest today is Mr. Nitin Agarwal,
00:05 the Managing Director and Head of Institutional Research at DAM Capital. Welcome to the show,
00:10 sir.
00:11 Thanks, Monal. And thanks for having me on the show today.
00:16 So Nifty has made quite a high last week and one of the sectors that prominently saw a
00:23 run up was pharma. It's right in the centre gaining focus. So what exactly do you believe
00:31 has led to this positive commentary around pharma? There are a lot of trigger points,
00:36 of course, strong results of the companies that have already come out with their earnings
00:41 last week. But what is typically aiding this sort of positivity around the sector? I mean,
00:46 overall, the return has been pretty negative. I mean, if we look at the last couple of years,
00:51 except for the Covid year. So what now is changing this sentiment towards pharma?
00:57 So I guess there are two things. The way I look at this thing is if I were to broadly
01:00 look at the sector in two parts, the domestic and the exports, I mean, domestic consistently
01:05 has been a very steady story. What has changed in the domestic essentially is that we had
01:11 a listing of Mankind Pharma, which was a listing of the first large, probably standalone, quasi
01:16 almost standalone domestic business. And the market in the past hasn't had an opportunity
01:21 to sort of trade up your domestic formulation business in the name. And so that business
01:27 got the, it got re-rated, got listed, which sort of indicates the premium market is willing
01:33 to pay for a pure play standalone domestic listed business. And that I presume has had
01:38 some rub off effect on multiples for other domestic focused franchises. So that's been
01:43 one part of it. The other part is, you know, there's been obviously the biggest story which
01:47 has been on there on the on the genetic export side, especially on the US side. I mean, genetic
01:52 exports, as you know, has been struggling for the last two years, as you mentioned,
01:56 after post-Covid. Right reasons and most of the weakness has been driven by the US. And
02:02 the US, I think things are beginning to change at the margin. I mean, structurally, there
02:05 were two issues impacting the business in the US. One is a there was a consolidation
02:09 of the distribution end, which stays as it is. And the other bit was, there was because
02:14 of this distribution, consolidation of the distribution, there was an aggressive pricing
02:18 erosion which was happening in the US market, you know, over the last year, year and a half
02:22 in particular. Now, what is beginning to change on that account is we've seen some easing
02:26 off happening on the on the competition in the US. And since US is a commodity market,
02:33 easing off competition essentially means some reprieve on the price front. And that leads
02:37 to improvement in the dynamics for for the genetic business. And that is a commentary
02:41 we're hearing more and more from companies now, that there is signs of improvement, easing
02:46 off the competitive pressures in the US, which is leading to improvement in in profitability
02:52 for for the US business, you know, on an ongoing basis. It is not a dramatic change, but it
02:57 is gradually getting better as we speak.
03:00 So just yeah, I believe Sipla also came out with this, this story, but on how the pricing
03:07 pressure in the US could be getting better because of lesser competition. But I have
03:10 one question there, Dr. Reddy's, which came out with its result last week. And of course,
03:14 we saw the stock not react despite the strong results. And if we were to look at its disclosures
03:18 in the US, we realize that there's a lot of growth that came in from Revlimid, the generic
03:25 version, and not in the base business. So while of course, Sipla doesn't make those
03:30 sort of disclosures, so we do not know how its growth was supported and to what extent
03:35 was it supported by the base business and Revlimid. What is the sense that you make?
03:40 I mean, is it just that these specialty products are going to give a leg of growth for a couple
03:45 of years, because everybody's talking about better margins, but is that what the distributors
03:50 are actually seeing on ground, where they're ready to pay more? There was a lot of talk
03:53 about how there's drug shortages in the US, but also that the US policies are not typically
03:58 changing as much, which is why there's always this discord that, you know, while of course,
04:04 we've seen price erosion moderate a certain bit, there's still a lot of, people are not
04:12 sure whether it'll go back to the original levels. So would it still be as lucrative?
04:16 You know, you saw, you're right. See, what is not changing in the US is we're not changing
04:20 a dramatic, we're not seeing a dramatic change, which is happening in the business, right?
04:25 What the changes which are happening are happening on the margin, right? Now, what has happened
04:28 is over the last six odd months, FDA has gone out and given import alerts, issued import
04:33 alerts on a bunch of manufacturing sites. And I guess whenever import alerts are given
04:37 out, it has implications on supplies from those from those units. And those in turn
04:43 start to create some sub supply challenges. And when the supply challenges begin to come
04:47 up, and they have said, and they have an increasing over the last couple of quarters, even the
04:52 buyers tend to be a little more sensitive about supply security. So there's a, so there
04:58 is this probably this at the margin incremental willingness to pay better pricing or not to
05:02 be so aggressive with the, you know, with sort of negotiating with the with the generics.
05:07 So what's happening is, you know, some bit of pressure is easing on not not the entire
05:12 portfolio, but in products where there are maybe suppliers constraints coming through.
05:16 So it is not to say that if someone's selling 100, if the 100 products being sold in the
05:20 US, you've seen price improvements happening across the entire 100 products which are being
05:24 sold. It's only in products, specific products where there are maybe some supply pressures
05:27 which are building through. And the point that you mentioned, and you know, it's a,
05:32 it's purely a function of the portfolio of various companies in terms of the proportion
05:36 of products where there is some supply situations, building out, and how companies are positioned
05:41 to leverage from that. So it's going to be company to company, depending on the portfolio
05:47 that you have, which is which is facing some of these supply challenges.
05:51 Then that brings me to another question, because we've seen the whole of Nifty Pharma run
05:54 up, you know, that is company agnostic. So do you believe that that that sort of run
06:01 was legitimate? I mean, or do you see some correction then coming in because it's already
06:06 run up and certain stocks will maintain their levels of the new heights that they've, they
06:12 made while the others correcting? How will it be?
06:16 So in the, you know, in Pharma, what's happening in the large caps, the export story that you
06:20 talked about, I think export story in India is more of a large cap story. It is mid caps
06:25 are largely driven by domestic sort of theme, large caps have a larger exposure to the generics.
06:31 And other factor apart from what we discussed on the shortages is, you know, at least three
06:36 or four of the large cap companies have a tailwind of Revolumid earnings, right? Yeah,
06:40 Revolumid as an opportunity to our understanding is going to be there all through FY26. So
06:46 there is a two to three year window of very strong tailwind coming in from Revolumid across
06:51 three or four of these names, that gives you an additional delta or tailwind for the earnings
06:56 for the large cap companies, right? And in the Indian market, in any market, three to
07:02 four year visibility of earnings is a reasonable, is a reasonable visibility, right? And market
07:08 in the past was maybe unsure about how Revolumid is going to play out. But the fact that you
07:13 know, Revolumid earnings have been holding up so far, I think there is this incremental
07:16 comfort that you'll see a reasonable delta on Revolumid continuing through FY26. So the
07:21 large caps have got getting the benefit. And when large caps move, typically, you know,
07:25 the sector, you know, that pretty much will stop moving the Nifty index to the farmer
07:29 index to an extent.
07:30 So the key takeaway here would be that we still look at individual names and how it's
07:36 performing for every company.
07:37 Oh, yes. It's a very, very portfolio specific situation in terms of A, as I said, the tailwind
07:44 for one and two, on your base portfolio, what kind of new launches you're getting through?
07:48 And what kind of opportunities you're getting on supply shortages?
07:51 Now, so if we wanted to understand pharma mid caps and small caps, how are we to look
07:56 at them? What sort of portfolio? A lot of pharma companies are now looking at other
08:00 branded formulation markets. They're talking about how going to other geographies apart
08:04 from the US could also be a lucrative opportunity where they'll get a solid regular growth.
08:08 So how is it that you view this? And what do you have in what do you think should be
08:13 looked at when you're looking at mid caps and small caps there?
08:15 That's a that's a valid point in terms of people beginning to look through beyond the
08:19 US. But also the reality is, our US is a key market for everyone because the single largest
08:25 market in the world, right? When you try to get into markets outside of the US, very few
08:30 markets offer the scale to build a meaningful businesses, right? So when companies can try
08:34 to build businesses outside of the US, it's not easy to get scale in each in a new geography.
08:42 So on an aggregate multiple geographies put together will make for a reasonable size ex-US
08:48 business. But it is not, it's going to take its own time. It is not there is no easy fix
08:53 like I mean, relatively speaking, getting a scale in the US is far more easier than
08:58 trying to get scale in a non US exports market. It's a valid opportunity, strategic plan,
09:03 a path to take, but it's going to be a gradual, you can build a business only gradually.
09:10 If you could give us some insight on how do you look at pharma in the near term, medium
09:15 term and over the long term? What sort of companies would you prefer? What sort of profiles
09:18 of companies would you look at if you were to stay invested?
09:22 So pharma domestic is a cleaner story, right? I mean, there's two or three parts to it.
09:26 There's a domestic story, that's probably the most secular story at this point of time
09:30 in the sector with a relatively long, you know, long sort of visibility of growth with
09:35 limited with limited fluctuation. So that remains pretty much the best sort of thing
09:40 to play into. And apart from that, you know, companies which are strong in the US, and
09:46 who have a cost competitive offering to participate in the US genetic story also have a long runway
09:52 of growth, because all that is done, pharma consumption will not come down. It's that
09:57 companies need to be in a position to compete in that in a more cost effective manner. And
10:02 the third is a companies which can pitch a plane in contract manufacturing for innovators.
10:07 So these are the three plans that we are more positive on pure domestic stories, genetic
10:12 companies which are very competitive on costs into playing into the US and third is companies
10:16 which have a play on contract manufacturing opportunities, which can come up for innovators.
10:21 I saw I have one question on the domestic formulations. There's a lot of talk around
10:26 trade generics with the Jana, Shirdi stores multiplying people in the tier two to tier
10:31 six cities, kind of preferring trade generics also with big companies entering the market.
10:37 There's Sipla, Sipla and Alchem which already had their presence in trade generics now with
10:41 Dr. Reddy's coming in. How do you how do you see this is going to change the market because
10:46 the kind of margins that you get on a branded formulation was the trade generic, trade generic,
10:51 I believe it's a more volume oriented game. So how do you see the story panning out in
10:55 the long run for India?
10:56 It's a it is something that we honestly need to keep an eye on. Just that the way things
11:02 are transition is not going to happen overnight. It's going to be a very slow transition that
11:06 happens in what companies are doing is they're keeping an eye on this transition. So they
11:11 want to be sure that they are present in that space if that space actually takes off. But
11:15 there's nothing to suggest right now that the trade generic growth is going to meaningfully
11:19 overpower the brand generates growth, which is there. The industry will keep continuing
11:23 to be dominated by branded generics for a while to come. Trade generics as an opportunity
11:28 will become bigger than where it is. But I don't think it's any time going to overtake
11:31 the brand opportunity anytime soon.
11:35 And so overall, how would you look at pharma? Since you look at the whole gamut of sectors,
11:40 where would you place pharma on your scale of ranking? It's obviously run up right now.
11:45 But is that your opinion also going forward? Because usually pharma has been more of a
11:49 defensive sector and while the market's running up, it's very strange to see pharma do extremely
11:56 well. That's sort of digressing from the usual trend. So how do you look at the sector?
12:02 So as I mentioned, you know, what Revlimid has done is, you know, it's given at least
12:07 three or four of the large cap companies very strong visibility of growth will FY26. And
12:11 then there are companies which don't have Revlimid, they've got some other, you know,
12:14 some other interesting launches coming up for them in the US. So all in all, I think
12:18 that the export business, especially for the large cap companies, extremely well placed
12:22 for the next two to three years. So the earning visibility on the large caps in particular
12:26 is very strong. And then the mid caps are primarily domestic focused businesses. And
12:31 there is again, a reasonable steady growth in that, you know, the steady growth visibility,
12:35 which is there for the mid caps also. So all in all, multiples aside, right, multiples
12:40 essentially becomes for more of, you know, in terms of how further multiples can stretch
12:44 is a separate story. But purely from an earning perspective, the sector is in a pretty decent
12:48 shape. There is reasonable earning visibility for most of the companies in the space for
12:53 the next two to three years. And in an environment where I think the market is getting maybe
12:57 has moved up the way it has moved up, and the concerns on earning visibility in sectors,
13:02 at least on that front, Pharma is really well placed. There is reasonable earning visibility
13:06 across bunch of the, across most of the companies. And then it becomes a function of what kind
13:11 of multiple market market is willing to put on on the earning visibility.
13:15 Thank you so much, sir. This really helped us understand the sector far more. It was
13:20 a pleasure speaking to you.
13:21 Thanks. Thanks for taking me up. And thanks, thanks Mural for your questions.
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