Despite the recent outperformance by pharmaceutical (pharma) sector in general and mid-cap pharma stocks in particular, we believe, there is still scope for substantial upside in mid-cap pharma stocks.
Our basket of six mid-cap pharma stocks still trades at almost 50% discount to the basket of four front-line pharma stocks. We believe, such steep discount is unjustified since the average compounded estimated earnings growth of the basket of our six mid-cap pharma stock stands at 28% over FY2009-2011, which is almost four times that of the basket of front-line pharma stocks.
We remain bullish on mid-cap pharma space and also on mid-cap pharma stocks under our coverage. Among the mid-cap pharma space, our preferred picks are Ipca Laboratories (Ipca Labs) and Torrent Pharmaceuticals (Torrent Pharma) in the shortto- medium term.
Front-line pharma stocks (Sun Pharmaceutical Industries [Sun], Ranbaxy Laboratories, Cipla, Dr Reddy’s Laboratories) trading at about 20x its FY2011 estimates are set to give an earnings per share (EPS) compounded annual growth rate (CAGR) of 7% (FY2009-11E), whereas the mid-cap pharma stocks (Sharekhan Universe) trading at 12x its FY2011 estimates are expected to give an EPS CAGR of 28%.
This clearly depicts the huge valuation gap in the earnings and the steep discount at which mid-cap pharma stocks are trading currently. Thus, we are of the view that the valuation gap is unjustified and should narrow in the near-to-medium term providing sufficient headroom for the Sharekhan mid-cap pharma universe.
We see strong earnings cycle for mid-cap pharma companies in FY2009-11E on following counts. Strong growth in domestic markets (for Sun, Lupin, Piramal Healthcare and Cadila Pharmaceuticals). Rising contribution and penetration in emerging markets (for Glenmark Pharmaceuticals [Glenmark], Torrent Pharma and Ipca). Increasing foray into drug discovery and research (Glenmark and Piramal Healthcare). Global alliances, strategic tie-ups and increasing mergers & alliances (Piramal Healthcare, Orchid Pharmaceuticals and Glenmark).