Shares of pharmaceutical companies seemed oblivious to the carnage in the markets on Monday, with the Bombay Stock Exchange (BSE) Health Care index?losing just 0.2% in value. Both the Sensex and the broader BSE 500 index lost 5% in value, taking cues from the fall in US stocks last Friday and the drop in Asian markets on Monday.
The pharma industry got a fair bit of mention in this year’s Budget, with a number of positive announcements, but an analyst with a foreign brokerage said he doubted the resilience in pharma shares had anything to do with the Budget. The upside from the Budget had already been factored in on Friday. In any case, the benefits weren’t huge. The cut in excise duty from 16% to 8% will have a limited impact. Unlike some other products, pharmaceuticals aren’t so price-sensitive that excise-related cuts will lead to a surge in demand. So, firms are likely to retain some of the benefits and earnings may increase. Morgan Stanley recently estimated the earnings of the firms under its coverage may increase between 1.5% and 4.5%, on the assumption that 40% of the duty cut is retained by firms.
Companies that have heavily invested in setting up facilities in tax-free zones, such as Baddi and Sikkim, may stand to lose out. The transportation cost from these facilities is significant, and devoid of the 16% excise differential, their cost benefit of these units would be reduced substantially. Firms that conduct clinical trials in their overseas units haven’t got the benefit of weighted deduction on the research and development spend. The markets were expecting this, which explains why shares of Sun Pharmaceutical Ltd’s hived-off research and development wing have lost more than 4% since the Budget announcement.
In sum, the Budget proposals hardly provide any reason for pharma shares to outperform the market by around 7%. Their outperformance lately could well be because they are being seen as a defensive play in a falling market.
Apart from the FMCG index, the pharma index has fallen the least from its highs in January. These stocks had underperformed the market by a large margin in the past and since prices of generics have already fallen sharply in most markets, earnings growth is expected to be steady in the near future. With valuations already running low, pharma stocks are among the few where the downside seems limited.
Manufacturing growth could surprise on the upside
Somewhat lost in the carpet-bombing coverage of the Union Budget was the release of the third quarter (Q3) gross domestic product (GDP) estimates. Its 8.4% growth rate, compared to the year ago period, is in tune with the advance estimate of 8.7% for the year, which implied a second-half GDP growth rate of 8.4%.
But, the sectoral break-up of that growth has been rather different from the Central Statistical Organization’s (CSO’s) estimates. Manufacturing growth in the third quarter has been good at 9.3%, well above the implied second-half growth of 8.7% for the second-half assumed in the advance estimates. But the deceleration in construction growth is more in line with the estimates, with the sector growing 8.4% in Q3, compared with the forecast of 8.6% for the second half. Whereas, growth in the services sectors has been lower in Q3 than CSO’s estimates for the second half suggest.
Also, contrary to the estimates, there has been no slowing in gross capital formation. The estimates showed that gross fixed capital formation was expected to grow at 15.1% this year. However, CSO had earlier said that growth in gross fixed capital formation was 15.5% in the first half of the year. That implies a slight slowing down in the second half to 14.7%. However, in Q3, gross fixed capital formation was up 15.7%, which is in line with evidence from engineering corporates reporting robust increases in order books. At the same time, consumption expenditure received a boost in Q3. The estimates put private consumption growth at 6.8% for the full year, implying 7.8% growth during the second half.
In Q3, growth was 7.2%. If the trends in Q3 hold up, growth in manufacturing could surprise on the upside, while services and construction growth slows. But perhaps the biggest surprise could come from agriculture: growth for the first nine months of FY08 for the sector has been 3.5%, while the advance estimates put annual growth at 2.6%.
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