Q3 results show pharma sector recovering in fits and starts
The pharmaceutical sector had a difficult time in the December quarter, with the BSE Healthcare index falling 10.6%. It has done relatively better in the quarter so far, with the index gaining 5%.
The heavyweights in the sector found the going tough in the US as a combination of pricing pressure, stiff competition and a relatively slow pace of approvals affected growth. Although demonetisation did cause some disruption, the effect was not as adverse as feared. Data from market research firm AIOCD-Awacs showed sales rose 10.5% in the December quarter over a year ago. This was lower than the 13.5% growth in the September quarter. While November saw sales growth improve since chemists could accept old notes, December saw it slow down after the concession ended.
Overall, the pharmaceutical sector’s sales rose 8.8% over a year ago but other operating income rose 22% (this component includes licensing/drug development revenue). As material costs rose only 8%, that constrained expenditure growth, leading to an 18.4% increase in operating profit. Profit after tax rose 15.4%. For a sector that is trading at a price-to-earnings multiple of 29 times its trailing 12-month earnings, that’s not enough.
Among firms that reported relatively better sales growth were Biocon Ltd, Glenmark Pharmaceuticals Ltd, Lupin Ltd and Cipla Ltd, partly due to revenue from the launch of important products in the US. Emerging markets and currencies have turned relatively stable, which augurs well as most companies have built sizeable businesses here.
On the US Food and Drug Administration (FDA) front, the news has been mixed. Sun Pharmaceutical Industries Ltd and Dr Reddy’s Laboratories Ltd got observations from the regulator on a re-inspection of their facilities. This dashed investor hopes that these plants would be cleared. But the news is not uniformly bad, with companies such as Lupin and Cadila Healthcare Ltd getting approvals for their units after re-inspection. More recently, Sun Pharma also announced that the warning letter on its Mohali plant has been lifted by the US FDA.
Companies have been going after acquisitions to boost their revenue and keep the growth engine humming. They continue to be on the hunt and the risk here is that companies overpay or the acquired assets don’t generate value.
The sector’s valuations suggest that investors still hold hope that the US market problems will get resolved and earnings growth of the sector will recover. FY18 is likely to provide a reality check on that front.