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Photo: Bloomberg
Photo: Bloomberg

Pharma sector rally needs backing with a strong earnings momentum

  • The covid pandemic showed the sector’s resilience with Nifty Pharma index gaining 63% over past year
  • Diversification of global sourcing has increased APIs’ demand from India, hence driving exports

Ever since the lockdown back in March 2020, the Nifty Pharma index has shown remarkable recovery. The fact that valuations were at their nadir after a nearly five-year squeeze also helped. The pandemic showed the sector’s resilience with the Nifty Pharma index gaining 63% over the past year. This is strikingly higher than the Nifty 50 index’s about 16% gains.

But even while there are tailwinds from the pandemic such as increased spending on medicines, the sector faces a valuation check in the coming quarters. That’s because earnings have to show better momentum.

“While Nifty Pharma has generated 60% returns in the past one year, we believe strong earnings momentum is needed to sustain the pharma rally," said analysts at Edelweiss Securities Ltd in a client note.

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No doubt, there are pockets where growth is likely to sustain. Domestically, sales could increase, thanks to an improvement in demand for chronic therapies. Acute product sales are also rising lately, after higher generation of their prescriptions.

In fact, the domestic market is expected to bounce back in the second half of the fiscal as demand disruptions ease, says a Crisil Research report.

Demand from some global geographies remains high. India has been able to grow formulation and bulk drug exports by 18% and 9% year-on-year (in constant currency) during the fiscal first half, compared with 11% and -1%, respectively seen during FY20, Crisil Research data show.

On the other hand, there has also been an improvement in sales of active pharma ingredients (API). A reason for the increased demand for APIs from India is the diversification of global sourcing away from China, which is another factor driving exports.

The higher realizations, though, may gradually normalize with rising inventories at buyers’ end, but API sales are expected to continue growing and driving export revenues too.

The US market could show decent growth for companies that managed to ramp up sales during the pandemic disruption. While there were no big-ticket launches lately, and the flu season has been slow, product sales such as Albuterol ramp-up and specialty product ramp-up will be key.

Prescriptions have started to increase in the US. A recent Nomura Global report suggests that in the US during the past 13 weeks, prescriptions have increased sequentially across all companies.

Nevertheless, investors may do well to note that some normalcy in terms of costs is returning to the sector. Activity in the field force of several companies has picked up with the easing of coronavirus-led lockdown restrictions, which could see some staff and other expenses rising over the next few quarters.

Hence, margins could also come off in the coming quarters.

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