The Novel Case of Pharmaceutical Resurgence

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The Pharmaceutical sector is all over the news and stocks of the sector have outperformed the markets in the last two months. The NIFTY PHARMA index rose a whopping 30% in April! Well, it is understandable that during a global health crisis, the interest in pharmaceutical stocks is bound to increase.

However, the question remains. Is this growth sustainable?

Chart Check - NIFTY PHARMA Index

Before diving into the future growth prospects of pharmaceutical companies, I will highlight the performance of this sector in the stock market over the last 10 years.

NIFTY PHARMA- Monthly
The image above showcases the monthly candlestick chart for NIFTY PHARMA index from January 2010 till the present day.

Each green/red candle indicates an increase/decrease in the price of the index over a period of 1 month.

We can see in the chart that the index climbed rapidly at the rate of 27.89% YoY from the beginning of the decade till April 2015. Here is where it gets interesting, the index began its decline pretty much at the same time NIFTY50 began its decline in 2015 (read more about that here). NIFTY50 fell 20% in one year but after that, a new leg of the bull-run began, compounding 10.36% year on year till its peak in January 2020. 

The NIFTY PHARMA index did not reflect the same reversal in trend as the NIFTY50 and continued its decline in a lower-top, lower bottom format within a channel (two green lines acting as support & resistance). Looking at this from a technical perspective, I forecasted that the index will go up when it hit the support in 2020 but I did not expect it to rebound with such a high magnitude (30% in one month). Perhaps, it was a result of two positive factors - technical factor and COVID-19's positive impact on the pharmaceutical sector - that caused this spike. 

Why did NIFTY PHARMA continue to fall after 2015?

The NIFTY PHARMA index rose rapidly along with the rest of the economy post the global financial crisis. At its peak, the NIFTY PHARMA index was trading at a PE of 56.84, more than double the PE of NIFTY50 at the same point in time. This ratio further deteriorated to 83.32 in August 2015. 

The earnings of these companies grew at an average CAGR of 5.80% from 2015 to 2019 which does not warrant a PE of nearly 84. The index, therefore, continued to decline at a rate of 11% YoY in the same period.

The Big Picture

The macro-economic state globally and within the country plays an important role in the development within an economy. The demand for a sector like pharmaceuticals is stable and continuously increasing. India's role at a global level is well documented and data suggests we are one of the leading countries in this field in terms of volume (not value).
  • India is the largest provider of generic medicines globally, supplying 20% of the global volume.
  • India ranks 3rd by volume and 10th by value when it comes to the production of all pharmaceutical products. This accounts for 10% by volume and 1.5% by value of global production.
The point I am trying to highlight here is that although we produce a high quantity of goods, its place on the value chain is low.

Points of Sale

There are two points of sale for pharmaceutical companies - consumption within the country and the export of goods.

Consumption Within the Country


India's domestic pharmaceutical sector turnover reached $20.03 billion in 2019, increasing by 6.5%  YoY from 2015.

Export of Goods


Pharmaceutical exports from India reached $19.1 billion in 2019, increasing by 6.4% YoY from 2015. This amounts to 3.8% of the global export of pharmaceutical goods. Germany is the highest exporter of pharmaceutical goods at $56.9 billion which accounts for 14.5% of global export.

Hence the total turnover for the Indian pharmaceutical industry amounts to $39.13 billion which is 1.4% of India's GDP in 2019.

Is there an opportunity to invest in pharma stocks?

The five-year doom and gloom for the sector was quickly turned around by a global health crisis that no one saw coming. Many analysts and investors believe this sector provides the next big growth opportunity. So let us look at its prospects in terms of future growth.

NIFTY PHARMA
The above table showcases some key ratios for the companies that make up the index i.e market leaders. Before I talk about growth, the safeguard of capital is of paramount importance. The current assets of all companies do not cover their total debt, this becomes worrisome if the company goes through a tough time financially. But, with positive cashflows, this debt should not be difficult to service.

Three of these companies have a negative EPS growth in a 1-year time frame. This can be an issue if not resolved immediately. I will not dwell too much on P/BV because the BV is an accounting value and not the market value. They tend to differ quite a bit at the time of realisation but a high P/BV ratio is not ideal.

Looking at the future prospects of these companies, a negative EPS growth over a 3-year time period is extremely worrisome and does not instil confidence over their longevity. The leading indicators of growth include ROE and ROCE. ROE of 20 suggests that the company has returned 20 times (net profit) its shareholder's equity. In an emerging market, an ROE over 20 is what one should look for when looking for high growth companies. 

The Bottom Line

India's contribution to the global pharmaceutical market in terms of financial value is limited. The top companies produce a variety of pharmaceutical products and equipment. But, from an investment perspective, someone looking to invest at the current prices will be paying an average of 30 times their consolidated earnings. In any circumstance that is a high multiple but when you weigh it against the low ROE and ROCE ratio, it becomes difficult for an investor to expect a meaningful return over the long-term.

Going forward, if private investments, government expenditure on healthcare and new technology help some companies gain greater market share/create a moat which positively influences their ROE, those companies can be reviewed. But, for the time being, I will not be an investor in this sector, even at lower prices.

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