CLSA Maintains Buy Rating on Sun Pharma, Cadila Healthcare, Torrent Pharma and Abbott India; Outperform on Cipla

As such, Indian pharma companies are expected to report strong numbers in Q2 FY21 after phenomenal show in the preceding quarter. Growth prospects have improved in export and domestic markets, regulatory pressures have eased and a focus on speciality/complex products in addition to emerging market opportunities will remain the key growth drivers. 

1. CLSA maintains buy coverage on Sun Pharma, raising target to Rs 710 (35.5% upside from CMP). 

2. CLSA maintains buy coverage on Cadila Healthcare, raising target to Rs 525 (20% upside from CMP). 

3. CLSA maintains buy coverage on Torrent Pharma, raising target to Rs 3450 (20% upside from CMP). 

4. CLSA maintains buy coverage on Abbott India, raising target to Rs 20,610 (28% upside from CMP). 

5. CLSA maintains outperform coverage on Cipla, raising target to Rs 880 (9% upside from CMP). 

Sun Pharma, Cadila and Torrent are their top picks in Indian pharma sector.

Sector fundamentals healthier today than in 2015

CLSA highlights that while the 2015 rally was followed by deterioration in sector fundamentals and subsequent earnings disappointment, Indian pharma is in much better shape today. Market dynamics in the U.S. have turned stable, complex assets in investment phases in 2015 are being monetised and U.S.FDA compliance has strengthened. A stronger outlook for the U.S. increases confidence in higher multiples for earnings.

U.S.FDA compliance has strengthened over the past five years

CLSA believes the compliance track record of U.S.FDA norms deteriorated for Indian pharma companies with warning letters for Sun Pharma and Cadila Healthcare. Pertinently, U.S.FDA observations were adverse in nature as they highlighted data integrity issues for Indian firms along with inadequate quality and lab control processes, documentation practices and manpower training methods as key deficiencies. Over the years, data integrity issues have declined significantly and many Indian pharma companies have had successful inspections recently with no serious observations.

Deteriorating market dynamics in the U.S. have now turned stable

CLSA says beginning in 2015, the U.S. generics market dynamics started deteriorating driven by a consolidation of buyers (three groups controlling 90% of the market) and rising competition in generics driven by a faster approval cycle by the U.S.FDA. This resulted in double-digit price erosion compared to mid-single-digit price erosion during prior years and forced leveraged companies to begin a restructuring by shutting down plants, exiting unviable products and restructuring overall costs. In current times, U.S. market dynamics are fairly stable with no imminent signs of further consolidation of buying groups or any fresh entrants in the industry. Players are focussing on profitability and ROCE improvement and this is visible in focused filings and new launches.

Complex assets which were in investment phases now being monetised

CLSA highlights Indian pharma companies over 2014-2018 entered a significant investment phase in relatively high-entry-barrier products such as specialty products and complex generics (biosimilars, inhalers and injectables). This drove up R&D spending and pulled-down operating margins which were further impacted by a weak base business in the US. However, over the past 12-18 months, R&D-backed products have started seeing monetisation: Sun pharma launched all its specialty products in the U.S. and out-licensed some to marquee players in other regions; Cipla is witnessing monetisation of their respiratory assets. With a realigned cost structure in place and the monetisation of these critical products, CLSA expects a significant improvement in U.S. margins over the next three years for Indian pharma companies.  

Improving earnings profiles and sector fundamentals stronger than 2015

CLSA thinks pharma sector fundamentals are stronger now than in 2015. A stable U.S. generics market, a strong outlook for India businesses, much improved compliance with U.S.FDA and improving product mixes (new launch driven) should drive margin improvement for Indian pharma companies. Note that while DIIs have been overweight since March 2016, the sector remains an underweight for FIIs. An improved outlook could help improve this position hereon. Also, an improving earnings profile coupled with to mid-teen growth over FY20-23 should help sustain current valuations.

(Authored by Rahul Kamdar)