HDFC Securities see several growth catalysts across key markets and product categories (inhalers, biosimilars, complex injectables) playing out over the next 2-3 years for Indian pharma companies. The investments made over the last few years leave them well placed to capitalise on these opportunities. With cost bases pruned and operating leverage benefits, the sector is poised to grow at 21% earnings CAGR and witness ROCE improvement of 430bps to 15% over FY20- 23e. This, coupled with strong balance sheets (near debt-free), should support valuations, in HDFC Securities view. BSE Healthcare Index has outperformed Nifty by 47% in the past one year and trades at 29x 1-yr forward, 30% above its historical average and 22% premium to Nifty (vs. 10-yr average of 31%).
 
India biz remains attractive; chronic leads, vitamins strength could sustain: 

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While chronic therapies continue to lead (Torrent Pharma, Lupin, Cipla to benefit), HDFC Securities see Vitamins as a promising therapy that could sustain higher growth, led by Covid induced changes in nutrition awareness and habits. The recovery in acute therapies will further consolidate market share gains for companies with strong therapeutic presence and leading brands (Alkem Labs).
Progress on complex pipeline in US augurs well for growth and profitability: 

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The share of injectables, specialty, biosimilars, and complex products in US revenues is expected to increase from 22% in FY20 to 33% in FY23e, for HDFC Securities covered universe. Improving the quality of pipelines in the US will not only ensure that the growth rates hold up better but will also drive higher profitability.
 
API business sees the turn of fortunes, PLI benefits a few years away: 

 

The strong performance in the First half of FY21 (21% YoY for the covered universe) was driven by factors such as customer stocking, pricing/currency benefits, which have largely normalised. However, the broader demand environment remains strong, driven by structural tailwinds (supply chain de-risk, PLI scheme), and is likely to drive healthy growth over the next few years. PLI scheme benefits are a few years away and will majorly benefit MSME players. Sun Pharma, Aurobindo Pharma, Lupin are likely to have participated, among covered companies.

Covid vaccine monetisation offers upside potential, not factored in estimates: 

Vaccine monetisation can add material cash flows, although upsides will be for limited periods and contingent on several variables (pricing, competition, capacity).

HDFC Securities see three possible ways of monetising with varying degree of lucrativeness:

a) develop/ manufacture own vaccine
b) undertake third party manufacturing
c) distribute vaccines. Among covered companies, Aurobindo Pharma, Cadila Healthcare and Dr. Reddy's are in the race to monetize this opportunity.
 
Cost savings, moderating investments to drive return ratios higher: 

Investments in R&D/capex have peaked and are likely to be more targeted towards complex filings/capabilities going forward. With cost bases rationalised, operating leverage benefits will drive margin expansion of 350bps over FY20- 23e. HDFC Securities expect sector RoCE to improve by 430bps to 15% in the same period.

Top picks are Alkem, Aurobindo, Cipla and Lupin:

HDFC Securities like Alkem (the best play on acute recovery), Aurobindo Pharma (building complex pipeline, Covid upsides), Cipla (strong India franchise, inhalers monetisation) and Lupin (chronic focused portfolio, inhalers, operating leverage).