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PERSONAL FINANCE Strong Medicine ... with some side effects. That's the story of pharma stocks, and you'd best read this prescription before you do anything else. By Shilpa Nayak
There are pharma stocks. And then there are pharma stocks. Multinational pharmaceutical companies boast strong fundamentals, and as you can see from the graphics scattered across these pages, appear safe investments. But there's a growing school of thought-one that several analysts are veering towards-that the mother lode of the pharma sector (read: stocks that promise aggressive growth) is the sub-segment comprising Indian companies. Indian Pharma Stocks Are Hot Research,'' some of these pundits are apt to mutter cryptically, when asked to substantiate their belief that these stocks are worth their weight in Viagra. For the uninitiated, what they mean is that the lower cost of pharmaceutical research in India will benefit these companies. There's no denying that fact, but there's a big caveat. Although some Indian pharma majors have touted their research-prowess, not one of them has been able to come up with an original molecule. One handicap is cost-it takes, on an average, $400 million or Rs 1,920 crore to develop a molecule from scratch. Another is time. And yet another is the low chance of success. ''Research is the flavour of the pharma industry today,'' admits K.K. Iyer, a partner at consulting firm Accenture, ''but one has to realise that out of the millions of dollars that flow into researching say 500 molecules, one may become a product.'' What Indian companies have done is to focus on bettering available molecules or creating novel delivery mechanisms for them. And what limited original research is done is in association with some pharma MNC that underwrites the costs. Even this limited research, as anyone who's tracked the progress of India's leading pharma companies (see The Molecule Millionaires, BT, July 6, 2001) would know, has proved lucrative. Indian pharma companies have also focussed their research efforts toward developing generics-the same as a branded drug in terms of composition and performance characteristics. DRL, for instance, has obtained US Food and Drug Administration approval (and six months exclusive selling rights) for a generic version of the best-selling anti-depressant Prozac. The company has also received FDA approval for the generic equivalent of Merck's anti-hypertension drug Vaseretic, a branch that had $69 million (Rs 324 crore) in sales in 2000. There's more: Ranbaxy's recently licensed a delivery system it had developed to Vectura and Cipla, as widely reported in the papers, offered to supply its own version of anti-aids drugs to the South African government. News like this has only served to boost the prospects of pharma stocks on the bourses. Expectedly, the stock prices of the three companies mentioned in the previous paragraph are higher today than they were at the same time last year. This, when the Sensex is down 20 per cent. And Analysts Think So Too Strangely enough, the domestic pharma market is growing at a crawl-an estimated 9 per cent. Caught between a sluggish market and DPCO (Drug Price Control Order) restrictions that dictate margins on several of their products, most MNC pharma companies operating in India have seen their fortunes flag. Their Indian cousins, too, have been hit by this, but exports, especially of generics has helped them log volume-growth. The export market for generics, though, is highly competitive. And margins in the business, low. That could explain the great research gambit Indian pharma companies have embarked upon. Do investors need to look beyond research? Actually, they do-at sustainability of revenues and earnings, and some old-fashioned value-investing metrics. The answer may be yes in most cases but the question will still need to be asked: ''Are you getting a good value proposition at the existing market price?'' You only have to mention the words generics and research to bring a smile to the most cynical of the analyst species. ''We see opportunities for pharma companies in both the domestic and the overseas markets,'' says R. Sukumar, Fund Manager-Equities, Pioneer ITI. ''The US generics market is opening up and other markets like Brazil are emerging as huge opportunities.'' The recent results of India's first-tier pharma companies justifies this confidence. For the three months ended September 30, 2001 Cipla saw its sales grow 25 per cent (exports by over 80 per cent); Ranbaxy by 16 per cent (exports by 56 per cent). Adds Jamshed Desai, Research Head at Taib Securities, ''With the kind of research DRL is investing in, you can expect a tangible revenue stream for the future''. There is, however, the ubiquitous dampener to this bullish sentiment. Most analysts (and that includes Desai) believe pharma stocks are good long-term bets, but do not expect major gains in terms of price appreciation. The reason? The recent movement of pharma stocks has been based on what they term ''news-flow'', especially for top-tier stocks like Ranbaxy, DRL and Cipla. That 'news-flow' ranges from reports on the US' possible reaction to a shortage of Cipro to the optimistic projections of consulting firms on the growth-potential of the Indian pharma industry and of its various segments. One such segment is contract research. ''Indian companies could become outsourced research and testing arms for MNCs'', says Nitin Raheja, Fund Manager, Sun F&C Mutual Fund. But while outsourced research is far less risky than original molecule development, it is a highly capital intensive process. And only ''original research'' can put an Indian pharma company on the global business map. But there's a flip-side So, should you disregard the conservative company-specific stock picking regimen we've advocated in past columns and go for the pharma sector? Well, in the fashion of the eternal fence-sitter, yes and no. Unlike the tech sector where valuations of companies are between 85 and 90 per cent off their peak, those in the pharma sector aren't. ''The market pays a premium for growth, and as this is scarce in other stocks today, it is being driven towards those of pharma companies,'' explains Sameer Narayan, an analyst an Enam Securities.Put simply, what Narayan implies is that pharma companies, while continuing to remain good-buys haven't really become the great bargains some tech stocks today are. Nor, given the outlook for the sector, are they ever likely to be that. And as Raheja of Sun F&C points out, ''The tech sector saw a secular industry (wide) growth; the pharma story will be a little more company specific.'' That's a function of the sector: products can fail; their launches can be delayed; and research initiatives, go off track. So while you can safely decide on pharma as the sectoral-destination for your investments, you still have to expend considerable effort understanding each company. The questions we'd like to suggest you pose: how much of a company' revenues comes from the export of generics? How much does it spend on research? What kind of research is it involved in? Having asked these QS and received some answers, look at the sustainability of the company's revenues. DRL, for instance will see its net profits jump from Rs 140 crore in 2000-01 to Rs 260 crore in 2001-02. But this is on the back of the exclusive six-month long selling rights it has bagged for the generic version of Prozac which could contribute as much as Rs 80 crore to its bottomline. In 2002-03 the company will no longer have this 'exclusivity' - other companies will be making and selling the generic - and it will be hard-pressed to maintain its profits unless it receives a milestone-payment for a molecule. So, what's the Perfect Prescription Investors will certainly be missing out on a high if they decide to give pharma a skip, but fact is, putting your money in the sector is an aggressive investing strategy. Sundaram Newton Mutual Fund's Anand Radhakrishnan agrees and it isn't just the urge to market his fund to investors that makes him do so. ''The imponderables are too many for the small investor to deal with unless he meticulously collects information on the company and spends a fair amount of time in collating and analysing the data.'' If you're willing to do that, go ahead, but make sure to spread your risks across companies. One way to do this is to pick some mnc pharma stocks for your portfolio. Asit Kothari, an analyst at BNP Paribas recommends Glaxo and Pfizer, but warns investors of the potential downside of the sector. ''The risk-reward ratio is certainly not in favour of retail investors. They can expect reasonable returns over a period of time, but prices will remain volatile.'' That bit about the MNC-stocks is reminiscent of the time-not too long ago-when pharma was considered a 'defensive' sector that could balance out the risks inherent in the then-favourite, tech, by most investment advisors. If it is a defensive investment strategy you are in search of, look no farther than the transnational pharma companies. Their valuations are attractive, and the tightening of India's patent laws in 2005 could help them. In a best-case scenario their stocks will move up from their current lows and actually register significant gains. In a worst-case one, investors can benefit from the above-average returns these stocks promise. Our recommendation: invest in the stocks of a few transnational pharma companies just to keep that conservative within you happy, and then go out and indulge in some old-fashioned aggressive-investing. This is the time to do so.
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Mea Culpa.
this correspondent has a confession to make: influenced by the largely
grey outlook on the markets she's written extensively on the art of
stock-picking and the importance of choosing individual stocks, not
sectors. That admission doesn't change anything that has appeared in these
columns. Everything that has been said here about value-investing and
stock-selection holds. Only, if the buzz in the stockmarkets is to be
believed, there's now a sector that comes as close as you can get to an
investing safe-haven in these troubled times-pharma. And it's a sector
that has something for all investor-types: safe stocks for the
conservatives, aggressive ones for the adventurous, and in-between ones
for those who prefer the middle-road.