Pharma sector could shed underperformer tag soon

Resolution of supply chain issues, defensive buying, and index inclusion are key triggers

The pharmaceutical sector has been an underperformer on the stock exchange during the bull run. While the Nifty50 has returned 45 per cent in the last 12 months and 5 per cent in the last 30 days, the Nifty Pharma index has returned 19.5 per cent and negative 5.6 per cent, respectively. However, this trend could change over the next three months, for a variety of reasons.

The Nifty Pharma is being extensively reworked. By September 30 it will track 20 stocks, selected and weighted on the basis of free-float market capitalisation. That doubles the population from the current 10 stocks.

This inevitably means rebalancing on the part of mutual funds, index watchers, and the pharma sector Index exchangetraded funds (ETFS). It may also mean some speculative buying from traders, who will ride any momentum that develops.

The pharma sector has seen year-on-year (YOY) expansion of both top and bottom line in the fourth quarter of financial year 2020-21 (Q4FY21) and Q1FY22. The sector has always been considered a strong defensive holding. This is due to high foreign exchange earnings, and it is usually not affected by cyclical factors.

Investors do watch for two red flags. One is possible legal trouble due to intellectual property related cases. The other is adverse reports from the US Food and Drug Administration, which regularly inspects export facilities in India (and elsewhere) for hygiene, quality control, etc.

In Q1FY21, however, the sector faced major issues because of global supply chain disruption. The import of Chinese APIS (active pharmaceutical ingredients) were taken out of the equation because of the pandemic, which was centred in Wuhan province where most of China’s APIS are manufactured. China holds dominant market share in the global API market and India imported approximately ~17,500-crore worth of APIS in FY20.

Local lockdowns and transport issues also led to disruptions in the manufacturing processes for Indian pharma firms, and transportation to markets. The sector has also been hit by margin pressures. The largest market, the US, is seeing lower drug prices. However, the Q1FY22 performance suggests supply chain issues have been sorted out, although US margin pressures remain.

As investors turn cautious with the stock market seeing churn and profitbooking on Nifty at 16,500 levels, the sector could attract defensive buying. This is especially true of the new stocks that will be added to Nifty Pharma.

The additions will be decided based criteria like being in the F&O list and average six-month free float market cap. So, it’s technically impossible to provide a definitive list now.

However, the probable candidates include Gland Pharma, Abbott India, Laurus Labs, IPCA Labs, Pfizer, Glaxosmithkline, Syngene International, Sanofi India, Ajanta Pharma, Natco, Alembic Pharma, and Glenmark. Several of these may also be included in the F&O list. While Gland and Laurus have excellent YTD returns of over 65 per cent and Ajanta has returned 37 per cent, the others have underperformed. We could see a trend reversal across this space.