Pharmaceuticals - Remedy for growth; Edelweiss

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Given the recovery in domestic growth, huge patent cliff opportunities in US over the next 12-18 months (drugs worth USD50bn going off-patent) and a favorable currency movement (rupee has depreciated by 15% in the last six months against US dollar), we believe that the pharma sector is in sweet spot. We expect an earnings upgrade of 2%-8% for Divi’s, Cipla, Sun Pharma and Lupin for FY13E if we consider a conversion rate of INR50 against our current rate of INR46. In order of preference, we remain positive on Lupin, Dr Reddy, Cipla and Glenmark. While we do not have a formal rating on Divi’s, it seems to be the biggest beneficiary of rupee depreciation among peers.

Indian pharma to benefit from growth influx in domestic market

Growth in November was robust, reflecting an all round performance across therapies. Acute segment, struggling over the last few months, has made a strong comeback with 20% growth driven by the recovery in Anti-infectives and GI segment. Chronic continued to depict a firm trajectory with CNS recovering from the lows of October and growing by 18% during the month. As Oct-Dec quarter is seasonally the best time for respiratory segment, the growth has picked up from 7%-8% in July-Sep quarter to 25% for the month of November. Cipla would be the beneficiary of an improved traction in respiratory segment.

Companies to cash in on rupee depreciation

Rupee depreciation is a positive for India pharma given they are net exporters. The extent of impact varies though on aspects such as net forex exposure, forward cover taken, operating leverage, near term debt repayment and interest liabilities in forex. Timing of gain or loss realization will depend on the extent of forex hedging (forward cover) done by companies. Most companies except Ranbaxy (USD700mn hedge) have hedges for next 3-4 quarters at an average rate of INR47-48. We have not considered the translation impact of forex on earnings given that this is a ‘non-cash’ impact, arising out of MTM of long term foreign debt. Companies like Divi’s, Cipla, Sun Pharma and Lupin are likely to gain the most.

Valuations: Higher currency peg to lift earnings by 2%-8%

While pharma sector has outperformed the broader market in the last three months, valuations have come off the peak. We thus continue to prefer a stock specific approach than remaining overweight on the sector as a whole. We expect an earnings upgrade of 2%-8% for Divi’s, Cipla, Sun Pharma and Lupin for FY13E if we peg rupee at INR50/dollar against our current working rate of INR46. In order of preference, we remain positive on Lupin, Dr Reddy, Cipla and Glenmark. Although we do not have a formal rating on Divi’s, the company seems to be the largest beneficiary of rupee depreciation.