Macquarie says Dr Reddy's, Cipla and Divi's Labs are top stock picks as Nifty Pharma trades at 12% premium to Nifty

Macquarie's Filter Coffee, in its short-form research series focussed on delivering pointed insights on India macro and equities through one curated chart. Nifty Pharma now trades at a 12% premium to Nifty, this compares to a long-term average premium of 38%. Macquarie stays positive on India pharma companies. Dr Reddy's, Cipla and Divi's Labs are their top stock picks in large-cap pharma space while Syngene, Solara and Jubilant life are preferred mid-cap picks.

Impact:

Pharma index trading much lower than historical premiums over Nifty:

Despite a solid operating performance by most pharma companies in Q2 FY21, the Nifty Pharma index has underperformed the broader market by 14% in the past month on likely sector rotation. Notwithstanding the solid 40% CYTD rally in the Nifty Pharma Index (74% from the March lows), the sector premium to the broader market is still much lower than its historical levels. Over the last decade, Nifty Pharma has traded at a 38% premium to Nifty. Currently, the Nifty Pharma trades at just a 12% premium to the broader market.

Strong earnings trajectory to continue:

Led by improving U.S. and domestic growth, along with continued strength in other key markets/segments like Europe, ROW and API, Macquarie expects healthy sales growth momentum to continue for our formulations coverage. For CRAMS/API companies, Macquarie strongly believes that well entrenched Indian companies are poised to benefit from increasing pharma outsourcing trends and de-risking the API supply chain. Macquarie expects a strong 22% and 25% EPS CAGR over FY20-23E, respectively, for the large-cap and mid-cap formulations companies under our coverage. For CRAMS/API, Macquarie builds in a 26% EPS CAGR over FY20-23E.

What can go wrong from here over the next six to nine months?

(i) Further supply/demand disruptions due to another COVID-19 wave
(ii) Reversal in most of the cost savings seen in first half of FY21
(iii) Major policy changes in the U.S.
(iv) Stringent regulatory actions
(v) Adverse forex movement.

Top large cap picks in Pharma space are Dr. Reddy’s Labs, Cipla and Divi’s Labs while Top mid-cap picks are Syngene, Solara and Jubilant Life.