The Healthcare Index is currently trading at 16,172.5 level, which was last seen in September 2018 when the index hit 16,061.58.

By Urvashi Valecha

With the start of the Covid-19 pandemic and the cascading effect of lockdown on the economy, pharma stocks found favour among investors who dumped risky, high beta stocks and moved towards defensives.

Currently, the BSE Healthcare Index is just 14.6% short of its all-time high of 2015, but experts say it would experience correction in the near term.

The Healthcare Index is currently trading at 16,172.5 level, which was last seen in September 2018 when the index hit 16,061.58. But the index has not reached its all-time high of April 2015, when it touched 18,534.41. After hitting rock bottom on March 23 this year, the benchmark Sensex is up by 27.89%, which is far less than the rise of the BSE Healthcare index, which clocked gains of 46.9% over the same time period.

Experts are of the view that the index is unlikely to breach its all-time high in the near term and will witness a correction. Rusmik Oza, executive vice-president – head of fundamental research, Kotak Securities, said, “Currently, some pharma companies are trading at a price earnings multiple of 21 times for fiscal 2021 and 22 times for fiscal 2022. But their return on equity (RoE) is around 15%. In 2015, when the index touched its all-time high, their RoE was around 25-30%, the current valuations of pharma companies are not justifiable, and so, it is likely that there will be a correction in the near term.”

While pharma stocks have risen, the growth of pharma companies continues to remain lacklustre. In a report, Nomura said, “New product growth came at around 1% during this period compared with average new product growth of 3% during the last eight quarters. New product growth was impacted due to lack of new launches and reduced promotional activities during the lockdown period, in our view.” According to the foreign brokerage, the Indian pharmaceutical sector saw a contraction of 8.6% year-on-year (y-o-y) in May, which includes a 14.4% drop in volumes, but it is lesser than April where the sector saw a 10.7% fall year-on-year. Volumes fell 16.7% y-o-y in April 2020 and 14.4% y-o-y in May 2020 against average volume growth of 2.2% during the last 8 quarters, the Nomura report stated.

The price rise in pharma stocks, according to market experts, is largely sentiment-driven. UR Bhat, director, Dalton Capital Advisors, said, “With pharma, there is a view that one of the listed companies will be able to discover the drug for the treatment of Covid-19 and if not that may be the APIs (active pharmaceutical ingredients) would be manufactured by them. Some recent successes in getting approvals by the USFDA and the possible improvement in earnings also are factors that are at play.”

Experts believe that the price rise of pharma stocks is largely on part of sector rotation as institutional investors, especially domestic mutual funds, bought into defensive stocks to park their funds. In April, the pharma sector was the biggest overweight for domestic mutual funds. “In the market, there is sector rotation that happens periodically and now the sector in favour is pharma. It is largely sentiment-driven and the rise is possibly a bit more than warranted by the ground reality on earnings growth that may be seen over the next couple of years,” Bhat said.

While pharma stocks seem to have picked up for the year, they continue to remain a long-term under-performer. The BSE Healthcare index has delivered negative returns worth 3.39% since 2015 compared with a 31.13% return given by the Sensex for the same time period. So far this year, the BSE Healthcare index is up by 20.1% whereas Sensex is down by 19.5%. “The upside for pharma companies going ahead could get capped because of the valuations. Till the time the broad economy does not recover, pharma stocks could continue to outperform, once the economy performs better, the attention again will shift from pharma companies. So for at least one or two quarters, outperformance of pharma companies is expected,” Oza said.