As investors turned apprehensive in the later half of 2024, all eyes turned to Pharma. Nifty Pharma gained 29 per cent in the last year, which is the highest among the large sectors, as it is unaffected by consumption concerns, trade volatility, reversal of cycles (auto, metal, commodity) or rupee depreciation. On the other hand, the sector made strides in product innovation, establishing a strong outlook for earnings growth.

Consequently, the sector valuations are at a peak of 29 times one-year forward earnings. This is a 25 per cent premium to its 10-year average. In the last one year alone, the valuations have expanded 14 per cent. Again, this is the largest expansion amongst the major sectors. The broader Nifty50 is trading below last year’s multiple, despite a premium of 8 per cent over the last 10 years. But sector headwinds must also be considered to temper expectations from Pharma.

Sector drivers

Easing of US FDA plant inspection concerns contributed to the multiple expansion. Cipla, Aurobindo, Lupin, Torrent Pharma and others have found resolutions of long-standing plant concerns. This unlocked the portfolios and boosted sentiment reflected in valuations.

Indian markets were a cause for concern as price controls took hold in the last year. But the overall market growth has hovered around 8-9 per cent in the latest quarters indicating a return to normalcy.

Complex product traction has been the main driver. Indian generic operators have established a divergence from long-standing generic markets, albeit on smaller contributions.

Sector headwinds

Valuations at 29 times should be a primary headwind to the sector. At such valuations, earnings growth of 15-20 per cent is required. This can be hard to generate, but few structurally positive factors can provide some offsets. For now ‘defensive’ tag of pharma can provide some support, but important to note it may dissipate if earnings growth revives for other sectors.

Although not an immediate threat, product cliff is not-too-far. The gRevlimid cliff in 2026 is a significant overhang for Dr. Reddy’s, Aurobindo and others. The initial burst of new launches by Sun, Cipla, Zydus and Lupin are in the mid-to-late stage of product lifecycle.

However, the industry as a whole has been downplaying the threat from trade generics in India.

Company outlook

While sectoral factors are important, individual trajectories are crucial. With Goa plant cleared, Cipla can target gAbraxane and gAdvair is on track for next year launch. Peptides and respiratory assets round up Cipla’s healthy launch pipeline. Similarly, Lupin has put plant issues behind and is currently monetising its base. Competition to Albuterol (Lupin and Cipla) is expected, but Lupin has launches lined up to secure revenue growth.

Concentration risk runs high for Dr. Reddy’s (gRevlimid) and Zydus (gAsacol). Dr. Reddy has utilised the cash flows to create alternate assets (acquired Nictine replacement for non-US markets recently and partnered Sanofi for India vaccine distribution). Zydus continues reliance on generics for future growth, but with limited competition and high-potential assets, such as Ibrance, Adempas and Sitagliptin, it should tide over any cliff.