JUST THE RIGHT MEDICINE

The last 10 years have seen phenomenal wealth creation in the Indian equity markets. While the BSE Sensex has moved up 4.3 times, the market cap of Sensex companies has gone up 5.6-fold. The healthcare index has marginally outperformed the broad-based Sensex by rising about six-fold during this period.

Over the last decade pharmaceutical exports have grown from a mere USD 3.72 billion in 2004 to USD 14.55 billion in FY14 - a four-fold jump. This is despite the slowest growth in pharmaceutical exports in FY14 – it grew at the rate of just 1.2 YoY. However, in the current year pharmaceutical exports are expected to grow to USD 16.2 billion - about 11 per cent YoY growth. Actually the period FY08-FY13 was a golden time for pharmaceutical exports – it grew at a CAGR of 22 per cent. This phenomenal growth in pharmaceutical exports during this period led to the healthcare index moving faster than both the Sensex and the mid-cap index – however, it has beaten the mid-cap index by a huge margin.

Solid Wealth Creation from Mid-Sized Pharmaceutical Companies

Actually the broad healthcare index doesn’t show the true picture of phenomenal wealth creation in the pharmaceutical pace. An analysis of 13 mid-cap pharmaceutical companies shows as high as a 154-fold jump in wealth creation. Granules India, Ajanta Pharma and Caplin Point Laboratories have created maximum wealth in this segment – their market-cap has gone up anywhere from 108 times to 154 times in the last 10 years!

Surprisingly even Infosys Technologies couldn’t create such wealth for its shareholders in this period – its market cap moved up only by 4.3-fold in this period. Of course, it is not possible for every kind of equity investor to participate in this story of mind-boggling wealth creation – it is feasible only for retail investors as the market caps of these companies were tiny in 2004. To put things in their proper balance, it should also be noted that it is quite risky to invest in such small-cap stocks. Ankur Drugs, which had a market cap of Rs 486 crore in 2007, lost 98 per cent of its market cap just before it got delisted from the stock exchanges. Another example is that of Surya Pharma which had a market cap of Rs 544 crore in 2010, lost 99 per cent of its value and now trades at a market cap of a mere Rs 6 crore! Therefore, it is most important to evaluate both the strength of the balance-sheets and valuation parameters before investing in such small and mid-cap pharmaceutical stocks.

It is vital to check the leveraging position in relation to net worth, price-earning ratios and enterprise value to sales, apart from the working capital management. It should also be noted that in the near future it would be almost impossible to get the kind of returns investors have got in the last 10 years from these mid-cap pharmaceutical stocks. It should be kept in mind that there has been a structural change in the business size of these companies in the past - many of them have moved from a small base of double-digits to around Rs 1,000 crore revenues. Hence, the pace at which the incremental growth would happen is limited going forward. However, some of these stocks would still give better returns as compared to the broad indices in the next three to five years. Based on the valuation multiples (both PE and enterprise to sales) and cash positions, BAL Pharma, Claris Lifesciences and JB Chemicals & Pharmaceuticals seem to hold still significant opportunities for wealth creation over the next one to three years.