Rally in pharma has just started, here are three ways you can play it: Envision Capital

API makers, Covid vaccine and medicine players and companies which have a very strong domestic portfolio and have some overlay of the regulated markets as well are the three ways to bet on pharma, says Nilesh Shah, Managing Director & Chief Executive.

When the market started rallying in April and May, everyone said markets are going higher because of central bank policy action. Now there is a widespread acknowledgement that it is not liquidity, the market is rising because there is a belief that the virus has got contained and earnings will recover.
The current view is probably partly right, at least there is now far more established remedy to take care of the virus which is getting reflected in improved recovery rates and very low fatality rates. That has come out to be reasonably true and to that extent, the scare around the virus has come down quite significantly. Of course, there is no denying the fact that there is a strong liquidity as well and in a way, this liquidity is very good because in a way it helps in containing interest rates but more importantly, it is helping corporate India to raise capital.

If we look at all the QIPs which are happening, this is essentially corporate India trying to muster up ammunition for the future. I still think there is a strong liquidity phenomenon and a third aspect is that whatever weak performance that we have seen, to some extent in the March quarter and substantially for the June quarter, that should at best be treated as exceptional because you are not going to have continued lockdowns on a nation basis.

We probably, of course, have local lockdowns. We are not going to have continued lockdowns and to that extent, it is a combination of the handling of the virus, liquidity continuing and the fact that the lockdowns are not permanent and recovery is likely to come back over the next few months or so. It is a combination of all this which is playing out over the last few months or so.

Can you elaborate or enumerate two or three data points or companies where the comeback both in terms of demand and management commentary has pleasantly surprised you?
I would not say a surprise but what has been very delightful in terms of the management’s commentary is pharma as a sector. Post the breakout of Covid, it was becoming clear that pharma as a sector could potentially do well but if we look at the kind of performance which it is churning out for both March and June quarters and the kind of commentary that they are holding out in terms of their outlook for not just the next two or three quarters but even for the next two or three years, has been the strongest in the pharma sector. So, that is one sector which clearly stands out.

The other area where I would not say the commentary is strong but very stable is essentially technology services and consumer staples. These are the two sectors where the commentary has not been very bullish or very optimistic, but it has been very stable and these are the two sectors where the managements have alluded to normalcy coming back and the second half being better than the first half.

So on one hand, in the global facing businesses -- pharmaceuticals and technology services -- the commentary has been strong to stable and also in consumer, it has been relatively more stable. The third area has essentially been within the financial pack. Credit card companies, life insurance companies, general insurance companies and mutual fund companies are witnessing relatively stable times. There is a whole bunch of sectors where the commentary has been strong to stable.

What is the best way to invest in pharma after the recent rally, given which way earnings are moving?
I believe we are probably at the start of the rally in the pharma sector. It is quite possible that the strong earnings momentum may continue for several low quarters ahead or may be even there for a couple of years at least. The way to look at it is to basically look at different plays like consumer or banking where you can just pick one stock and ride it.

In a way, pharma as a sector is very heterogeneous and pretty much every company has its own strategy. In the case of pharma, it would be best to own a basket of opportunities and within that,one can look out for the API plays where they are still enjoying a strong pricing momentum. There are likely to be some more policy initiatives which will benefit the API space. So look at companies which are substantially API plays.

The second opportunity is to look out for companies which probably have a very strong possibility of going positive or striking it in terms of vaccines as well as medicines for Covid. That is something which will continue to play out and that is the second way to look at it. The third is to look out for companies which have a very strong domestic portfolio and have some overlay of the regulated markets as well. A combination of these three to four opportunities would be the best way to play the pharma sector over the medium term.

When it comes to pharma and IT, is the easy money now behind us? Would these sectors go into timewise consolidation or is the story at a nascent stage?
In the case of technology, probably the easy money is probably already there because technology is a sector which is not going to grow to high double digits. It will at best remain a high single digit or a low double digit kind of a growth opportunity and in a way, a fair bit of the easy money is already there but nevertheless it still has the ability to outperform.

But when it comes to pharma, I would not say that we are at the start of the rally but I still think it has got a long way to go because in the case of pharma, there can be a lot of positive surprises and there can be a lot of developments which could be potential game changers for individual companies. The beauty of both pharma and IT is that whatever India does or whatever India caters to the rest of the world is pretty much non-discretionary. That means I do not think the world today can do without either the Indian technology services or generic companies. So, to that extent, the demand is relatively non-discretionary and has got reflected and manifested in the earnings for the last one or two quarters as well.

In the case of pharma, we might still have a long way to go and it looks like that the tailwinds that they are currently enjoying are likely to sustain for a few more quarters ahead.

The other theme is specialty chemicals which continues to do well for quite some time now. Ancillaries like some of the packaging films businesses are doing very well. Do you like this pocket or perhaps specialty chemicals?
The poly films packaging companies are currently enjoying benefits of lower raw material prices, lower crude oil prices and that is the base for them. These are at best cyclical plays. These are once in three years, once in five years companies that suddenly come up because they have benefited from something happening in the external environment.

But the bottom line is that they remain extremely capital intensive cyclical businesses and to that extent, medium to long term investors are better off avoiding them. They are good as trading bets. But keep in mind that you should not become an Abhimanyu as in these kind of businesses, you need to have an exit strategy.

Specialty chemicals is still an exciting space and it is almost entirely a contract manufacturing space. There has to be some commonality with pharma and at this stage between pharma and specialty chemicals, I would be more positively inclined towards pharmaceuticals versus specialty chemicals. But having said that, specialty chemicals will continue to enjoy some of the tailwinds because of strong global demand. Indian specialty companies definitely have some value proposition to offer to the world and will continue to grow. I would be positive about it, but in terms of the pecking order, pharma clearly stands up high on top.