Profits in pharma more sustainable than IT: Ravi Dharamshi, ValueQuest Investment

In a chat with ET Now, Ravi Dharamshi, CIO, ValueQuest Investment, says super normal profits are now shrinking back to normal profits and which is why there is severe valuation erosion in some pharma companies. Edited excerpts


US based pricing plus DOJ probe plus high dependence on few production plus higher valuations. It is a perfect storm for pharma, you said in your tweet. But your views that this is a perfect storm is also giving a perfect buying opportunity.

You have to put a context to today’s news actually. In isolation, actually DOJ probe might not have meant anything. It might have been limited to one or two companies. But pharma as a sector has gone from Rs 1 lakh crore market cap in 2008-2009 to Rs 10 lakh crore. So it has been a fantastic expansion over a eight-year period. Obviously some correction was justified and then you add to that valuation, a few negative events panning out like the base business of US eroding for generic companies and then you add regulatory issues and lack of approval.

Actually, the regulatory issues and lack of approvals were turning out to be advantage for a few companies. Now some companies are earnings super normal profits because of these limited competition and once the US FDA approval started coming in, the regulatory issue started going away. Those super normal profits are now shrinking back to normal profits and which is why there is severe valuation erosion in some of the companies.

One would argue that the basic sunrise period for Indian pharma is now getting challenged. Pricing has come down, competition has intensified and we know that US FDA is very, very stringent.

There is no doubt that we are at a transition phase. The easy picking for the generic companies are over. They will have to migrate to becoming speciality pharma companies. For that, they have been investing. So there are a lot of parallels that can be drawn between IT and pharma. But a couple of things in which pharma is different from Indian IT is that pharma has been investing for the past four years in building their future pipeline.

Second, it is not a plain vanilla commodity business like IT. You can still find small pools and small ponds of profit in niches which can be exploited by some companies. Right now, the mood is such that the baby is being thrown out with a bath water but once the dust settles in let us say next one-two quarters, once the elections are over, once this pricing pressure is abated a bit, then you will realise that the profits in pharma are much more sustainable than the lack of growth in IT.

So are you saying that it is time to go overweight on pharma and that is what you plan to do?

No. I am saying over the next six months period, one should be keeping their eyes open. There will be opportunities that will emerge and it is not a sector wise call. You will still have to unearth companies whose dependence on US business is not much at this point of time. The approvals are still in the future and whose size can double or triple over a three-four-five-year period if they get into the correct products.

Should one stick to large cap pharma because ultimately that is where I guess the edge is both in terms of product, dealing with complexity and also in terms of compliance with US FDA norms?

The risk is also in the largecap. Teva used to be some $70 billion market cap. It has come down to $35 billion and if Teva is at $35, Sun Pharma at $25 billion does not look that attractive. Mylan also used to be a $36 billion company, Now it is a $18-billion company. So the entire sector is getting derated and without naming any particular company, if the profits of those companies were dependent on one, two or a few products and those products are at risk, then the valuations are more difficult to come back.

So you have to find companies where it is more sustainable the profit and the growth can easily also be attained. So for a Sun Pharma to become a $50 billion market cap will take far more effort than let us say a small company that can go from billion dollar to two billion dollar.