Is the pain over in pharma pack? Keep margin of safety, say experts

NEW DELHI: The $20 billion Indian pharmaceutical industry is going through a phase of prolonged crisis. The recent spate of regulatory scrutiny, warning letters and Form 483s from the drug regulator of the biggest export markets – US and Europe – has resulted in complete loss of faith for investors.

Once a darling of the Street, today pharma has become a place that make one think twice before investing.

What are the warning letters all about?

An increasing number of Indian pharmaceutical firms have come under the knife of US Food and Drug Administration (FDA) due to lack of trained staff and cleanliness at their manufacturing units.

In the just-concluded financial year, many major pharmaceutical companies from Lupin to Sharon Bio received warning letters from the USFDA for reasons ranging from faulty manufacturing practices to unhygienic facilities.

A warning letter is a notification by the USFDA to a company for violating its rules and regulations. In the case of Indian companies, this leads to an import ban on products manufactured by them. Given the high contribution of the US market to the revenues of many Indian firms, it leads to downgrades in earnings estimates.

What’s the situation right not?
As many as five listed pharmaceutical companies have been issued warning letters by the USFDA in 2015, including big names like Sun Pharmaceuticals, Dr Reddy's Laboratories and Cadila Healthcare.

The BSE Healthcare index is down over 19 per cent in the past one year, while individual stocks have lost as much as 40 per cent in the same period.



On top of the warnings letters, many firms have also received Form 483, which is a report given after the USFDA inspects a facility and makes observations that may constitute a violation under its rules.

How to go about investing? Once upon a time, pharma companies were considered safe bets with investors running to them as their first option during the time of distress in the broader market. Today, the situation is opposite. But in the stock market, every pain is an opportunity to derive gains and pharma can be looked at from that perspective.

“In pharma, our stance is to buy after the pain rather than before the pain, so we buy once the warnings letters come in. We are looking at businesses that go through huge price corrections because of warning letters and where we see that as a non-fatal problem. The recovery should come in a year or two,” said Rajeev Thakkar, CIO, Parag Parikh Financial Advisory Services, who oversees assets of Rs 650 crore.

“The best thing to do at this point would be to probably trade stocks whose valuations are not too expensive,” suggested Deven Choksey, MD, KRChoksey Investment Managers.

“The basic principle of having a lot of margin of safety (MoS) when you are buying needs to be diligently practised when it comes to investing in pharma, because these are like binary events of 0, 1 where if anything goes wrong significantly, there could be a major hit in terms of profitability,” said Sachin Shah, Fund Manager, Emkay Investment Managers.