Pharma Funds Review, And Why Should Invest?
Sectoral Overview – Pharmaceuticals:
In India, pharmaceuticals have been one of the fastest-growing sectors, catering to the domestic as well as global markets. The Indian Pharma industry is serving about 40% of the demand in the US market for generic medicines and around 25% of the medicinal demand of all sorts in the UK. Indian companies export medicinal supplies to about 200 countries around the world, while the US is the market of focus. Both the domestic market and exports have been on the rise in recent years. Our country being a consumer market, the local consumption has been about USD 20 Billion for the year 2019 (grown by 9.6% yoy). Also, the pharmaceutical exports were valued at around USD 19 Billion for FY19. Annually, the industry also earns foreign exchange (net) of USD 10 Billion. Our exports include drugs & drug formulations, surgical, herbal products, intermediates, etc. Overall, the pharma industry was valued at USD 38 Billion in 2017, and expected to be around USD 65 Billion by 2020.
The key players in the Indian Pharmaceutical Industry are:
• Sun Pharmaceutical Industries Ltd.
• Cipla Ltd.
• Dr Reddy’s Laboratories Ltd.
• Divis Ltd.
• Lupin Ltd.
• Cadila Healthcare Ltd.
• Abbott India Ltd.
• Piramal Enterprises Ltd.
• Biocon Ltd.
• Aurobindo Pharma Ltd.
The pharmaceutical sector is considered by professionals as a ‘Sunrise Sector’ on a global scale and it provides a competitive advantage to our country. The middle-class economic segment has now been seeking better quality healthcare, and our companies were able to entice patients across the globe as well via medical tourism. The introduction of Ayushman Bharat Scheme by the Government of India to provide free health coverage has played a vital role in a resultant positive outlook for the Pharma sector at the beginning of 2020. This scenario was prevalent before the COVID-19 outbreak. The pandemic has halted progress for a lot of industries and has also led to the complete shut down of several businesses. Amidst all this crisis, the pharma sector has remained optimistic.
At the beginning of COVID outbreak in China, the Indian pharmaceutical companies got a hit, as we depend on Chinese raw materials (Active Pharmaceutical Ingredients – APIs) for the manufacture of several drugs. However, the industry sustained this by boosting local manufacture of APIs and KSMs (Key Starting Materials). The Indian pharma industry has taken the crisis as an opportunity to flourish and grow largely on a global scale. There is a major uncertainty about the time that would take for the introduction of vaccines and the type of recovery the economies are going to have. In a condition of extended lockdowns, companies must be looking for digitalization in various aspects, conservation of supplier relationships, maintaining liquidity, scaling API investments, etc.
Most of these pharma companies have been valued at their peaks around 2015, and have been facing difficult times thereafter. The prime issues they faced in the last 5 years were the price drops up to 10% in the US market for the generic drugs and the regulatory compliance issues under the USFDA (US Food and Drug Administration). Other issues involving the US healthcare policy reviews and slowing economy in emerging markets contributed to the headwinds faced by the pharma industry. However, the conditions have been improving recently.
Mr. Gaurav Seth, Head - Research & Content - Zfunds, who has been in the financial services industry for more than 17 years, has expressed his views on the headwinds faced by the pharma sector. In his statement, he said “The current pandemic situation has created an opportunity for the Indian pharma sector. The Indian industry has always been a high production and low-cost player in the global scheme of things. However, the one place that our companies have probably lacked is the R&D space. Also, another headwind for the Indian pharmaceutical companies might be the availability of raw materials such as APIs which were imported from China. We do expect and hope that the Government will lend the required support for Indian companies to start their own production of the raw materials and become Atmanirbhar.”
He also added, “Indian companies are still reliant on the Chinese manufacturers of API products as raw material. Owing to the lockdown, the Chinese manufacturers have increased the prices and the depreciating rupee has not helped costs either. On the other hand, export-oriented manufacturers would be benefiting from the rise in the dollar.”
Types of Pharma Companies in India:
Out of the pharma companies that are operating in India, not all of them are of the same nature. They differ based on the market they serve, kind of operations performed, types of offerings, market capitalization, etc. As we are aware that our pharmaceutical sector is actively involved in imports and exports, let us try to understand the different types of Pharma companies based on the market served.
MNCs based in India:
A list of companies found in India were able to serve the domestic market, as well as capture the market overseas. These companies were boosted by the Patent Act 1970, which allowed the patent of process and later for products as well. Some of our Indian pharma companies are the major player in serving the US and European pharma market. The following companies are among the MNCs that were founded in India.
- Sun Pharmaceutical Industries Ltd.
- Cipla Ltd.
- Lupin Ltd.
- Dr Reddy’s Laboratories Ltd.
- Aurobindo Pharma Ltd.
- Cadila Healthcare Ltd.
MNCs based outside India:
Though we have top performing companies founded in India serving domestically, we have also been consumers for MNCs based outside India. These companies founded abroad have managed to tap the Indian pharma market and provide their services:
- Pfizer Ltd.
- GlaxoSmithKline (GSK) Ltd.
- Merck & Co.
- Novartis International AG
- Eli Lilly & Co.
- Abbott Laboratories.
Non-MNCs in India:
Apart from the global players, we also have Non-MNCs in the pharmaceutical sector. Though these companies have their exports overseas, they mainly operate and cater to our local pharma needs.
- Arvind Remedies Ltd.
- RPG Life Sciences Ltd.
- Jagsonpal Pharmaceutical Ltd.
- Marksans Pharma Ltd.
- Mangalam Drugs & Organics Ltd.
- Themis Medicare Ltd.
In addition to the classification of the pharmaceutical companies based on the markets they serve, these firms can also be categorized based on the offerings. The products of pharma firms can vary from APIs, medical devices, surgical products, dietary supplements, whereas the services could include pharma manufacturing, pharma marketing & distribution, pharma retail, hospitals, etc.
API (Active Pharmaceutical Ingredient) firms:
Until the outbreak of COVID-19, the Indian pharma companies have relied heavily on Chinese manufacturers for APIs. The level of dependence was up to 60-70% for most of the drugs and even 100% in a few critical drugs. However, the production halt due to the lockdown in China made our government allocate USD 1.3 Billion to incentivize local manufacture of APIs.
The MD of Sun Pharma, Mr. DIlip Sanghvi has said that “This move would safeguard healthcare security and create an ecosystem for a strong Indian API industry.”
In addition to the big players producing APIs, the following companies also produce these active ingredients:
- Lasa Supergenerics
- Shilpa Medicare
- Gujarat Themis
- Solara Active Pharma
- Granules India
The following companies in the pharma sector are involved in manufacturing of medical devices. Their offerings include innovations in imaging & radiology, in-vitro diagnosis, radiation protection, surgical blades, syringes, needles and other disposables.
- TransAsia Biomedicals Ltd.
- Trivitron Healthcare
- Polymed Medical Devices
- Hindustan syringes & Medical Devices (HMD)
- Sahajanand medical technologies
- Meril Life Sciences
The following companies produce dietary supplements as their main offering. Individuals who need to meet the deficiency of nutrients:
- Biophar Lifesciences
- Nucleus Inc.
- Zeon Biotech
The hospital chains play a major role in the performance of other pharmaceutical products. These entities muster the trust of people and are valued more in the industry. The following are the top hospitals (Non-government) that are widely regarded in the industry.
- Medanta - The Medicity
- The Christian Medical College
- Apollo Hospitals
- King Edward Memorial Hospital
- Sir Ganga Ram Hospital
Future prospect of the Pharma industry:
Although FY20 has not registered a substantial growth, forecasts suggest that the sector could see a 5% growth in the current fiscal year. A few analysts are highly optimistic about the pharma industry earnings could double in 4 to 5 years period. The sequence of events that occurred after the upsurge of COVID-19 cases in China has dramatically contributed to the enhanced perspective on the Indian pharmaceutical industry.
• Most of the drug manufacturing companies were solely dependent on China for chemicals and other raw materials. Due to the initial outbreak of COVID-19 and the local lockdown following that in January, the Chinese supplies could not reach the customers. Since then, there has been a widespread ideology to diversify supply chains and decentralize production. Also, there is a politically negative sentiment prevailing over China due to the controversial reporting on COVID outbreak. To capture this opportunity, the Indian pharma companies are trying to lure investors by positioning themselves as the best alternative for Chinese manufacturers. The Indian government too recognised this chance and announced an incentive package of USD 1.3 Billion for local drug production of drugs.
Also Read: Impact of COVID-19 on Economy and Finance
• The Indian government reportedly was ready to offer twice the size of Luxembourg (i.e., 461,589 hectares) for the manufacturing companies moving out of China. Apart from this, the states are also involved in bringing foreign investments. Pharma is one of the 10 sectors that could immensely benefit from this move.
Recently Mr. Anshul Saigal, the Portfolio Manager of Kotak Pharma Fund expressed his optimism over the Pharma industry in the next 4-5 years. In his statement, he said ”The Pharma stocks have outperformed over the last 2months. Our analysis suggests India Pharma sector has a cost-competitive advantage globally with R&D expertise, which provides robust earnings growth potential over the next 2-3 years. This apart, the sector is still relatively under-owned by institutional investors; which we think could drive further upside for Pharma stocks and provide an attractive risk-adjusted return.”
While the COVID-19 outbreak has set the base for the growth of Indian pharma, all of the following factors contribute to the prospects of the industry, which is quite positive.
• The accessibility of Medical infrastructure is expected to improve to a great extent, wherein around USD 200 Billion is to be spent in the next 10 years. And 1,60,000 hospital beds are to be added on a yearly basis.
• India has the highest number of USFDA approved manufacturing facilities outside the US. Also, we have more than 1300 manufacturing plants compliant with WHO Good Manufacturing Practices.
• Pharmaceutical firms have increased their expenditure in order to tap the rural market. By 2024, the hospital market size is expected to grow by USD 200 Billion.
• The cost of production by Indian companies is just 40% of what it costs in the US and about 50% of the production costs in Europe.
• Moreover, India is a large exporter of pharmaceuticals and equipment, wherein the transaction happens using the US Dollar. The value of USD has been appreciating for quite some time and is expected to remain the same in near future. The Indian pharma companies are expected to gain short-term benefits from this forex scenario as well.
• In comparison with several other countries, India has a skilled workforce with better technical and managerial skills. The cost of labour is also lower in our country.
• The pool of patients is also anticipated to rise by about 20% (over the next decade) owing to change in lifestyle, rise in population and new diseases.
• The government has also been supportive to the industry by allowing Foreign Direct Investment in the sector. The FDI policy was amended in 2016, allowing 100% FDI in greenfield pharma projects and up to 74% FDI in brownfield projects through automatic route (beyond which government approval can be demanded). The foreign investors are expected to leverage this in the forthcoming years.
Investments in the Pharma Sector:
The fund manager at Nippon India Mutual Fund, Mr. Sailesh Raj Bhan, has said the pharma sector is undervalued and under-appreciated. “So clearly we remain bullish. Earnings in the sector will surprise on the upside over next three to five years or even more” he said. “With that possibility there is a great opportunity here.”
The last time there was a bullish run in the pharma sector was from 2009-2016, providing a CAGR of almost 30%. After a drop in growth for the next 4-5 years, the sector is viewed as prepared for the next bullish run. The above discussed factors make the pharma sector an attractive investment. One can consider the following means of investing.
• Pharma Stocks: Investing in pharma stocks involves the direct purchase of stocks of pharma companies. A thorough knowledge in the market and sector is a prerequisite for investing in Pharma stocks directly. Also, there is a minimal scope for diversification in pharma stocks and hence high risk. Moreover, there are high trading costs as well.
• Pharma ETFs: Exchange Traded Funds (ETFs) are those funds which carry all the stocks in the same weights as that of the underlying index. A sector ETF similarly tracks the performance of a particular industry / sector. The Pharma ETFs are good options in case of liquidity and short-term returns. Though the cost of management is lower in case of ETFs, the purchase or sale results in the cost of commissions.
• Pharma Funds: These are equity-based mutual funds that invest in the Pharmaceutical sector. They provide the necessary diversification (in comparison to stocks) by investing in most of the companies in the industry. Like any other mutual funds, these are managed by professional fund managers who take active investment decisions, ensuring better returns. These funds invest in pharmaceutical companies which form the major portion of their portfolio. In addition, they also invest in related entities like hospitals, chemical manufacturing companies, biotechnology, healthcare services and relevant financial services stocks (like insurance companies). There are different sector funds performing brilliantly on a rotational basis. The forthcoming years are considered to be in favour of pharma funds. Experts and advisors suggest that pharma funds are set to provide excellent returns in the near future. However, they advise investors to not just invest based on the myopic gains that could be provided by the COVID scenario, rather to invest for at least 5 years. In mutual funds, there is also a facility of staggered investment through SIPs, which provides the benefit of rupee-cost averaging during volatile markets and can prove to be a safer method for long investment horizons.
Top Pharma Mutual Funds
There are quite a few Pharma Mutual Funds available in the Indian market. The following funds have been performing well and investors could consider opting them in their investment portfolio.
ICICI Prudential Pharma Healthcare And Diagnostics (P.H.D) Fund:
Although this fund was launched by ICICI Prudential Mutual Fund very recently (2018), the assets under its management have grown rapidly up to Rs 1460 crore. The fund has been managed by Mr. Dharmesh Kakkad since May 2020. This fund has invested in as many as 33 stocks related to the sector (46% in large caps) and it provides necessary diversification within the sector. Hence, this fund becomes an excellent option for moderate risk investors. The top holdings in this ICICI pharma fund are Cipla, Sun Pharma and Lupin Ltd.
Also, its PB ratio (of 2.62) and PE ratio (of 19.52) are the lowest among its peers, making this fund a potential investment option. This signifies that the underlying stocks are not as highly valued as others, indicating a potential growth of the fund forthcoming.
This fund has generated higher year-to-date return (26.21%) than the benchmark (20.88%) and pharma sectoral equity (23.74%). The fund has provided a 14.57% return since launch. However, the 1 year return has been brilliant at 35.36%.
The rate at which the investments in this fund grow can be understood with the following comparison:
Rs 1 lakh (Lump Sum) for 1 Year → Rs 1.39 Lakh
Rs 10000 (Monthly SIP) for 1 Year → Rs 1.53 Lakh
Launched by the fund house Nippon India Mutual Fund in June 2004, and has been managed by Mr. Sailesh Raj Bhan since 2005. This is the fund with the highest Assets Under Management of Rs 2992 crore.
The Nippon India Pharma fund has generated better returns than benchmark S&P BSE Healthcare TRI and Pharma sector equity over time. Also, the risk factor (standard deviation of 20.11% ) is lower than the above-said entities (S&P BSE Healthcare TRI - 23% & Pharma sector equity - 20.23%). The return since launch is impressive at 20.12%. While the 1-year return is 34.54%, the 3-year (14.2%) and 5-year returns (7.69%) of this fund are also top amongst its peers.
In spite of the fact that the returns are commendable, the Nippon Indian Pharma fund is advisable for more seasoned investors. This is due to the high concentration risk carried by the fund. The fund has invested in least number of stocks (18) compared to other funds in the category. The high PE (3.65) and PB (31.65) ratio also might also prove risky under the circumstances of market correction. But, these high ratios might not necessarily interpret overvaluation. This also indicates that investors are willing to pay more considering the underlying assets as growth stocks.
The rate of growth of investment in this fund can be understood as:
Rs 1 lakh (Lump Sum) for 5 Years → Rs 1.44 Lakh
Rs 10000 (Monthly SIP) for 5 Years → Rs 7.95 Lakh
The UTI Mutual Fund house introduced UTI Healthcare Fund in 1999, and is currently managed by Mr V Srivatsa. This fund manages assets worth Rs 475 crore.
“The (pharma) sector is coming out of a prolonged period of slow earnings and falling return ratios and challenging environment in both India and USA which are the key markets for the Industry. The outlook for both the markets are getting better and companies have also focused on streamlining their operations and repairing the balance sheets and focused on improving the return ratios. Given the defensive nature of the Industry, the sector offers decent growth visibility amongst the major sectors of the markets. The valuations are in line with the long term averages and the sector is expected to show reasonable earnings growth.” said Mr.V.Srivatsa – Executive Vice President & Fund Manager – Equity at UTI AMC.
The fund proves to be better than the benchmark S&P BSE Healthcare TRI in terms of year-to-date returns. Also, the standard deviation of returns (20.68%) is better compared to the benchmark (23%). The return since inception of this fund stands at 13.33%. The UTI Healthcare fund also looks promising to investors as April 2020 being its best performing month so far.
The PB ratio (3.95) is the highest among other funds, and the PE ratio is also higher (29.56). One possible significance of this is that investors foresee a potential growth of these stocks in the future and are willing to pay for it. However, one must be cautious about the volatility factor as well, since these ratios are higher.
Another fact to be considered is that this fund has 24 underlying stocks. Though this is comparatively better, the top 5 stocks account for 43%. But, the investments include a major portion of large caps ensuring safe returns. The top holdings of this fund are Dr Reddy’s, Cipla and Aurobindo Pharma. There is a small portion invested in an FMCG stock (Advanced Enzyme Technologies).
To visualize the returns:
Rs 1 lakh (Lump Sum) for 5 Years → Rs 1.14 Lakh
Rs 10000 (Monthly SIP) for 5 Years → Rs 7.21 Lakh
The Mirae Asset Mutual Fund launched this pharma fund in July 2018, and it has generated 18.71% returns since then. Mr Vrijesh Kasera has been managing the fund since inception, and currently this fund manages an asset of Rs 581 crores. The Mirae Asset Healthcare fund has enticed the investors for the spectacular 1-year return of 40.77%. Also, this fund has outperformed S&P BSE Healthcare TRI and the equity of the pharma sector under the year-to-date return parameter.
While the PB ratio is 3.65, the PE ratio (19.52) shows that the underlying stocks are not highly overvalued. Around 38% of the investment is made in small & mid caps, while the rest 62% is in giant and large caps. This is the same proportion observed in the category. The fund possesses 28 underlying stocks, with the major holdings being Sun Pharma, Dr Reddy’s and Divi’s Laboratories. Apart from the investments in the pharma sector, the fund has also invested a small portion in the financials and chemicals industry.
The fund is capable of providing returns like the following:
Rs 1 lakh (Lump Sum) for 1 Year → Rs 1.42 Lakh
Rs 10000 (Monthly SIP) for 1 Year → Rs 1.54 Lakh
Investment Strategy for Pharma Funds
Sectoral funds are preferable only when the investors are highly confident about the performance of the industry in the upcoming scenarios. However, in order to ensure the diversification of an investment portfolio, it is advisable to allocate only up to 5%-15% of the assets in a sector fund, depending on the investors' risk profile. The investor must also account for the shares invested in ETFs (if any), which might have invested in the same sector. Moreover, the appropriate investment horizon for a sectoral fund should be at least 5 years, and one must avoid looking for myopic gains. Considering the mode of investment, it is quite wise to opt for staggered investment via the SIP mode than the lump sum mode.