Nifty Pharma Index surges 25% in 3 months — what's driving the rally, a look at the valuation landscape now

The Nifty Pharma Index has rallied close to 25 percent in the past 3 months with multiple stocks either hitting fresh or 52-week highs, so what has led to this rally or where do valuations stand? The surge prompts an exploration into the driving forces behind this rally and an assessment of the current valuation landscape.

One of the key triggers for the surge in pharma stocks has been companies cashing in on the key drug opportunities. The biggest one has been from the $12 billion cancer drug Revlimid generic that saw competition entry last year. Currently, the street estimates companies such as Sun, Cipla, Dr Reddys and Zydus Life could rake up anywhere between $200-500 million from the drug in just this fiscal.

Other key drug opportunities playing out include Sun Pharma’s specialty drug portfolio which could hit $1 billion in sales in FY24E to Lupin’s launch of the generic version of the $ 1 billion inhaler drug Spiriva which is projected to yield sales of $150-200 million annually.

These lucrative drug opportunities have coincided with an improved performance in the US market. Companies across the board have indicated that pricing pressure has eased in the US to mid-single digits, a positive shift from the lower to mid-teens previously experienced. Moreover, companies could benefit from potential opportunities emerging from drug shortages in the US, which are currently at a five-year high. And while companies such as Gland and Aurobindo don’t foresee an immediate opportunity emerging from Pfizer’s injectable plant being damaged in the US, it is a space to watch.

The augmentation of gross margins is another significant trigger for this surge. Companies have reported anywhere between a 100 to 500 bps gross margin improvement in Q1 mainly due to resolution of disruptions in the key starting material supply from China and clearing of high cost inventory. Gross margins are expected to improve a total of 200-400 bps in FY24E.

Other triggers include growth momentum in the domestic market. Q1 growth varied in the domestic market between 6 to 15 percent with the street anticipating a range of 8 to 10 percent growth for FY24E. An important trigger will be possibly NPPA unveiling an amnesty scheme to resolve pending cases of overpricing.

Additionally, the pharma sector has been abuzz with speculation regarding potential deal activity. Cipla, for instance, surged to a record high on the back of rumors about the promoter considering a stake reduction. Glenmark is reportedly exploring shedding 7-8 percent in Glenmark Life Sciences, while Biocon's biosimilar arm is seeking funds to reduce its debt burden of over $1 billion.

Amidst the surge in stock prices, it's noteworthy that valuations are approaching or surpassing their 10-year averages on a Price to Book basis. As the sector continues to flourish, vigilance is advised on potential challenges, including adverse pricing dynamics in the US, USFDA issues, and potential regulatory headwinds within the domestic market.