Top 5 Pharma Stocks To Buy Now: Edelweiss Research Report

In FY21, we initiated our ‘Buy’ call on the Pharma sector after being Negative/Neutral since FY16. Since then our Pharma basket has given returns of 101% v/s the Nifty’s return of 70% (an outperformance of 31%). While we replaced Biocon (BIOS) with Lupin (LPC) in May’20, we have now replaced Abbott India (ABT) with Sun Pharma (SUNP). Through this report, we are reiterating our positive view on the Pharma sector.

LAURUS a winner; Expect SUNP to shine

Within our recommended stocks, Laurus Labs (LAURUS) with 4x returns transformed into a massive wealth creator in FY21, followed by Dr Reddy’s (DRL), Ajanta Pharma (AJP), and LPC with +25% returns each. ABT with negative returns was a laggard. LAURUS has seen EPS upgrades of ~250% for FY22E (from EPS of INR7.4/share in Apr’20 to INR19.5/share currently), driven by significant ramp-up in antiretroviral (ARV) portfolio and incremental order inflows. On the other hand, ABT has seen earnings downgrade and multiple de-ratings due to the Covid-19 induced weak Domestic Formulation (DF) business and competition in key drugs (such as Duphaston/Duphalac). While ABT’s DF business is expected to grow FY22E onwards, we expect product-specific competition to remain elevated; and hence, we have removed it from our Focus-5 list.

Multiple headwinds earlier dented SUNP’s performance

Over the last 4-5 years, SUNP has massively underperformed, driven by multiple structural issues such as (a) pricing pressure in the US generics market, which impacted both Taro and SUNP’s core US business, (b) heavy investments in the Speciality portfolio, and (c) lower growth in DF due to SUNP’s acquisition of Ranbaxy (RBX) whose portfolio is Acute heavy, which led to margin contraction and significant earnings downgrades. Further, the company faced an adverse US Court ruling on price fixing during FY13-15 for certain drugs. Apart from these, few corporate governance issues like the holding structure of its DF business led to multiple de-ratings.

SUN PHARMA entering into an earnings upgrade cycle

Most of the headwinds are now behind for SUN PHARMA and we believe the company is entering into an earnings upgrade cycle driven by:

(a) change in the business mix – from being a heavily US-focused company five years ago to having a well-diversified geographical presence currently,

(b) improvement in Speciality business – it has seen significant traction over the last six months in key products (Illiumiya market share gain, ramp-up in Odomozo/Cequa and shifting market in Absorica), and

(c) stabilisation in Indian formulation business post restructuring (Aditya Medi sales) and base effect of FY21 (Covid-19 induced).

Outlook and view

With tailwinds in place for SUN PHARMA, we expect the company to see margin improvement by 100-200bps and to deliver 20% EPS CAGR over FY21-FY23E. An upside in earnings upgrade could emerge from early resolution of its Halol facility.

Key risks:

(a) Higher market share loss in Absorica, and
(b) Over 5% decline in Taro portfolio.