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Nifty Pharma Index: Will The Momentum Continue Amid High Valuations?

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Nifty Pharma Index

By: Tavaga Research

In the financial world, indices are designed to track things such as bonds, publicly-traded stocks, and other commodities. A stock market index is a measure that tracks the performance of the stocks that constitute the index.

Investments funds such as exchange-traded funds (ETFs), index funds, and mutual funds frequently use indexes as benchmarks. This role as a benchmark highlights the significance of these measures and the systemic importance index providers have within the financial world.

Having outlined their significance, it is also imperative to understand how the constituents are selected for inclusion in the index. The construction of an index has a defined methodology and has characteristics that distinguish it from other indices. The factors that are generally used to select companies for inclusion include liquidity, listing history, free-float market capitalization, impact cost, etc.

For instance, for a company to qualify for inclusion in the NIFTY Pharma Index, it must form a part of the NIFTY 500 at the time of review. The company is required to have a listing history of 6 months. Also, the selection is done based on the free-float market capitalization of pharmaceutical companies.

Given the fact the markets are constantly changing, the factors that affect the selection too keep evolving with time. This, therefore, raises the need to rebalance these indices. Some companies that fail to fulfill the inclusion criterion have to be excluded, while others have to be included. Every index has distinguished rules for rebalancing purposes and is usually done twice a year, although, the indexes are reviewed quarterly.

NIFTY Pharma Index

There is no NIFTY Pharma share price, rather the NIFTY Pharma Index captures the performance of the companies in the pharmaceutical sector. It comprises of 10 pharmaceutical companies listed on the national stock exchange (NSE). The index uses a free-float market capitalization method, wherein the index level reflects the total free-float market value of the index constituents relative to a particular base market capitalization value.

The NIFTY Pharma Index can be used for a gamut of purposes including benchmarking mutual fund portfolios, launching of ETFs, index funds, and structured products. A variant of this index is the NIFTY Pharma Total Returns Index. The index is rebalanced semi-annually.

Nifty Pharma Companies – Nifty Pharma Stocks list

Nifty Pharma Weightage

Nifty Pharma Constituents
Source: NSE, Tavaga Research

The largest contributors to the index are Sun Pharmaceutical Industries Ltd., Dr. Reddy’s Laboratories Ltd., Divi’s Laboratories Ltd., Cipla Ltd., making about 67 percent of the index.

The NIFTY Pharma Index’s value is determined based on the performance of the Nifty Pharma company stocks in the chart above. It is, therefore, updated in real-time, like the price of the shares that make up the index.

Performance of the NIFTY Pharma Index – Nifty Pharma Index Historical Data

Performance of the NIFTY Pharma Index
Source: NSE, Tavaga Research

The Nifty Pharma index live chart above shows that the index has been trading at near record-high levels, buoyed by the central role that it is playing in tackling the coronavirus pandemic. The Pharma Index was the top sectoral performer in 2020 as demand for several drugs sky-rocketed to counter the virus, which sent healthcare stocks higher.

In comparison with the NIFTY pharma index’s historical data, the 10-stock gauge ended CY20 with gains in excess of 60 percent, its best return since 2003. This performance came as the margins improved on continued sales with improved product mix, lower cost, and minimal headwinds from price erosion and US FDA issues.

The table below shows the key financial ratios of the index.

Nifty Pharma Financials

Top Constituents of the Pharma Index

  • Sun Pharmaceutical Industries Ltd.

Sun Pharmaceuticals is the largest Indian pharmaceutical company and the fifth largest specialty generic company in the world. The capabilities of the company traverse all dosage forms like injectables, sprays, ointments, liquids, creams capsules, and tablets.

The operations of the company include producing generics, anti-retroviral (ARVs), active pharmaceutical ingredients (APIs), and intermediaries in the full range of dosage form.

Sun Pharma also produces specialty APIs. In fiscal 2018-19, US formulations contributed the most to the company’s revenue with 37 percent, followed by the India branded formulation at 26 percent. The company markets around 2000 products in over 150 markets across the world. It manufactures all these products in over 40 sites.

Key Financial Metrics

Sun Pharma financials
Source: Company Data, Tavaga Research

With a weightage of 19.64 percent in the Nifty Pharma Index, Sun Pharma is the largest constituent of the index. The stock has delivered a return of 29 percent over the last year.

1-Year Performance of Sun Pharma

1-Year Performance of Sun Pharma
Source: Google Finance, Tavaga Research

The market capitalization of the company, currently, is Rs 138,000 crores.

  • Dr. Reddy’s Laboratories Ltd. (DRL)

DRL is an integrated global pharmaceutical company catering to the needs of the pharmaceutical sector. The company started its operations in 1984 in the Active Pharmaceutical Ingredients (APIs) segment, with a single 60-tonne manufacturing facility near Hyderabad.

DRL is among the top three API players in the world. It has a presence in more than 100 countries with subsidiaries in the US, UK Brazil, and Germany and joint ventures in China, Australia, and South Africa, and representative offices in 16 countries.

The company is the first pharmaceutical company in Asia, outside Japan, to be listed on the New York Stock Exchange (NYSE). DRL is the largest custom pharmaceutical services (CPS) player in India.

Key Financial Metrics

Key Financial Metrics of DRL
Source: Company Data, Tavaga Research

With a weightage of 19.40 percent in the NIFTY Pharma Index, DRL is the second largest constituent of the index. The stock over the past year has returned around 65 percent.

1-Year Performance of Dr. Reddy’s Laboratories

1-Year Performance of Dr. Reddy's Laboratories
Source: Google Finance, Tavaga Research

The market capitalization of the company, currently, is Rs 83,762 crores.

  • Divis Laboratories Ltd.

Established in 1990, Divis Laboratories is a leading manufacturer of Active Pharma Ingredients (APIs) with a focus on developing new processes to produce APIs and Intermediates.

The company within a short span of time expanded its breadth of operations to provide turnkey solutions to the domestic pharmaceutical sector.

Divis established its first manufacturing facility in 1995, five years after it started helping companies with its turnkey and consulting strengths. The first manufacturing plant of the company is built over a 300-acre site in Hyderabad, with its second manufacturing plant in Vishakhapatnam on a 314-acre site.

The company has its presence in Switzerland and New Jersey, as well.

Key Financial Metrics

Key Financial Metrics of Divis
Source: Company Data, Tavaga Reserach

With a weightage of 15.03 percent in the NIFTY Pharma Index, Divis Laboratories is the third-largest constituent of the index. The stock over the past year has returned around 91 percent.

1-Year Performance of Divi’s Laboratories Ltd

1-Year Performance of Divi's Laboratories Ltd
Source: Google Finance, Tavaga Research

The market capitalization of the company, currently, stands at Rs 94,000 crores.

  • Cipla Ltd.

A global pharmaceutical company whose goal is to ensure that no patient is denied affordable and high-quality medicine and medical support. The company was established in 1935 with a vision to make India self-sufficient in healthcare.

Cipla, with 85 years of operations, has established itself as one of the world’s most respected pharmaceutical names, worldwide.

With a strong presence in over 170 countries and a product catalog of over 2000 products in 65 therapeutic categories, Cipla is a name to reckon with in the pharmaceutical sector. It manufactures its products in 34 state-of-the-art manufacturing facilities that engender Active Pharma Ingredients (APIs) and formulations.

Key Financial Metrics

Key Financial Metrics of Cipla
Source: Company Data, Tavaga Research

With a weightage of 12.79 percent in the NIFTY Pharma Index, Cipla Ltd is the fourth-largest constituent of the index. The stock over the past year has returned around 71 percent.

1-Year Performance of Cipla Ltd.

1-Year Performance of Cipla Ltd.
Source: Google Finance, Tavaga Research

The market capitalization of the company, currently, stands at Rs 65,186 crores.

Outlook for the Pharma Sector

Given the increasing incidents of previously unseen diseases and the impending threat of climate change (the effects of which are still to unfold), the pharmaceutical industry is expected to be the foremost line of defense against these uncertainties. Therefore, over the long term, the outlook for the pharma sector remains positive.

However, over the short term, the valuations seem to be a bit stretched. For instance, as mentioned above, the PE ratio of Divis Laboratories is above 50 compared to an industry average of 37.

How to evaluate Pharma Stocks?

Pharma companies invest considerable resources in research and development. While evaluating pharma stocks, therefore, it is important to focus on three factors including how much cash they generate, valuations, and pipeline potential.

Cash is the lifeblood of any business and more so the pharma companies. Without cash, they cannot fund their testing and trials implying that the company is doomed for failure. The other important factor is the pipeline potential. The pipeline includes the company’s drugs that are either in the market and/or are currently being tested.

Investors should look for companies with a diversified pipeline. For instance, if a pharma company has one drug in their pipeline, it is highly risky because if the drug is unsuccessful, the company risks going under. Keeping this in mind, it pays to look for value in drug firms than speculating on the next blockbuster.

How to invest in Pharma companies?

Investors looking to invest in pharma companies can do so directly by buying the shares of pharmaceutical companies in their Demat account. However, it is recommended, given the high risks, to look for thematic index funds investing in the pharmaceutical sector. Unfortunately, no AMC has launched any Nifty Pharma ETF yet.

Currently, in India, there is only one thematic index fund launched recently by Edelweiss and MSCI (in partnership) that has exposure to pharmaceutical and healthcare stocks.

The Edelweiss MSCI India Domestic & World Healthcare Fund 45 Index Fund predominantly replicates the MSCI India Domestic & World Healthcare 45 Index.

The index comprises healthcare stocks from both India & the US and thus provides diversification.

Edelweiss MSCI India Domestic & World Healthcare Fund 45 Index Fund
Source: Edelweiss

Nifty Pharma index mutual fund (active scheme) is another way to get exposed to healthcare stocks, however, the expense ratio of most of the actively managed mutual funds is considerably high.

Taking that into consideration, an investor should either choose to invest directly into stocks after consulting a SEBI Registered Investment Adviser or watch out for any upcoming thematic index funds / ETFs.

What are the recent trends in Pharma?

The pharma sector has time and again responded to global demand and technological advancements. The industry is currently working overtime to discover treatments for coronavirus. In this digital era, there is a gamut of other trends that will impact pharmaceutical companies. These include large scale use of artificial intelligence, technology innovation in the supply chain, legalization of medical marijuana, big data and analytics precision medicine, extended reality, etc.

The government of India approved the Production-Linked Incentive scheme for 10 sectors including pharmaceuticals in November 2020. The PLI scheme helps make manufacturing in India competitive and attracts investments from companies to set up capacities in India. This helps build core competencies with cutting-edge technology. In turn, the government aims to provide incentives for incremental sales from the products that would be manufactured in these domestic units.

The PLI application for Aurobindo Pharma Ltd was recently approved to produce Penicillin G (Production capacity – 15000 MT), 7 – ACA (Production capacity – 2000 MT) and Erythromycin Thiocyanate (TIOC) (Production capacity – 1600 MT) by the Ministry of Chemicals and Fertilizers.

Major threats to the pharma industry in India

India is the largest manufacturer of generic medicines in the world, which includes the same ingredients as the original version and go on the market after the patent expires. This advantage is slowly being challenged by China, which has increasingly been exporting active pharmaceutical ingredients (APIs) in recent years.

Indian companies benefit by using these ingredients to supply medicines at affordable prices while cutting their costs and research and development spends. But China has also been expanding into the formulation of those drugs. This rise has been aided by improved standards that appear to be making the world less apprehensive about the quality of Chinese medicine.

In addition, western countries appear to protect their pharma industry. In August, last year, Mr. Trump issued an executive order that called for the elimination of drug imports, both as APIs as well as formulations. Germany and France appear to be moving in a similar direction. If these orders are strictly adhered to, it will drastically impact the Indian pharma industry.

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