In the last 10 years despite being integral to the Indian economy, the market capitalisation of none of the pharma companies ever breached the ₹1-lakh-crore mark, barring Sun Pharma.
For a brief period in FY20-21, even Sun Pharma was valued below ₹1 lakh crore.
But as of today, seven companies have breached the psychological mark and Sun Pharma set a new benchmark with a valuation of ₹4.5 lakh crore.
Divi’s, Cipla, Torrent Pharma, Dr. Reddy’s, Zydus Lifescience and Lupin have evidently gained from improved valuations ascribed to the sector apart from operational growth, with Nifty Pharma trading at 30 times the one-year forward EPS now compared to 23 times in 2014.
But viewed from a balance-sheet perspective, the sector holds more promise despite the rich valuations.
Our analysis of 48 pharma companies with available data revealed strong balance-sheets. While the asset turnover has shrunk impacting profitability, if companies leverage this wide asset base, further growth can be charted from here.
Asset rise tops revenue
The companies reported a gross block growth of 13 per cent CAGR in the last 10 years (FY14-24) compared to 10 per cent revenue growth. This has resulted in companies reporting a lower utilisation of assets. The asset turnover ratio has shrunk from 1.5 times in FY15 to 1.1 times now.
Among the top five, Torrent Pharma saw the sharpest decline (1.9 to 0.8 times) as the company acquired Curatio (₹2,000 crore) and other assets in the period.
In varying degrees, the sector followed the same path adding assets organically or inorganically, but the utilisation levels are below peaks in the recent period.
The faster asset addition is despite a persistent trend of CMOs (contract manufacturing outsourcing) shouldering a large part of the demand sourced from these companies. The gross block addition also encompasses R&D labs or plants for backward integration. While not contributing directly to topline, the benefit should flow through on optimal utilisation.
It is pertinent to note that despite the asset growth, pharma continues to be a low debt sector and the overall leverage has declined. The sector net debt to EBITDA has come down from 0.6 times to 0.3 times in FY14-24. The sector did witness an increase to 1.4 times by FY19 before the reversal started, especially in FY24, when the net debt declined 37 per cent.
Room for more profitability
That said, lower utilisation of assets has impacted profitability. The EBITDA and PAT margin for the sector have declined from 26/16 per cent to 24/12 per cent in FY14-24.
The impact of the recovery in the US segment (which earlier faced high price erosion) can be seen in the FY24 margins being better than FY23. But the full recovery could have been held back by lower asset utilisation resulting in inability to absorb the higher overheads.
The pharma rally over the past year has been driven by favourable market dynamics in India and the US. Improved asset utilisation could boost growth further.
Though valuations seem expensive, this may benefit pharma players. Investors should watch asset utilisation trends closely.