DIY Investing . Five under-valued pharma stocks to buy

With the outbreak of the Covid-19 pandemic, investors latched on to stocks from defensive sectors such as pharmaceuticals, IT and FMCG to beat market volatility. Investors in such stocks were handsomely rewarded in 2020. Take for instance, the S&P BSE Healthcare Index that surged 97 per cent from the March low until December-end 2020.

With the economy showing definite signs of revival, also testified by the December quarter company results, cyclicals stocks are set to do well. While the pharmaceutical sector may not offer another successive year of spectacular returns, one can still search good long-term bets here.

Identifying opportunities

Today, many pharmaceutical stocks are trading at expensive valuations. Here, we highlight a few that investors can consider for further research. These are companies with strong financials (see table) and are trading at relatively reasonable valuations – compared to their historical P/E multiples, and to their peers..

Shortlisting criteria

Using the Capitaline database, we shortlisted pharma companies that have clocked net sales, operating profit and net profit growth of at least 10 per cent (CAGR) between FY15 and FY20. These companies have operating profit and net profit margins of at least 20 per cent and 10 per cent, respectively, in each of the five years until FY20. Of these, we picked companies that are trading at relatively inexpensive valuations. Fast-growing companies that also enjoy good margins merit investor attention.

The selected companies also have negligible debt on their books. These companies have managed to deliver revenue and profit growth and maintained their margins over the nine-month period ended December 2020 too.

Who made the cut

Alembic Pharmaceuticals is one such company. We had recommeded a ‘hold’call on the stock in November 2020. Weak US sales, though, seem to have weighed on the stock which is down 5 per cent since then. Despite this, Alembic Pharma has grown its net sales and operating profit at a healthy pace during the nine-month period ended December 2020. The stock trades at a TTM P/E of 15.4 times, below its five-year average multiple of 20 times. The impact of new capacity expansions undertaken over the past few years, is expected to flow in largely from FY 2023.

Eris Lifesciences is an India-only branded generics player in chronic therapies segment, particularly related to diabetes and cardiovascular diseases. We recently recommended a ‘buy’ call on the stock. A portfolio of leading brands along with a wide distribution network and a strong force of medical representatives place the company in a strong position to capitalize on the growing prevalence of lifestyle-related diseases. The stock trades at a TTM P/E of 23.4 times, below its five-year average multiple of around 29 times.

Alkem Laboratories enjoys a leading position in acute therapies but was severely impacted by the Covid-19 lockdowns. However, the company’s business spanning several acute therapeutic areas such as anti-infectives, gastro-intestinal and analgesics has since recovered. Alkem derives 65 per cent of its revenue from India and has been growing volumes at a faster pace than the industry. The operating profit margin ranged between 16 to 22 per cent during the five years until FY20. However, at a TTM P/E of 22 times, the stock trades under its five-year average multiple of 29 times. The company’s strong market position in India and new product launches for the US market should serve it well.

Caplin Point Laboratories also figured in the shortlist, as it has in our previous screeners too. At a TTM P/E of 16 times, the stock trades well below its five-year average multiple of 26 times. The company’s performance in the tightly regulated US generics market for injectables ( 8 per cent of company revenue) is a key factor to watch out for given the large market opportunity.

Aurobindo Pharma made the cut based on financial metrics. However, the stock is not cheap vs 5-year average PE. The company plans to focus more on API manufacturing, and is among the key beneficiaries of the government’s PLI scheme.