Pharma companies: A safe haven for investors in this bear market

The stock market's Broad Index (DSEX) is down 12% while the Blue-chip Index (DS30) is down 16% year-to-date in 2022. 

Whether it is increasing inflation, depleting foreign reserves or energy supplies, depreciating local currency or increasing power outages, most indicators suggest that the growth and profitability of most manufacturing companies would be adversely affected. This implies that the bear market may be far from over. 

As a result, investors are pulling funds out of the market, which in turn is making markets plummet faster, despite the 2% lower circuit breaker in place aimed at preventing prices from dropping more than 2% daily. 

For the uninitiated, a circuit breaker refers to a price band – it includes a lower limit called a lower circuit and an upper limit called an upper circuit, at which the stock can be traded in the market on a given trading day. And a circuit breaker is set up to ensure that there is no extreme price movement and investors are protected from any unwanted surprises.

However, unlike other manufacturing companies, regulatory changes and historical performance of pharmaceutical companies indicate that they are going to outperform the manufacturing industry in the upcoming years.

Robust top-line growth

Historically, large-cap pharma companies have averaged 15-17% top-line growth every year during the last five years, organically, due to higher out-of-pocket healthcare costs. Top-line is the revenue or gross sales of the company.

However, revenues are set to get even a bigger boost in 2023 as the DGDA (Directorate General of Drug Administration) has approved drug price hikes for the first time in seven years.

In July 2022, the DGDA approved a drug price hike for 53 drug brands (made using 20 generics). On average the prices of essential drugs have increased 50% to 100%.

Among others, three listed pharma companies are set to benefit most from this hike – Beximco Pharmaceuticals (BXPHARMA), Square Pharmaceuticals (SQURPHARMA) and Renata Limited (RENATA).

Some of the generics that have encountered price hikes, account for roughly 16% (IQVIA, 2021) of BXPHARMA's portfolio, the highest among listed pharma companies. Hence, it is best positioned to reap the benefits of the increased prices.

For instance, prices of paracetamol, one of the most commonly used drugs in the country, will see a 71% increase. Paracetamol accounts for 15% of BXPHARMA's portfolio, the company's revenue is expected to grow 11% due to the price hike.

According to portfolio weight (composition) data computed using IQVIA data, it is estimated that BXPHARMA's revenue will increase 12%, SQURPHARMA's by 2.7% and RENATA's by 0.23%.

Less exposed to global macro risks

Weakening global macroeconomic factors indicate a recession is unfolding. Fortunately, this signals stabilisation of both commodity prices (such as aluminium imported from Russia for medicine packaging), fuel prices and logistics costs.

On top of that, pharma companies are less exposed to recessionary risks compared to other manufacturing companies. Historical data indicates that the performance of listed pharma companies is unaffected by global fuel prices.

Between 2009 and 2013 when crude oil (WTI Crude Oil) prices jumped from $66 per barrel to $99 per barrel, Gross Profit Margin (GPM), which indicates ability of company to manage its cost of production, and Net Profit Margin (NPM), which indicates ability of company to manage all costs and expenses (production and operational), have both improved. 

This indicates that pharma companies are less exposed to risks of oil price volatility. This phenomenon is radically different for other manufacturing companies that are having to bear the burden of increased costs.

Reasonable valuation and return

On a TTM (trailing 12 month) basis, at the end of Q1-22, BXPHARMA, adjusted for vaccine income, was trading at a P/E of 12.8x, while SQURPHARMA was trading at 11x earnings. 

RENATA is expensive compared to the aforementioned companies, as it is trading at a 25x TTM P/E. However, an outstanding management and board allows the company to rebalance its product portfolio in a manner that helps maintain costs and drive growth.

In 2021a, BXPHARMA reported an ROE of 13.8%. That of SQURPHARMA was 17.5% and RENATA was 19.8% respectively.

Furthermore, the companies have the following dividend yield based on current prices and these companies' last dividends are as follows: BXPHARMA (2.4%), SQURPHARMA (2.9%) and RENATA (1.2%) respectively.

Lastly, a 20% tax rate, subject to conditions, for listed companies will help support bottom-line margins and increase likelihood of decent dividend payouts in upcoming years.

Other growth drivers and risks

Monkeypox has been declared a global health emergency by WHO. The organisation also recommended vaccination of high-risk groups. Both medications and vaccines recommended by CDC (US) for prevention or treatment of monkeypox are not available in Bangladesh. 

Hence, it is probable that one of the large-cap pharma companies will introduce it in Bangladesh, as regulators in India begin talks about vaccine manufacturers.

Pharma companies are resilient in the sense that they have the potential to reap benefits from the most adverse of situations. 

For instance, large-cap pharma companies have a growing share of their revenue coming from exports. Given the depreciation of local currency, export earnings will increase in local currency.

Likewise, a global recession is impending. In such anticipation, commodity prices and logistics costs are falling and are further expected to fall. However, given the geopolitical exceptions triggered by the Russia-Ukraine war and Western sanctions, uncertainties remain regarding commodity prices.

Lastly, another concern is increasing load-shedding, which may force these companies to rely on diesel-run generators to continue operations during power outages, leading to added costs of production. This factor is systematic and true for all manufacturing companies.

Even so, the potential of the growth drivers of the pharma industry outweighs the risks such that the companies (discussed above) will most likely be able to maintain margins and growth in adverse market conditions - thus making pharma companies a safe haven for investors as markets continue their "free" fall.

Abrar Ahmed is an Investment Analyst.

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.