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Assessing impact of COVID-19
As per ICMR, the number of positive cases in India has increased to 341 out of total ~16,100 people being tested and six deaths have been reported. Based on our channel checks, the pharmaceutical industry has not faced any direct impact of COVID-19 until now. As medical supplies are critical in nature, they have not been affected in any country and we don’t foresee any meaningful impact on continuity of supplies or logistics. Possibility of raw material shortage had been a concern, however, sufficiently large inventories and resumption of supplies from China have allayed this concern. On the other hand, INR depreciation would benefit the export focused companies. Hence, we remain positive on the sector and don’t expect any material negative impact of COVID-19.
* Concerns surrounding raw materials easing: China is one of the largest supplier of Active Pharmaceutical Ingredient (key drug) as well as the intermediates (key starting materials apart from API) for pharmaceutical products. As per experts, the dependence of India on China for raw-materials is ~60-70% (both direct and indirect). Most of the pharma companies generally store ~3months of inventory of raw materials. Owing to Chinese new year (holidays in China) and initial concerns of COVID-19 inventory levels were raised. Currently, most of the companies have sufficient inventory till May’20. Recently, supplies have resumed from China albeit at lower levels. Sufficient inventories and resumption of supplies from China have allayed major concerns surrounding raw material shortage at the moment.
* Very less probability of supply chain disruptions for medical products: We don’t expect any major supply chain disruptions for pharmaceutical products on account of lock-down in several geographies and closure of some airline services. This is due to the inherent criticality of medical supplies that they are part of the priority list of all countries. Companies have not faced any logistical issues even in countries under lock-down, although, there could be some inventory pile-up in near term. Hence, we expect some sales preponement with customers and distributors holding onto higher inventory driven by uncertainty brought by COVID-19.
* INR depreciation to be an additional benefactor: The INR has depreciated ~7% in recent past and we expect it to be positive for the export focused companies. However, companies do have forex outgo such as import of raw material, payments to foreign offices and servicing foreign debt. Also, most of the companies hedge some part of their net forex exposure while keeping the balance open. On a net basis, most of the companies would have net forex inflow which would benefit profits due to INR depreciation against USD. We have done sensitivity analysis of impact on net profit from 5% INR depreciation vs US$ (refer Table no 3).
* Our view: We believe COVID-19 will not have any meaningful impact on pharmaceutical industry and major correction in stocks would provide opportunity to add at reasonable valuations. We upgrade Torrent Pharma and Alembic Pharma to BUY and Shilpa Medicare to ADD on reasonable valuations. Top picks:
Cipla: Renewed strategy of India focus, rationalisation of R&D spend towards US and attractive valuations.
Torrent Pharma: Among best execution in India business, deleveraging of balance sheet end and focus on return ratios.
JB Chemicals: Solid India performance, improving margin trajectory, consistent track record of shareholders’ reward and attractive valuations.
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