Pharma rally mostly played out, 30-40 PE for API cos not justified: Sandip Sabharwal

We should see a phase of consolidation now, but I do not think pharma stocks will get sold out big time unless and until there is a negative surprise, says the analyst, asksandipsabharwal.com.

It seems the action is going to continue in pharma for some more time. Are there any fresh opportunities to invest in or do you think a major chunk of the rally has already played out?
For the near term, a large part of the rally has been played out because it is the most crowded trade today. A lot of people I talk to are 30-40% into pharma now because that has been the sector that has been performing and a lot of stories are getting built up especially around the API opportunity, etc. Finally, API companies are a lot like commodity companies. They are not really branded companies and for them to trade at 30-40 PE is not justified. Plus their earnings tend to fluctuate a lot with the input prices as well as final pricing.

The first quarter was a good one for many of the companies because input prices are low and there was a sudden demand that took the final prices up. We saw a huge gross margin expansion across the board. That is what is happening now in the markets. The price earnings ratios for most of the pharma companies are now almost 25% to 40% more than their averages over the last few years.

One part of it is justified because they were going through very bad times as obviously there was PE contraction. Now they have a PE expansion as earnings come back and the outlook becomes better. But at some point of time, the valuations catch up and beyond a particular valuation based on earnings, it is tough to buy. We should see a phase of consolidation now. I do not think pharma stocks will get sold out big time unless and until there is a negative surprise. Investors need to watch out for a) the impact of rupee appreciation on profitability; b) President Trump has been talking about lowering prices in the US and whether that impacts the generic companies or not.

Are any of these new market offerings or IPOs on your radar?
I studied all three of them. I think CAMS offering has very little to offer to investors. Their growth is just 4-5%. They are coming at a 35 PE. They leave nothing on the table for investors. The only thing which people get excited about is the huge anchor investment because it is a known company but I seriously doubt that there is any big upside because the growth will remain 4-5%.

Similarly, Angel Broking is coming at almost 30 PE on their average last three-year earnings. This year obviously all brokerages are doing much better. So nothing unique in that offering. These are just bull market offerings.

Chemcon does seem to have some unique products given the fact that speciality chemicals and pharma is a fancied sector today and it is coming at around 20-22 PE, which is similar to some other speciality chemicals and lower than some others. So there is a possibility of listing gain in Chemcon, although it is a relatively smaller company. Among the three, this is the one which could offer listing gains and as all of us know that in most IPOs, the state of the market when the listing happens is more important. Among the three, Chemcon seems to be the better one.

The atmanirbharta pitch is going to increase, rural economy is picking up. Do you think it makes sense to buy Emami, Colgate, Dabur, the typical rural facing FMCG companies?
I would think that among all these companies, Dabur clearly stands out not only because of the kind of product profile it has but also because of its success rate in introducing products and categories and making them successful; its success in acquiring brands and making them grow and the new found aggression under Mohit Burman. All these combined make Dabur a compelling case. Dabur has been one of our very old holdings and in fact we have added it over the last few weeks because growth will surprise on the upside for Dabur.

Britannia is also something where I have been positive but given their product categories, as the economy opens up more, we could actually see some sort of negative surprise in the near term because they reported such a huge growth in the first quarter and also will report very good growth in the second quarter. Going forward, as relatively normalcy returns, we could see slower demand for some of their product categories and valuations might need to adjust for that. The stock might go through a prolonged phase of consolidation.

Wipro and Tech Mahindra are two IT stocks which have done well of late, but on a relative basis they are cheap and have not created a lot of wealth. Should one go for TCS instead?
Sandip Sabharwal: We are not comparing very small companies with very large companies, we are comparing relatively large companies with relatively larger companies. Those relatively large companies like Tech Mahindra and Wipro had some issues and those issues were there for a long time because of which their growth was lower than industry.

From the way the management of these companies are speaking and the way things are, it seems like they could be coming back to possibly industry growth rate and maybe Tech Mahindra could actually exceed that. In that context, their valuations are relatively cheap. Cash generating companies which are throwing cash and are also growing while giving very good dividends, need to be evaluated separately.

Wipro and Tech Mahindra will still do well. So what is the right strategy to buy? Whenever there is a dip because of overall market correction, the sector gets some negatives and there is a correction. That is the time to buy. Would investors who are buying now when the stocks have run up, still make money? I would think they would still make money over the next one, two, three years but if you want to make better returns, then it is better to spread out your buys rather than buy it at one shot.