Stock pick of the week: What has made Cipla a favourite of analysts

The Indian pharmaceutical sector has been facing the heat for past several years owing to sales slowdown in the US export market. This is the reason behind the sector’s 30% underperformance (ie ET Pharma Index fell 18% compared to 12% gain in Sensex) in the past one year.

Besides, stock prices of individual companies also react violently to the ‘letters’ they get from the US Food and Drug Administration (USFDA) once in a while and this time it was Cipla’s turn. The pharma company’s share price crashed after USFDA issued notice with 12 observations about its Goa facility, which contributes around 25% of its export to the US. The US business contributes 21% to Cipla’s overall sales.

However, the analysts say that the US FDA observation letter is not very serious and therefore, doesn’t deserve such reaction. These are procedural observations about its facility, equipments, etc and not on data integrity or drug specifications. Only two of the 12 observations, about lack of adequate procedures for the prevention of microbiological contamination merit concern while the other observations like equipment design, size and construction of the building, etc can easily be mended. Also the fact that Cipla has handled US FDA issues quite well, the chance of this ‘observation letter’ becoming a ‘warning letter’ later, ie impacting exports from this facility, is remote. Even if Cipla fails to deal with these procedural issues on time and it ends up as a warning letter, it will not impact the company much, as most of the products from its Goa facility also have filings from alternative facilities.

Analysts’ views
Buy: 23
Hold: 17
Sell: 3

Analysts are also getting bullish on Cipla now because the recent price correction is much more than warranted by the fundamentals and therefore, the risk-reward ratio has turned favourable. For example, Cipla is currently trading at 20% discount to its historical valuation average. Since Cipla is a strong domestic player and its US contribution is less than that of its peers, the valuation discount of this magnitude is unjustified.

Despite the tough environment, Cipla is taking steps to increase its US business by introducing one limited product every quarter and that has started yielding results also. For example, its US business grew by 67% in the first quarter of 2019-20 due to increased Cinacalcet sales. Cipla also got approvals for Ambrisentan and Pregabalin in the first quarter and the same should help Cipla to show higher growth in coming quarters.

Cipla Ltd compared with ET Pharma and Sensex. Stock price and index values normalised to a base of 100. Source: ETIG and Bloomberg.

Selection Methodology: We pick up the stock that has shown maximum increase in “consensus analyst rating” in the past month. Consensus rating is arrived at by averaging all analyst recommendations after attributing weights to each of them (5 for strong buy, 4 for buy, 3 for hold, 2 for sell and 1 for strong sell) and any improvement in consensus analyst rating indicates that the analysts are getting more bullish on the stock. To make sure that we pick only companies with decent analyst coverage, this search will be restricted to stocks with at least 10 analysts covering it. You can see similar consensus analyst rating changes during the last one week in ETW 50 table.