Valuations, near-term outlook leads DIIs' exit from pharma stocks

There is a divergent trend of institutional holdings in the healthcare space with foreign institutional investors (FIIs) increasing their stake while the domestic funds (DIIs) have reduced their holdings. In the March 2015 quarter, while healthcare attracted the second largest inflows across sectors at $702 million from FIIs, the sector saw the largest outflows by domestic investors at $472 million.

At the end of the March quarter, while FIIs had increased their holding by 50 basis points on a sequential basis to 26.4%, DIIs had reduced the same by 60 basis points to 6.7% (see chart). Although prior to September 2013 quarter, too, the trends were divergent on various occasions, there have been instances when the trend has been same. With regards the recent trend, except for a very small change in December 2014 quarter, the last four of five quarters has seen a divergent trend in FIIs and DIIs holdings in healthcare space with FIIs largely been buyers and DIIs emerging as sellers.

The hike in FII limits in select stocks as well as profit-taking by domestic institutional investors are the key reasons for the trend. Over the last few months FII limits and foreign investments have been hiked/increased for companies such as Lupin, Glenmark Pharma and Aurobindo Pharma. In fact at $353 million, Lupin received nearly half of the overall FII inflows into the sector.

There has also been a churn in DII portfolio away from defensives towards cyclicals with the fast moving consumer goods and healthcare companies witnessing the highest outflows on a sequential basis by domestic investors in the March quarter. Unlike FIIs, domestic investors are significantly overweight on capital goods, oil and gas and PSU banks, according to Motilal Oswal Securities.

"Domestic funds are more optimistic about the recovery and believe that cyclicals are highly undervalued and once recovery starts these stocks will give good returns. Since pharma stocks have gone up quite a bit, they have booked a bit of profit from defensives such as pharma," says Daljeet Singh Kohli of IndiaNivesh. FIIs, according to him, want to see some change on the ground to go completely overweight on cyclicals with not too many good options in cyclicals with some of them burdened with debt, he adds.

There is also a view in the market that valuations are still quite high despite the fact that the US FDA product approvals have come down dramatically. Either approvals come in or valuations correct but neither is happening, says an analyst. "DIIs have cut their exposure to pharma given the higher valuations and moving to other sectors where valuations are more supportive, it is cyclical shift. Globally FIIs are more comfortable in the healthcare space," says Vikas Khemani, president and CEO, Edelweiss Securities.

Analysts say FIIs are looking at the long-term story and initiatives of Indian pharma companies to transform themselves into global players with a focus on niche pipeline, geographic expansion and R&D to improve revenues and margins.

Abhishek Sharma of IIFL says that domestic investors have been major buyers of the pharma companies in the 2010-2014 period and some of the funds still have a major exposure to pharma. Of late there has been some profit-booking due to a sharp run in price as well as valuations as compared to 2012 levels.

While the healthcare space has been one of the best performers over the last few years, valuations too have moved up substantially. From 18.7 times one year forward earnings estimates in FY12, valuations had peaked at 27 times at the start of FY15 (Q1FY15) before correcting to the 24 times at the end of March quarter 2015.