Thursday, June 4, 2015

Sun Pharma would not remain a defensive stock; So will be TCS

During last few years, when Rupee lost significantly against dollar, two export oriented industries - Pharma and IT were seen as defensive in the stock market. When the broader market was seeing sell-off, these two sectors attracted that money. And the leaders in those sectors Sun Pharma and TCS respectively, outperformed Nifty.

3 Year stock performance chart for Sun Pharma and TCS along with Nifty (Source: Google Finance)

But that story seems to be changing now. When Sun Pharma announced its last quarter results, stock fell by 10%. And when the broader market is seeing selling pressure, Sun Pharma joined hands with them which was unusual few months ago. What has changed? Sun Pharma has become real big, that’s all. When a company is small with great products, and it has a growing market, both its revenues and profits will expand rapidly (like it is happening in e-commerce now). But when the target market reaches a saturation point and the company in focus has already grabbed a big market share, its growth opportunities will reduce. For further revenue growth, it has to acquire other players in the game. So Sun Pharma bought out troubled Ranbaxy. That would mean cost structures would change for the combined entity before they are properly integrated. There will be many one-time expenses as Sun Pharma reported in its last quarter. But for few more quarters to come, margins would take a hit. And the stock would react accordingly.

Similar structural changes are happening in the IT industry too. Their customers are tightening their spend. Revenue expansion in double digits is not a ‘taken for granted’ any more. When the top lines would stall, operational models need to be tweaked to generate more profits. Once the operations are also set in great order, there is not much to optimize. Profit growth too would slow. TCS did grow at a good pace in the last decade, did many M&A and then worked on its cost structure to generate superior profits. But now it is seeing that market it serves is not growing like before and there are many avenues left inside to tweak and save considerable cost. So there is a likelihood that it would not keep up with its pace like before. But look at the P/E multiple of stock. It is lot higher than industry P/E and the index P/E. When earnings do not grow at the same rate as before, its P/E multiple would shrink and the stock price would not command the same premium. In the quarters to come, do not be surprised if TCS stock behaves the same way Sun Pharma stock did after this quarter result. Tech Mahindra (another IT stock) lost 10% after its latest earnings surprised investors.

I do not mean they are turning bad companies but there are signals that their stocks may not outperform. They would become what Reliance Industries has become, a slow moving big elephant.

1 comment:

  1. Sun Pharma plummets 15% after FY16 warning spurs downgrades

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