Defensive Sectors: Are they still “No Longer Defensive” on the stock markets?

On 10th November 2015, we discussed how defensive stocks (in IT and pharma space) are no longer defensives in nature on the domestic equity markets. Since then, while the combined market cap of top five pharma stocks fell by a whopping 27.5%, the same for top five IT companies fell by lesser extent at about 2% as of yesterday. However, the Sensex has moved up 21% from 25,743 on 10 November 2015, to around 31,100 yesterday.

The sectors which used to provide safety in the falling markets historically have now actually failed miserably in the rising markets.

The pharma space has underperformed by 50% in comparison to Sensex in this period. The stringent regulatory norms and pressures on realisation in the export markets have primarily led to the destruction of wealth in the pharmaceutical sector.

The base effect of the IT exports, uncertainty regarding the visa issues and slowdown in the global growth are the reasons behind poor performance of large IT companies since November 2015.

About five years ago, the number of Indian pharmaceutical companies getting observations/alerts/warnings from the US FDA (regulator) was a small proportion of the total number of companies. But now it is very difficult to find out which pharma company in India hasn’t received such adverse reactions from the regulator.

For the large IT companies, the year-on-year revenue growth in the US dollar term first slipped into single digit, then since the December 2016 quarter, they started growing in single digits even in rupee terms. It is going to be very difficult to get back to strong double-digit revenue growth as the base of India’s annual exports has grown beyond $100 billion.

However, the stock prices of some of the large pharmaceutical companies have crashed more than 50% from their 2-year peak prices and are trading at roughly half their valuation (PE) multiples that they commanded about 3 years ago. Similarly, the IT stocks’ valuation multiples have also shrunk to around 13 to 14 times on one-year forward earnings as compared to over 20 times 3-4 years ago.

Most of the large IT and pharmaceutical companies continue to enjoy strong balance sheets with either a significant amount of cash or a low debt and solid working capital management system. Thus, cheap valuations and strong balance sheets could make some of these large companies in the so-called defensive sectors to become real defensive stocks in the near future.

The writer is founder and managing director, Equinomics Research and Advisory