Blog on HealthCare – Time to Invest or Cash out?

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HealthCare – Time to Invest or Cash out?

AIF & PMS Experts recently have curated a spiffing session with Mr. Aditya Khemka (Fund Manager, Incred PMS). The bonzer, Aditya Khemka’s fund once delivered 40% of Alpha with his stewardship. Having an ample amount of experience in the Healthcare industry, he says that, the stock has been beholding the queue of doubling and tripling up by witnessing a lot of peaks and valleys from a long period of time.

What exactly is this industry?

Looking back to the FY 2009 to 2015, it has been a golden run for the healthcare sector. Each and every of these years, the BSE healthcare index has outperformed the Nifty. Some years have observed the outperformance as high as 45% and some years eyed it as low as 5%, but notwithstanding of this fact, it continued to outplay each year. The sector also onlooked the exception as a tenure of four years of reversal where BSE index has underperformed the Nifty. Some period has seen the underperformance of as high as 24% and at some period, the underperformance was as low as 5%. Nevertheless, from past 2 years, the healthcare index started outperforming the Nifty and the outperformance is very likely to persist in.

5 Components of Healthcare Industry

Mr. Khemka addressed primary segments in the Pharma industry which has been illustrated below:

5 Components of Healthcare Industry - HealthCare – Time to Invest or Cash out?

Source: Incred PMS

  • Generics: This presses the price irrespective of the brand. It observes pricing pressure easing, ROE witnesses revival.
  • Branded Generics: It talks about high margin, low capex & steady cash flow business. It is more like branding the products irrespective of their price. It depends on the brand of the product where there is high ROE and no scope of re-investment.
  • APIs: Active Pharmaceutical Ingredient (API) are the raw materials used to produce the finished products. China tops the list in this business by selling 40 billion dollars globally and India sells 4 Billion dollars in the export markets.
  • Hospitals: It is not capital intensive unlike 20 years back. It is more like a retail business now. When new capacity is created, there are losses but once they mature it starts growing in the longer period of time.
  • Diagnostics: It is more of a branded business. A lot of money is spent in their branding and this has become the aspiration to fetch a better diagnostics.

Inclination towards Pharma!

Backpedaling to the Pharma industry, from last 12 years, it had traded at the premium of 35% to the broader market. Just before this rally began, it has gone to 0% premium and after the rally it bounced back to 30-32% premium like it traded formerly.

Mr. Aditya have seen vocalizing the normal logic that is generally applied to the stock pricing. He added that, we are not expensive but are purely traded at average multiples. Any stock price have two components: Multiple and Earnings. Multiple is just the average and talking about earning, the best barometer of earning is return on equity (ROE). Now average ROE for the industry has been about 14 – 15% from last 12 years. The peak was 24% and the valley counts for 8%. The first league of recovery has been witnessed from the bottom.

Going forward no one will really invest in US market. On the hand, the earnings will continue to grow which means there will be an increase in the ROE. If the ROE continues to improve, the multiples will either stay there as it is or continue to improve but will not fall down. If his happens, and the multiple is stagnant, for an investor, the returns on the stock will be equal to the earning growth. On the other side, if the multiple also increases, this opens a window for the investors as there is earning growth plus multiple re-rate. This visualizes for a good opportunity to invest in Pharma.

What stands with the decision-making process?

The session followed the factors that counts for the decision-making process. This could be glimpsed in the figure below:

What stands with the decision - making process? - HealthCare – Time to Invest or Cash out?

Source: Incred PMS

Three constituent contributes for the decision-making process. Buying decision, selling decision and Sizing decision has been addressed to look into while arriving at the destination.

Let’s dive into what these concepts talk about:

Buying decision- Buying has always been overtaught and often over analyzed or under- analyzed. This concept sticks to buying great businesses at fair prices because they are rarely available at discount without having them at extremely rich valuations. Secondly, buying good businesses at discount since they are often misread by the markets and often seen at discounts. Lastly, always avoiding the bad businesses irrespective of their prices.

Selling decision- Sell companies only on two occasions. First is, when the stock runs way too much than our expectations so the risk reward becomes unfavorable. In this case, stock could be sold and replaced with something which can improve the risk reward. The second is the breakdown in the investment thesis. It happens when the expectations and reality goes into opposite direction and shows a negative relationship. This asks for the attention to go somewhere where there is more predictability and seeks the exit irrespective of the fact that we have booked a profit or dipped into loss.

Sizing decision – The last constituent is the sizing of the portfolio. The allocation should be based on conviction. A good room for diversification should be provided so that risk reward could be in favor of each and every investor.

The Fervid session continued to ablaze the attendees with brainstorming Q&A round. In case you missed the opportunity to associate with the experts, we are providing below the link to connect with them on YouTube!

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