Incred Healthcare Portfolio

Fund Snapshot

Healthcare – A Secular Theme

The Indian Pharma Market (IPM) is a secularly growing segment with extremely high RoE due to the brands owned by pharma companies. We expect the market to continue to grow at 8%-10% in sales and mid to high teens in profits

US generic market has gone through earnings down cycle over the past 4 years and has seen signs of earnings recovery. Better pricing and gain in volumes as competition may get crowded out would lead to better RoE of the business in coming years

A ‘valuation-gap’ exists today in many companies where the poor RoE of US business is suppressing the overall RoE and valuation multiples. We expect this to reverse as US generic profitability Improves

We believe the consolidated valuation as of now lends a negative valuation to the capital guzzler (US generics) implying that this business may never turn positive and losses in the business may compound over time. This is highly unlikely and also unreasonable.

Why Indian Healthcare?

Unbranded Generics: Pricing pressure easing & RoE’s seeing revival

• Pricing pressure easing in US market as companies start optimizing their portfolios (price erosion now at 4% vs 17% in 2017)
• China, which is largely dominated by MNCs (~85% ms) is now looking at Indian companies to introduce generics (China market size USD150bn)

Branded Generics: High margin, low capex & steady cash flow business

• Branded generics have high sustainable cash flows, low capex & high RoE with high barriers to entry (8-10% growth & 40%-80% RoE)
• Increasing lifestyle related diseases, better diagnostics and affordability driven by Ayushman Bharat (affordability to expand from 150-200 m individuals to 500-600 m individuals over time)

APIs/CDMO/CMO: ‘China + 1’ a huge boost to API players

• Anti-China rhetoric could play out well for Indian API players. China exports ~USD 30bn worth of APIs vs ~USD 4bn from India. A 10% shift in demand can double India’s API industry size
• Given noncompliance to ESG and recent supply disruptions, Big Pharma is also looking at diversifying sourcing beyond China

Hospitals: Capex phase largely over; time to monetize

• Indian hospital players have incurred huge capex to increase capacity which is coming to an end (Mature hospitals RoE at ~20% vs consolidated 4%-12%)
• This may lead to better margins, cash flows and lower debt resulting in re-rating of the business

Diagnostics: Low penetration to benefit organized players

• Diagnostics is 85% unorganized. With increase in health awareness, the organized players are expected to benefit the most
• The broader market growing at 10% pa and organized gaining share. High RoE and low reinvestment needs

How much should one allocate? – 10%-15% of equity portfolio is justified

• Healthcare portfolio offers a solution that invests in 5 baskets of businesses.
• Upon closer examination, one can deduce that the portfolio in itself is a multi-cap diversified equity portfolio with exposure to 5 segments. The only difference is that consumption in healthcare in non-discretionary and secularly growing, whereas for these analogies, consumption is discretionary.

The thesis for like-to-like comparison

Hospitals

We believe that hospital companies work on similar business model as apparel retail segment, where hospitals have to open new units, track performance of existing hospitals and have similar economics as retail stores

Diagnostics

Just like QSR companies where per store economics, opening of new stores, etc. matter, diagnostic companies too have to open new centres, expand into newer markets

Unbranded Generics

In unbranded generics demand supply determines the price, and hence we believe these companies do not have pricing power; similar to metals and commodity companies

API

Similar to industrials, API companies have huge capacity, higher utilization improves operational efficiencies, scope for China +1 strategy, have global cost leadership

Branded Generics

Branded generics are being considered like FMCG, as patients tend to prefer brands of reputed companies, have large distribution channel, have pricing power, marketing and promotional activities can drive sales

Uniqueness of Incred Healthcare PMS

• Healthcare portfolio offers a solution that invests in 5 baskets of businesses. One can deduce that the portfolio in itself is a multi-cap diversified equity portfolio with exposure to 5 segments. The only difference is that consumption in healthcare is non-discretionary and secularly growing, whereas for these analogies, consumption is discretionary.
• Portfolio currently has a larger allocation to domestic oriented businesses
• Currently, ~75% portfolio is Small and Midcap space (with very limited dependency on US business) and a long runway to growth
• Managed by a domain expert fund manager Aditya Khemka, who has always been professionally associated with Healthcare businesses and investments)

Why Indian Healthcare equity?

• Indian Companies in Healthcare are globally competitive
• Healthcare consumption is non-discretionary (Zero beta)
• Over the last 10 years, the BSE Healthcare Index has outperformed Nifty50 by a total of 100% (~3.3% annualized outperformance).
• Valuation still below 10-year average : Improvement in Business and Return on Equity (ROE) is leading to Earnings growth