4 tips for investing in healthcare

© Provided by The Financial Express Experts believe that the healthcare sector provides a good opportunity for investment.

Unlike seasonal businesses, demand for healthcare products and services more or less remains intact at any point of time. So, like FMCG, investments in healthcare also provide the investors an opportunity to get a relatively stable return.

In fact, during the market meltdown at the onset of Covid-19 pandemic, the healthcare sector-though not spared from some losses-outperformed most of the other sectors.

Experts believe that the healthcare sector provides a good opportunity for investment.

“The first step in investing in any business is to understand the business. The healthcare sector in India is not as difficult to understand as is often made out to be. There are multiple business models within healthcare and the nuance of each business is different. Hence, one has to pay attention to details,” says Aditya Khemka, Fund Manager, InCred AMC.

There are generally 5 different business models within the ambit of healthcare in India, explains Khemka:

Domestic and export branded generics market

Most companies in India sell branded generics in India and many emerging markets. These products are made by these companies and they own the brand and promote the product to the customer as well. This is a high return on equity (RoE) business with very secular growth as penetration of allopathic medicines in India is still growing.

Exports unbranded generic market

Many companies in India manufacture and sell unbranded generics to distributors based out of different developed nations like US, UK etc. The products are not branded and hence there is no differentiation between two manufacturers of the same product. This is a low RoE and highly capital-intensive business which sees bouts of volatility in pricing and volumes.

Active pharmaceutical ingredient (API) manufacturing

Some companies manufacture API and sell it to formulation manufacturers. API is a key raw material to manufacture formulations. This is a B2B business with varied levels of profitability depending on the product segments a company is present in.

Hospitals

Hospitals are generally either multi-specialty or super specialty. Super specialty businesses can be very profitable if the brand is reputed and reach is widespread. Multi-specialty hospitals are less profitable compared to the former but get higher volumes and easier to scale up.

Diagnostics

Diagnostics is a very unorganised market within India with few pan India organized players gaining share from the unorganised segment.

“The healthcare sector has been a wealth creator for shareholders over long periods of time,” says Khemka.

While a basket approach is generally recommended, below are a few tips from Khemka on how to invest in healthcare:

1) Look at the investment as secular and not tactical

Most errors in investing are made due to incorrect timelines. Many investors chose to look at sectoral investments as tactical. However, given that healthcare as a sector in India is secularly growing for the past few decades and will likely do so over the next few decades, we recommend that investors look at this sector with a longer-term horizon.

2) Most pharma companies are conglomerates

Most pharma companies engage in either all of the business models (points 1, 2 and 3) discussed above or a combination of the three. There have been periods where segment 1 was doing well for them while sector 2 was suppressing profits. In such times, it is important to understand these details and value these companies as conglomerates. Consolidated earnings are often suppressed or depressed in pharma due to abnormally low or super-normally high profits in segment 2.

3) Size of the cash flow is not as important as sustainability of cash flow

While conventional wisdom tells us that investing in large market cap companies is “safer”, we recommend that investors do not extrapolate this convention to pharmaceutical companies. It is possible that a company which has a fairly large revenue from segment 2 above, fails to grow revenue for a few years whereas a company that has larger pie coming from segment 1 grows every year.

4) Regulatory risks are a part of this business

Many investors allocate lesser capital for pharmaceuticals stating regulatory risks like price control and USFDA audit failures. We would like to highlight that these risks are a part and parcel of the business and investors have to learn to take these in their stride. These events do create shorter term volatility in profits and stock prices, but pharma companies have exhibited an ability to overcome these setbacks over the longer term.

“Generic pharmaceutical manufacturing is an area where India has exhibited a global competitive advantage. Hence, we strongly recommend that investors not only allocate capital to this segment but maintain their investments for long periods of time to experience compounding of wealth,” says Khemka.

However, with the opportunity to get a higher return, investments in equities also involve capital risk. So, before taking a decision to invest, a prospective investor should consult his/her financial advisor.