The COVID-19 pandemic is likely to benefit pharma companies as they will witness improvement in business and return on equity which may further lead to earnings growth and a sector re-rating, Aditya Khemka, Fund Manager of DSP Healthcare Fund, said in a webinar on investment opportunities in the healthcare sector.
"Pharma companies could see favorable impact due to higher demand and better ability to price in export markets," Khemka said, adding that hospitals and diagnostics may see a couple of bad quarters before they recover.
However, he feels, currency, competition and regulations pose risks to the sector.
In terms of valuation, healthcare sector is currently positioned in Low Valuation and Bottom of the Business Cycle and the sector is trading below 10 year average of 42 percent premium to Sensex and at a 10 year low of just 2 percent.
COVID-19 Impact
Khemka detailed demand, supply side and regulatory impact to pharmaceutical companies and healthcare sector on the back of COVID-19 pandemic.
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In terms of supply side impact, Khemka said that Indian pharma companies source 60-80 percent of their raw material supply from China.
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On demand side for pharma companies, he said: "Initial data indicates that India has seen some stocking of medicines due to the scare of a nationwide outbreak. This will be a near term positive but could get normalized over a couple of quarters and may have no long-term impact."
“Indian companies like IPCA Laboratories, DRL, Cadila Healthcare have shown capability and capacity to manufacture HCQS (hydroxychloroquine sulfate ) & chloroquine phosphate (CQP) APIs which are being tested as possible treatments for infected and at-risk of infection population. This can be a meaningful cash flow,” Khemka added.
Speaking about the supply side impact on healthcare sector, the fund manager said that many hospitals and diagnostic labs have seen disruption in their ability to provide normal service. Elective / preventive procedures/tests are being postponed and patients with chronic conditions are being discouraged to come to facilities.
On the demand front, Khemka feels, many hospital chains have informed the government in terms of their willingness to treat COVID patients if need be.
"As of now, the government has enough capacity, but if the outbreak spirals, there could be enormous demand for ICU beds. Many diagnostic chains have been approved to test patients for COVID. Although, the profits may be low per test, the volumes can be very high in the near term. So, I see no longer longer term impact," Khemka said.
Regulatory impact
COVID-19 outbreak has shown government's excessive reliance on China for raw materials.
The government has announced measures to provide incentive to the industry to manufacture raw materials indigenously.
"In case of a outbreak spiral, the number of ICU beds and testing labs in our country wouldn't be able to cater to the demand. The government is aware and may in future consider incentive for the hospital & diagnostics segment," Khemka said.
Investment Opportunity
The healthcare sector outperformed broader market every year from FY09-15 and it has underperformed for every year in FY15-19, Khemka said.
"India business continued its secular growth in FY15-19, however the exports business witnessed volume growth and price deflation leading to RoE moving from 27 percent to 10 percent and valuations moving from 6x PB (price-to-book) to 2x PB over the same period. As a result, we are in a business cycle where pricing is at cyclical lows (so is RoE) and so are valuations. This represents an investment opportunity. We have witnessed growth in base business in US for last 2-3 quarters. We expect the trend to sustain. The sector is at a cyclical low in terms of valuation and margin of safety is high. Going ahead, as ROEs recover, valuations could also re-rate and may lead to a double bonanza," Khemka added.
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