As pharma crawls back into spotlight, here are Aditya Khemka's tips for spotting value investments

Aditya Khemka, fund manager at Incred PMS has 17 years of experience in covering the pharma and healthcare sector and currently manages a Rs 200 crore healthcare fund.

The pharmaceuticals and healthcare sector is slowly crawling back into the spotlight as several market experts see pockets of reasonable valuations in this corner of the market. Combine that with the strong growth prospects for the various segments within the sector and one might end up finding investment options offering lucrative opportunities of strong future returns.

However, the sector is highly fragmented, with companies in different sub-sectors driven by distinct growth factors and triggers that make the hunt for good investment opportunities that much harder. To tackle this, InCred PMS's fund manager Aditya Khemka, who has 17 years of experience in the sector and currently manages a Rs 200-crore healthcare fund, suggests three key parameters that investors should consider when sifting for value investment opportunities in this space.

Pricing power

For Khemka, the freedom to set prices is a crucial metric when evaluating companies in the pharma and healthcare space from an investment perspective. He highlights the importance of identifying companies that can set their prices independently, without being pressured by competitors.

Khemka illustrates this by comparing non-branded generics—where companies lack pricing power and are vulnerable to price erosion as competition for a specific drug grows—with branded generics, diagnostics, and API (Active Pharmaceutical Ingredients) for innovators. In the latter areas, companies typically possess strong pricing power, which helps protect their margins.

Steady cash flow

Another sector metric chalked out by Khemka is the sustainability of cash flows. He suggests investors evaluate whether a business will continue to thrive in the future and avoid those likely to face declines.

One practical tip for this analysis is to determine whether the company's revenue relies on a product or service that could lose relevance in the near to medium term. If so, these companies are at risk of inconsistent cash flows, making them more vulnerable to earnings declines and sharp stock corrections during tough times.

Also read | Top healthcare stocks that keep mutual funds in the pink of health

Khemka uses non-branded generics in the US as an example, noting that their earnings growth, often dependent on the exclusivity and market size of certain drugs, may falter once competition intensifies, leading to unstable cash flows.

Efficient capital deployment

Thirdly, Khemka suggests evaluating the efficiency of capital deployment, such as improvements in return on equity or return on capital. Efficient use of capital indicates a well-managed company, according to him.

He believes businesses characterised by shorter timelines from setting up capacity to pushing the product or service into the market are more vulnerable to increased competition in the future, hampering the efficiency of their capital deployment.

The real challenge for businesses, Khemka says, lies in building a brand: convincing doctors to prescribe it, patients to trust its quality, pharmacists to stock it, and wholesalers to distribute it. "This process can take a decade to break even, but once you do, the business becomes a long-term success, with growth and profitability continuing to rise," he says.

The key point Khemka tries to make is that investors being drawn to businesses with the promise of quick earnings growth in the next one or two quarters is a short-term mindset and is common. "When everyone piles into the same investment with the same expectation, the result is often a rush to sell once the initial gains are realised," he warns.

"In investing, patience and long-term perspective are key to achieving greater rewards, similar to how building a brand and market presence takes time but leads to enduring success," Khemka adds.

Also read | Pharma deep dive: Not the time to buy hospitals, bullish on diagnostics, says Incred’s Khemka

Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.