Even after the pharma and healthcare sector’s strong run in recent months, Chirag Dagli, a fund manager with DSP Mutual Fund, isn’t concerned about valuations stretching beyond fundamentals. He believes valuations within the sector are still far from their historical highs and also at a discount to the overall broader market, leaving more fuel for them to go further.
Dagli manages the DSP Healthcare Fund, which has been investing in Indian and global pharma and healthcare companies across the large, mid, and small-cap segments, since 2018.
“The premium of the BSE healthcare index versus the broader indices is at a discount, and historically, or on average, it has been at a premium, so that way, I think valuations are doing fine,” Dagli said in an exclusive interview to Moneycontrol. “We’re not worried about valuations to be honest; sure, the sector has done well recently, but it’s only a bit of catch-up going on.” He also pointed out that in the past couple of years the sector has been a consistent underperformer as compared to the broader market.
According to Dagli, the strong growth trajectory expected of the sector also supports its valuation metrics. He also forecasted strong scope for varying double-digit growth across the various segments within the vast spread of the pharma and healthcare space. “I think there is a scope for double-digit growth across most segments, whether it is APIs (Active Pharmaceutical Ingredients), hospitals, India formulations or export-oriented companies,” he said.
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Dagli also remains optimistic about the API segment which has been an underperformer in the pharma space. In recent quarters, the API segment has struggled with raw material inflation, and a high base due to COVID-related sales and eroding margins. However, Dagli’s optimism suggests the weak trend for APIs might soon wither away.
“Volumes for APIs always had steady growth as they are, in a sense, linked to overall pharma volumes, which are generally doing well. What happened in APIs though is that intermediate prices went through the roof and even though price hikes were announced, they came with a lag. Consequently, margins were under pressure for the last one-and-a-half years,” Dagli explained. “But now, this is normalising as price hikes are coming through and raw material or intermediate prices are also coming off from the highs we’ve seen in the past few quarters. So, profitability for APIs will certainly improve and I think we will start seeing this from the first quarter onwards.”
Diagnostics worry
Another segment within the pharma and healthcare space that has many analysts concerned is diagnostics. The entry of new-age online players with cheaper pricing and the sector moving away from the high-margin COVID-related revenue has made things difficult for listed diagnostic players. However, here, too, Dagli sees an element of price-led growth coming back for these listed diagnostics players.
“Pre-COVID, most of these diagnostics players used to have between 2-2.5 percent portfolio-wide price increases. But for the last four or five years there haven’t been a lot of price increases. However, with the recent price hikes by the likes of Dr Lal Pathlabs, Dagli sees some element of pricing coming back at the margin level, even though it is not as much as 2 percent but 1-1.5 percent on a portfolio basis.
Additionally, Dagli said that it remains to be seen whether these price increases will persist into the following year. He clarified that while the pricing pressure on these companies has somewhat decreased, it will take some time to determine if it has completely dissipated or will return to previous levels. It is also worth noting that listed diagnostics companies have also emphasised that they do not anticipate significant pricing pressure from the emerging new-age players. These newcomers are predominantly focused on the wellness segment, which constitutes only around 5 percent of the revenue for the established companies.
Positive outlook
On growth prospects, Dagli is confident that the pharma and healthcare sectors will witness a trend of margin improvement over the next year. This anticipated margin recovery is based on several factors, including the completion of capital expenditure by most domestic-focused companies, easing pricing pressure within the US market, and a moderation in the raw material prices of APIs. As these favourable conditions converge, Dagli foresees a positive upturn in profit margins for companies in the industry.
Furthermore, Dagli also commended the remarkable progress achieved by Indian pharmaceutical companies in recent times. After focusing on the generics space for the past decade, several Indian drugmakers have now significantly increased their investments in research and development (R&D). This strategic shift has enabled them to enter the market for complex generics, a segment characterised by high profit margins and lower competition.
“I think this complex generic journey for most of our Indian players is on and the effort that they’ve put into building these complex generics over the last four or five years will yield tangible results in the near future,” Dagli said. “This is no longer just talk; we are seeing Indian players get approvals for a lot of complex generic products and more of that will happen over the next few years. Whether it is complex injectables, complex inhalers, or all of those products, I think more of that will be seen in the coming time.”
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