InCred’s Aditya Khemka On A ‘Well-Made’ Healthcare Portfolio, And His Top Bets

A “well-made healthcare portfolio” can help tide over the impact of inflation and rising interest rates, according to Aditya Khemka, fund manager at InCred Healthcare Fund.

InCred has invested 45% of its healthcare funds in branded generics, 20% each in hospitals and API manufacturing companies, and 5% in diagnostics, he told BQ Prime’s Niraj Shah in an interview. The rest comprises 7% exposure in unbranded generics and 3% cash.

Unbranded generics, Khemka said, are like any other “commodity” where whoever can sell the cheapest gets the highest volume but at the cost of margins. Since demand for unbranded generics in markets like the US is stable, supply would be the price-driver. According to him, “there is more and more supply hitting the market” and therefore, “he does not see the pricing improving”.

Branded Generics

Branded generics have the most stable risk-reward ratio, and are Khemka’s top bet. This is followed by hospitals, diagnostics and APIs. Active pharmaceutical ingredients, he said, have the highest risk-reward ratio.

Branded generics is a hold-to-maturity business, Khemka said. “While the branded generics business in India is extremely competitive, it is also extremely profitable.”

But it takes 8-10 years to build a brand and the company must have the money to stick through that period, he said.

According to Khemka, it's the only sector where large companies have lower return-on-equity than smaller companies. The reason, he said, was that a small company may only be doing branded generics, while a large firm may have unbranded, branded and APIs.

Hospitals

The hospital business, Khemka said, is similar to branded generics where people go for the brand of the hospital and the doctors, building loyalty. Superspecialty hospitals are his top bet in the segment.

Across the globe, superspecialty companies are valued higher than multispecialty companies, he said. “It is only in India right now that super-specialty hospitals are available cheaper than multispecialty hospitals.” While multispecialty hospitals enjoy scale and are being preferred by investors, a superspecialty hospital’s audience is “extremely sticky”.

The perception towards superspecialty hospitals, he said, is changing. “One should focus on cash flows when the business is asset-heavy.”

Except for FMCG, the only other business that has a negative working capital is hospitals, he said. “A negative working capital means absolute bargaining power where customer is at your mercy and you can ask them to pay sooner, while you can pay your vendors later.”

Diagnostics

As competition intensifies with some chains offering discounted pricing, Khemka said “diagnostics is a branded play; there is quality attached to it, perception attached to it and acceptability attached to it. If the doctor does not accept the report and asks it to be redone, then what use is the low price”.

Khemka, along with portfolio manager Marcellus Investors, acknowledged that on ground, competitive pressures resulting in pricing erosion or lower business is not evident.

The non-covid business for the listed diagnostic companies is recovering, he said. “If competition were the key factor impacting these companies, then growth in the non-covid space would not have happened and the business would have gone to new players.”

Since 85% of the diagnostic market is unorganised, “there is enough space for new players to come and cannibalise the unorganised market share”, Khemka said.

APIs

Khemka looks at API in two buckets—the branded generics that comprises contract manufacturing for innovators or for branded players; and contract manufacturing for generics.

“The outlook on contract manufacturing for innovators has never been better,” said Khemka. “The problem area is contract manufacturing for generics.” This is where there is significant pressure since the customer is under pressure, raw material pricing is going up and it is difficult to pass on costs, he said.

But if the manufacturer has a lion’s share of profit coming from the innovator side, it is pretty much insulated from what happens on the generic side, said Khemka. That’s the business that InCred would want to buy.

Watch the full interview here: