BQ Edge | Incred Capital’s Aditya Khemka On Why Investing In Healthcare Is Different

The healthcare sector is one where popular investing beliefs may not work, he says.

<div class="paragraphs"><p>A technician runs a test at a pilot lab operated by Esco Lifesciences Group in Singapore. (Photographer: Lauryn Ishak/Bloomberg)</p></div>
A technician runs a test at a pilot lab operated by Esco Lifesciences Group in Singapore. (Photographer: Lauryn Ishak/Bloomberg)

While the healthcare sector remains a good investment option, it’s one where popular investing beliefs may not work, according to Aditya Khemka.

In a BQ Edge conversation with BloombergQuint's Niraj Shah, the principal fund manager of healthcare equity portfolio at Incred Capital suggested what investors should keep in mind while considering healthcare and pharma.

Here are the key takeaways:

Smaller Vs Bigger Drugmakers

Contrary to most other industries where larger companies are considered to be more robust, most small- and mid-cap Indian drugmakers have a higher return on equity, Khemka said. That’s because companies earning a higher percentage of revenue from the domestic business are more stable compared to those with higher cash flows from the export business—a segment that’s more prone to competition, he said.

“While larger pharma companies trade at premium valuations even today, we believe volatility in profits from exports will eventually lead to a relative derating of these companies versus the smaller ones,” Khemka said. “We’re far too obsessed with cash flow size and far less focused on the source of the cash flow.”

According to Khemka:

  • Small- and mid-cap drugmakers source most of their revenue and cash flows from branded businesses.

  • They don’t face price erosion or market share loss in most of their revenue streams.

  • Are less capital intensive.

  • Generate higher return on equity.

  • Have more sustainable cash flows with minimum reinvestment requirements.


While 18-19 firms are targeting biosimilars, it may not be as exciting an area as people believe it to be, Khemka said. He expects the segment to grow but return on equity and consistency of cash flow is unlikely to warrant high valuation multiples over time.

The risk-reward may be favourable when buying biosimilars at 7-8-10 times their earnings, but not at a 20-30-40 P/E multiple, he said.

According to Khemka, threats to biosimilars include:

  • Risk of substitution like the U.S. market share loss of Biocon Ltd.’s biosimilar Fulphila’s to Sandoz’s Udencya.

  • Industry data indicates double-digit price erosion for biosimilars amid new entrants in existing molecules.

  • Biologic innovators are cutting prices to meet biosimilar pricing.

  • Although first movers may enjoy cash flow advantage in the first one to three years in India, there will be eventual price erosion and loss of market share once competition sets in.

API Business

Domestic firms have a huge opportunity as even a 10% demand shift from China can double India’s market size, according to Khemka.

“Similar valuation multiples across all (integrated and non-integrated) API companies may not work out well for investors,” he said, adding backward integrated players will have lower raw material price fluctuations resulting in stable gross margins and cash flows.

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“Diagnostics is going to be a consistent wealth compounder,” said Khemka, adding it’s a cash-rich model yielding a high margin and return on capital employed with less capex requirements. “The ROCE of most of these companies is better than that of the FMCG companies.”

Khemka said IPO-induced branding of diagnostic companies has led to a change in consumer behaviour. These companies assure better service, have pan-India presence and provide vast test offerings, he said.

Organised players are growing at 15-20% per annum versus 6-7% among unorganised players that make up 85% of market share.

“This offers a large runway of growth to organised players,” he said. “Next 20-30 years they (organised players) can continue to take market share and still grow in double digits.”


Hospitals are cyclicals that earn returns at the end of the capex cycle, according to Khemka. Those hospitals that have incurred capex in the last two-three years have a lot of fresh losses in their balance sheets, he said.

The most profitable hospital chain in India is Apollo Hospitals Enterprise Ltd., which has a return on equity of 35%. “Younger hospitals have a far lower ROE but as they mature, they will grow at ROE similar to Apollo Hospitals' and the entire chain will grow at that rate.”

As no new capex is incurred, the losses will get narrower leading to better margins, cash flows and lower debt, resulting in re-rating, he said.

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Contract Researchers, Manufacturers

The sector is poised for “super-normal” growth for the next 10 to 20 years, Khemka said. “A lot of large caps will emerge from this space in the future.”

Watch the full interaction here:

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