Finding the opportunities that lie beneath the uncertainty

As healthcare and pharma companies chart their recovery strategies, Aditya Khemka, Fund Manager, DSP Investment Managers, sheds lights on certain market variables that have an impact on strategic decision making, in conversation with Raelene Kambli

Which sectors within healthcare are most impacted by the pandemic and lockdown, and how will it affect their business strategies in future?

I believe that the impact is more severe on the healthcare delivery sector (hospitals, diagnostics, medical devices) and less so on pharmaceutical companies.

Hospitals: The impact is highest within hospitals as they have voluntarily shut down their outpatient departments and are actively discouraging less serious patients from coming to the hospital. The surgeries which can be deferred have been deferred leading to a 30-40 per cent dip in patient volumes for hospitals. Further, medical tourism accounts for 10 per cent of revenue for the larger hospital chains in India. Given the lockdown, medical tourism has come to a standstill. In addition to it, hospitals have a high fixed cost base which would lead to operating deleverage when financial results are released. Hospitals have started venturing into telemedicine (online consultations) which would evolve over time as a viable strategy. Further, the lockdown may increase awareness amongst patients about their own healthcare and hence may lead to more penetration for the hospital business overtime. This may encourage many larger hospital chains to do more CAPEX to increase their presence in the country.

Diagnostics: Due to the shutdown of outpatient departments in hospitals, the lead for diagnostics has been muted. Further, wellness health check-ups are a substantial portion (30-50 per cent) for larger diagnostic chains. Due to the lockdown, wellness patients are also being actively discouraged to visit labs leading to a significant dip in volumes. Diagnostics also have significant fixed costs and thus could experience operating deleverage. In terms of evolution in strategy, diagnostics are increasing COVID testing capacity so that they can absorb fixed costs better. Also, the home collection of samples is increasing vs walk-ins. However, these changes may be short-lived in nature and may go back to normal once lockdown is lifted.

Pharma: This sector has suffered the least as it has been classified as an essential service. In fact, it has been a beneficiary from a demand perspective. However, the sector has seen some transitioning challenges like availability of labour in the factory, delay in delivery timelines owing to lack of transportation facilities, etc. Nonetheless, we have seen many proactive steps being taken by the industry and the government to ease these bottlenecks. We do not see any meaningful shift in strategy for pharma companies going ahead.

What does the turnaround look like for healthcare companies in India?

The turnaround in the pharma sector is being led by stabilisation and a gradual return to growth in export revenues largely led by the US market. The domestic business continues to be stable as it has been in the last 20 years. Further, driven by the fall in prices in export markets, most Indian companies (especially small and midcaps) have significantly reduced their investments and costs related to that segment of the business and hence would show improvement in profitability over time.

For hospitals, new beds (recently launched capacities) are contributing losses while the mature beds (older capacities) contribute a lion share of profits. At the current juncture, most hospitals have stopped capital expenditure. This would lead to lower losses from new capacities while older beds continue to mature and improve overall profitability and RoE.

For diagnostics, there isn’t a challenge in the current environment and hence no turnaround per se. However, the sector will be a major beneficiary of the PM’s Ayushman Bharat programme. The programme would give 10 crore families (45 crore individuals) health insurance which would boost diagnostic volumes (you can’t treat anyone unless you know what’s wrong with them).

What are the market scenarios to be aware of, as healthcare companies start making realistic changes to their strategies?

Price regulations are the single biggest risk to the sector. While India has had drug price regulation since 1975, pharma companies have managed to take these regulations in their stride and still grow profitably. While we recently saw price regulations in hospitals, the profitability of the corporate hospitals came back to original levels with a three to four quarter lag. Similarly, India has introduced a national list of essential diagnostics tests which may be a precursor to price regulation in the space. However, we believe that diagnostics would also be able to tide over the challenge when that happens.

What could be the opportunities in future?

Opportunities lie in the domestic health environment. India has been adapting to the western lifestyle over the past and it is yet to adapt to the western style of medication. We don’t see this gap lasting too long. Eventually and gradually, India would adapt to the western pattern of healthcare consumption as well. Healthcare consumption as a percentage of GDP is 10-15 per cent in the western countries and it is three to four per cent in India.

What are the actionable growth strategies to invest in?

There are several growth strategies ahead of the industry. Improving access and affordability for healthcare by the government will be a cornerstone of the evolutionary process. Opportunities that can be very large in the next five years are:

• Migration of bulk drug manufacturing base from China to India – We have seen the Government of India announce incentive packages for companies that want to start or increase capacities in this space. Concurrently, we have seen companies that have announced or started doing capital expenditure to enhance such capacities;
• Increasing presence in the domestic market to cater to demand buoyed by Ayushman Bharat – Most pharma companies are already well-positioned to cater to this. Hospitals and diagnostics also have enough idle capacity to cater to this demand for the near-to-medium term;
• Plain vanilla generics in export markets – As the larger generic companies of the world exit the plain vanilla generic space (like tablets and capsules) due to lack of market size/profitability, most small and midcap pharma companies are already enhancing capacity to cater to this market and fill the vacuum.

How can healthcare businesses identify trigger variables that will affect revenue and cost?

The single most important trigger variable for revenue is pricing in export markets. Pricing in exports, which is a commodity business, due to lack of branding is purely a function of supply. When supply for a given product expands meaningfully, the prices decline and vice versa. Hence, each pharma company monitors the competitive landscape in a given product carefully to understand the economics of the product. The cost is mostly controllable in the hands of the pharma company itself. However, given the current dependence on China for its raw material and pricing inflation, there is an external variable. Disruptions like COVID can cause fluctuations in cost which may or may not be passed on to the end consumer.

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