49
Kotak Portfolio Management Services Pharma Focused Strategy July 2017
Kotak Portfolio Management ServicesPharma Focused Strategy
July 2017
2
Kotak Portfolio Management
Services
Strong Pedigree Enviable Track Record
Strong Pedigree And Client Focus
3
Amongst the Oldest PMS’ on the street• Over a decade of experience in the Indian capital markets
• Part of Kotak Mahindra Asset Management Co
Proven track record of market beating performance• Since inception, Special Situations Value portfolio has generated
a CAGR of 31.2 % vs. Nifty 500 at 15.4 %
Strong Research and Operations team• 8 member research team
• In-house, top-notch, IT systems and back-office support
Consistent client interaction• Quarterly performance reporting
• Fund manager outlook
Broad Investment Strategy
1. Large market opportunity : Market size should be at least 2x company’s
current sales. This gives the company a long runway for future growth
2. Businesses with robust competitive advantages : Strong brands, High
Switching costs, Network economics , Low cost advantages or Innovative
products
3. Strong Financials and Earnings Growth : We prefer low debt companies
and our portfolio debt to equity is under 0.5x. We prefer companies with
earnings growth and margins higher than their peers
4. Management Dynamism and Good Corporate Governance : We prefer
companies with passionate and transparent management. Asset turns and
working capital turns at industry levels or trending there
5. Fair Valuations : We look to buy businesses at fair valuations, where future
earnings growth is not priced in 4
What is the source of our edge?
Information Asymmetry
Insider trading rules, hence
not possible
Superior analysis of same
data
Possible only in pockets, as
the street is crowded with
analysts
Durable Differentiator
Behavioral
differentiation
Awareness of human
biases and avoidance of
same
Work to consciously avoid Common human biases
Social Proof: Herd like behavior, for safety in crowds
Overconfidence and Over-optimism: In one’s business assessment
Present-ism: Projecting immediate past into future
Misunderstanding randomness: Seeing patterns where none exist
Anchoring: On irrelevant data, etc.
There are three broad sources of outperformance on the Street
Our focus areas
5
SSV Significant outperformance
6
Date of Inception 31-Jul-12
INR (%) 3 Months 6 Months 9 months 1 Year 2 Year 3 Year 4 yearSince
Incp.
KMAMC Special Situations 5.0 20.2 19.2 34.4 31.0 33.8 41.3 31.2
Nifty 500 4.2 19.3 12.7 19.4 9.9 10.5 16.6 15.4
* Returns are of Model portfolio (net of management fee)
** Returns are annualised for periods greater than 1 year
Performance of 100 invested at Inception (31st July 2012 )
380
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SSV Nifty 500
SSV Portfolio Construct
7
Sector Allocation June 2017
Market Cap Break up June 2017
Large Cap17%
Mid Cap66%
Small Cap14%
Cash 3%
Agri Commodities
6%
Agrochemicals2%
Banking and Financial Services
23%
Consumer Products4%
Engineering and
Capital Goods7%
Media5%
Mining7%Others
4%
Paper2%
Pharmaceutical & Healthcare
9%
Real Estate
Development5%
Technology12%
Textiles11%
Cash & Cash Equivalent
3%
Team Details
8
Research Team
Anshul Saigal : Fund Manager Anshul heads the Portfolio Management Services business of Kotak Mahindra AMC. Anshul has a total experience of over 14 years in the Indian Capital Markets, of which he has spent over 9 years at Kotak PMS. In the past he has worked with organisations like JP Morgan, ICICI Bank and Standard Chartered Bank, analysing equities and corporate credit. He is an MBA (Finance) from Management Development Institute, Gurgaon. He reads extensively in a bid to constantly upgrade his skill sets and to instil multi-disciplinary thinking to the investment process. He has particular interest in the field of behavioural finance.
Rukun Tarachandani Rukun is responsible for equity research, new idea generation and tracking the performance of existing holdings. Prior to Kotak, he was with Goldman Sachs as an equity research analyst. He is an MBA (Finance) from Management Development Institute, Gurgaon and an Engineer (Information Technology) from Nirma University. He has also cleared all the three levels of CFA examination. He is an avid reader of books on Behavioral finance, Psychology and Value Investing.
NameSector Managed/ Portfolio
ManagedEducation Background Total Experience
Ms. Shibani S KurianHead Equity Research, BFSI,IT and
Economy
B.Sc (Hons) -Economics,
PGDM16 yrs
Mr. Akshit Gandhi
Infrastructure, Real Estate, Cement,
Ports, Airports, Hotels and Building
material
MBA Finance ,
CFA14 yrs
Mr. Devender SinghalFMCG, Auto, Paints and Consumer
DiscretionaryB. A(Hons) Maths, PGDM 15 yrs
Mr. Nalin BhattInfrastructure, Power Utilities, Real
EstateB. Com , CA 12 yrs
Mr. Mandar PawarOil & Gas, Metals, Pipes, Shipping,
Retail and LogisticsB.Com, MMS 11 yrs
Mr. Dhananjay TikarihaTelecom, Capital goods, Industrials,
PharmaceuticalsB.Tech, PGDM 10 yrs
Mr. Arjun Khanna Auto Ancillary, Media ,MidcapsB.Eng., MMS(Finance),
CFA9 yrs
9
Pharma Sector
Opportunity to average in
Pharma – Wealth creators in the last cycle
-
50,000
1,00,000
1,50,000
2,00,000
2,50,000
Sun Pharma Lupin Cadila Cipla Dr. Reddy's
FY06 FY09 FY12 FY15
16x 7x 2x 4x
12x
Pharma large caps have been the leading wealth creators of the last cycle,
driven by robust US growth and high profitability in India
In ₹. Cr
And more Dollar Billionaires than any other sector
11
Pharma Sector has been a big outperformer
12
In last 15 years – Rs 1 Cr invested in Pharma index would be over Rs 11.1
Cr today, while the same amount invested in Nifty would be Rs 7.25 Cr
13
Pharma Sector has been a big outperformer
Same story in last 7 years – Rs 1 Cr invested in Pharma index would be
over Rs 5.9 Cr today. Same amount invested in Nifty would be Rs 3.1 Cr
14
Law of average also applies to Pharma Sector
Trend changed over last 1 year, with Pharma index underperforming Nifty
by 5.4%... Reversion to the mean
15
Pharma Sector
Past, Present and Future Potential
Pharma Sector – Sustainable Value Creation Drivers
16
Secular growth outlook, reasonably insulated across business
cycles• Penetration & US FDA compliance to drive years of growth
• Moving from simple to complex/ specialty products would provide long
term opportunity of growth
Scalable Business• Huge domestic patient population
• Globally competitive: Most global sector out of India selling in over 100
countries
Shareholder Return Business/Consumer Sector Characteristics• High ROE
• Strong cash flows
• Low Capex
Offers a combination of stability & growth potential
Key beneficiary of the currency depreciation• Last 1 year INR depreciated over 6% vs US Dollar
Pharma outperformance has been driven by Earnings
BSE healthcare has generated an amazing 11% CAGR alpha over BSE
Sensex
The alpha has been mostly a result of superior earnings growth. BSE HC grew
earnings at a CAGR of 20% vs 9% for the Sensex
17 Source: Bloomberg, Kotak Asset Management
Pharma sector earnings have grown at 2x the broader market
2006 - 2016
20% -2%
18%
Earnings CAGR MultipleCompression
Stock Return
BSE Healthcare
9% -2%7%
Earnings CAGR MultipleCompression
Stock Return
BSE Sensex
Earnings growth was driven by industry strength
• Increasing generic penetration in US (largest pharma market)
• USFDA efforts to promote generics led to faster approvals
• Large number of patent expiries of large products and shortages leading to
opportunities for super normal gains
• Volume growth in US Markets accelerated
• These volumes were of higher realizations than the home market and hence
higher margins
• Steady strong growth in the India, which generated cash for investing in
R&D and US entry
• High profitability from the emerging markets
Last ten years were a golden period for profitability and wealth creation in
the sector
However…..dynamics are changing…
• Volume growth decelerated from past levels due to…
• USFDA doubling total number of ANDA approvals as a result of GDUFA
(Generic Drug user fee Act) implementation to increase competition
• Size of patent expiries in chemical entities plateauing
• Focus of USFDA on improving quality impacting facility approvals
• Margins have also been under pressure as…
• Consolidation in US distribution channel has impacted pricing
• There has been an increasing political focus on price hikes
These developments have impacted profitability….
…Leading to Blip in Large Caps’ EBIDTA growth…
-
5
10
15
20
25
30
35
(20)
(10)
-
10
20
30
40
50
60
70
80
90Q
1F
Y12
Q2F
Y12E
Q3F
Y12
Q4F
Y12
Q1F
Y13
Q2F
Y13
Q3
FY
13
Q4F
Y13
Q1F
Y14
Q2F
Y14
Q3F
Y14
Q4F
Y14
Q1F
Y15
Q2F
Y15
Q3F
Y15
Q4F
Y15
Q1F
Y16
Q2F
Y16
Q3F
Y16
Growth P/E
Sector hit an air pocket after robust growth for many years. Valuations
however were still at peak. Sector was primed for a correction
Earnings Trajectory to move
upwards. Valuations to follow?
21
…and Mid Cap EBIDTA growth, with resultant
correction in valuations…
0
5
10
15
20
25
-50%
-30%
-10%
10%
30%
50%
70%
90%
110%
Q1
FY
12
Q2
FY
12
Q3
FY
12
Q4
FY
12
Q1
FY
13
Q2
FY
13
Q3
FY
13
Q4
FY
13
Q1
FY
14
Q2
FY
14
Q3
FY
14
Q4
FY
14
Q1
FY
15
Q2
FY
15
Q3
FY
15
Q4
FY
15
Q1
FY
16
Q2
FY
16
Q3
FY
16
Ebitda growth (LHS) PE (RHS)
Similarly in Mid Cap space also EBITDA compression led to valuation
compression
…and valuations have become reasonable
22
Source: Capitaline, Kotak Asset Management
Valuations have corrected now and are below historical average
49%Average: 48%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
No
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EV/EBITDA premium of BSE HC over Nifty 500
Multiples of Key stocks have corrected significantly from
peak
23
32 32
26
30
2624
2321
2019
0
5
10
15
20
25
30
35
Sun Pharma Lupin Dr. Reddy Cipla Cadila
Peak P/E Multiple Current P/E multiple
Have these stocks become bargains??
PE Multiples have corrected between 25% to 35%
Pharma sector is in consolidation phase
Indicators
Growth
Competition
Regulatory
issues
Profitability
Stock returns
FY06-15
Up cycle
Robust growth in
US and India
low due to rapid
expansion of mkt
Low as USFDA
promoted generics
Sharp Improvement
5x-15x
FY16-17
Consolidation
Moderate US growth.
Steady growth in India
High due to large number
of players
High as USFDA is
pushing to improve
quality
Steady
Correction &
consolidation
FY18 onwards
Up cycle
Moderate growth in
US and India
Low in complex and
speciality products
Likely to see decline in
as companies become
compliant
Expected to improve
as companies move
into complex products
Should do well again
Growth is likely to return in the ensuing future, with concerns
largely priced in
25
Large US Opportunity
Secular Generics Play
US Markets – major growth driver
26
US is the largest market in terms of healthcare spending (per capita
healthcare cost ($8508) in the world
There are concerted efforts to reduce this cost with higher aging
population & slowdown in economy.
Obama Healthcare (The Affordable Care Act) focuses on
providing more Americans with access to affordable health insurance,
improving the quality of health care and health insurance,
regulating the health insurance industry, and
reducing health care spending in the US and hence higher usage of
generic drugs.
This has provided a very big opportunity for Indian pharma companies
to tap the huge generic market in the US
The US generics opportunity expected to be huge over the next 5 yrs
Healthcare is at the center of US Political & Social debates
27
After Esmin Green, a 49-year-old black woman, was involuntarily admitted for "agitation and
psychosis“, she collapsed and died on the floor of a waiting room at a Brooklyn psychiatric
hospital and lay there for more than an hour as employees ignored her. Upon her admission,
Green had waited nearly 24 hours for treatment.
Since the video went viral, there was a public furore about the state of US healthcare
Pharma Sector
Macro environment favourable for the sector
19%
33%
43%
52%
72%
88%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1984 1990 1996 2002 2008 2015
Generics share of prescriptions in US
Share of Generics in prescriptions has risen from 19% in 1984 to 88% in
2015. This trend is likely to favor Indian Pharma
Pharma Sector
Macro environment favourable for the sector
USD 88 Bn of drugs will go off patent in next 5 years and Indian Pharma
will be the key beneficiary
US: 10 years of strong growth for Indian Companies
30
Source: Companies, US FDA
Disproportionate growth of Indian generics companies over last 10 years
is expected to be replicated in the coming years
US$ Mn
Still Revenues of Indian Generics are miniscule v/s Large
Global Generics
The largest Indian Generics company (Sun Pharma) is small by global
generics standards. Large Canvas for Growth
Sun
Pharma
$4.3Bn
Mylan
$9.8 Bn
Teva
$19.5 Bn
Allergan
$17.8 Bn
Sandoz
$10 Bn
32
Domestic Opportunities
Big Consumption Play
33
India is underserved and underpenetrated
Per Capita consumption of medication in India is amongst the lowest in
the developing world. Room for Secular Growth
Many drivers for growth of Indian Pharma market
34
Growth to be driven by a combination of low penetration, growing markets and
increasing insurance coverage/ household incomes
35
Emerging Market Opportunity &
CRAMS
Huge untapped market
EM: India’s Penetration of EM’s is miniscule… large room
for growth
36
Source: Capitaline, Kotak Asset Management
Branded generics dominate sales in emerging markets. Indian Pharma
cos have core competence in this space, which they can leverage to grow
beyond their sub 5% share
EM: Market opportunity is large
37
Source: Capitaline, Kotak Asset Management
The incremental emerging market opportunity is over $200 Bn and
growing at a CAGR of 7%
CRAMS: Drivers for outsourcing
38
Global majors desire to focus on research is a key driver for growth in
outsourcing. India with a low market share to be a key beneficiary
39
Pharma Sector Opportunity
Secular Upside Ahead
Pharma Sector - High growth the norm
40
9%
14%
9%
12%
4%
6%
8%
10%
12%
14%
16%
Revenue Growth (CAGR)
2012 - 2015 2015 - 2017E
Nifty 500 BSE Healthcare
Source: Capitaline, Kotak Asset Management
Revenue growth of pharma companies is expected to outpace that of Nifty
companies over the next two years
Pharma Sector
High RoE at Reasonable Valuations
41
14%
19%
12%
19%
4%
6%
8%
10%
12%
14%
16%
18%
20%
22%
Return on Equity (Avg)
2012 - 2015 2015 - 2017E
Nifty 500 BSE Healthcare
Source: Capitaline, Kotak Asset Management
Pharma companies’ return ratios are also superior by a margin
M&A protects downside
42
The sector has witnessed large M&A activity over the last few years,
which has ensured downside protection
Indian companies in Pharma sector are world class
43
Windlas Healthcare, a small drug
manufacturer which set up a tablet
manufacturing unit in Dehradun, is
one such firm that has come up
trumps from a pre-approval
inspection by US FDA in February.
"We closely examined and re-
examined the reams of FDA warning
letters and made our processes
foolproof against chances of
deviations, or human errors, that
were mentioned in those
letters," Hitesh Windlass, chief
executive, Windlas Healthcare,
told ET.
Source: Economic Times
44
Pharma IPOs have given handsome returns
39%34%
50%
32%
24%
41%
28%
74%
14%
56%
0%
10%
20%
30%
40%
50%
60%
70%
80%
Thyrocare NarayanaHrudalaya
Dr Lal Pathlab Alkem Lab SyngeneInternational
% Gain on listing day % Gain since listing till date
There were 22 IPOs over last 1 year on the Indian bourses. 14 of them are trading
in positive territory today. All 5 pharma IPOs are trading in positive territory
Universe
45
Name SegmentMkt Cap
(Cr.)
5 yr
CAGR
10 yr
CAGR
15 yr
CAGR
Sun Pharma.Inds. Formulation 197,219 30% 25% 31%
Lupin Formulation 66,698 29% 31% 59%
Dr Reddy's Labs Formulation 51,778 13% 16% 16%
Cipla Formulation 41,149 10% 7% 13%
Cadila Health. Formulation 32,448 15% 22% 27%
Glaxosmit Pharma Formulation 32,192 13% 10% 16%
Torrent Pharma. Formulation 22,670 36% 29% 36%
Glenmark Pharma. Formulation 22,412 23% 18% 38%
Piramal Enterp. Formulation 17,877 20% 15% 22%
Alkem Lab Formulation 16,339 NA NA NA
Ajanta Pharma Formulation 12,413 121% 64% 38%
Alembic Pharma Formulation 11,321 NA NA NA
Wockhardt Formulation 10,754 25% 7% 14%
Strides Shasun Formulation 9,725 24% 12% NA
Biocon Formulation 9,642 7% 8% NA
Syngene Intl. Formulation 7,685 NA NA NA
Ipca Labs. Formulation 7,316 14% 24% 34%
Natco Pharma Formulation 7,177 50% 31% 41%
Sequent Scien. Formulation 3,488 55% 34% NA
FDC Formulation 3,294 13% 14% 21%
Denotes outperformance over Nifty 50
Denotes underperformance over Nifty 50
Universe
46
Name SegmentMkt Cap
(Cr.)
5 yr
CAGR
10 yr
CAGR
15 yr
CAGR
Dishman Pharma. Formulation 2,710 27% 6% NA
Indoco Remedies Formulation 2,653 37% 19% NA
J B Chem & Pharm Formulation 2,115 13% 8% 20%
Unichem Labs. Formulation 2,016 3% 7% 19%
Aurobindo Pharma API 43,595 50% 27% 30%
Divi's Lab. API 26,150 24% 27% NA
Jubilant Life API 6,632 20% 5% 36%
Shilpa Medicare API 3,301 37% 32% NA
Granules India API 2,599 67% 29% NA
Suven Life Scie. API 2,454 63% 25% 25%
Vinati Organics API 2,001 40% 59% 39%
Abbott India MNC 10,003 28% 22% 20%
Sanofi India MNC 9,212 15% 7% 16%
Pfizer MNC 8,173 8% 4% 8%
Astrazeneca Phar MNC 2,892 -2% 6% 20%
Novartis India MNC 2,073 0% 1% 6%
Apollo Hospitals Hospitals 18,426 23% 18% 23%
Fortis Health. Hospitals 8,126 3% NA NA
Narayana Hrudaya Hospitals 5,839 NA NA NA
Dr Lal Pathlabs Diagnostics 7,619 NA NA NA
Denotes outperformance over Nifty 50
Denotes underperformance over Nifty 50
47
Catching a falling knife
Recommendation
NSE Pharma Index has underperformed NIFTY in FY 16 by ~ 6.4 %. Few Pharma
Stocks have corrected for concerns like US FDA issues, Few are in the process of
correcting.
The underperformance may continue in FY 17 due to US FDA related challenges
and Rebuilding of pipeline for US Markets.
Market is likely to have discounted many of the concerns & hence could provide
opportunity for a long term investor
Recommend to invest on a STP ( Systematic Transfer Plan ) or SIP (Systematic
Investment Plan ) basis in FY 17 to average your entry into a Pharma Sector
Portfolio
We are aiming to play for a revival in Pharma Sector over FY19 onwards.
Investment horizon of more than three years is a must.
Risk to the strategy is regulatory changes not priced by the market, inability of
Indian Companies to meet US FDA standards, longer recovery cycle than priced
by the market. 48
49
Important Notice
49
Investments in securities are subject to market risk and there is no assurance or guarantee of theobjectives of the Portfolio being achieved or safety of corpus. Past performance does not guaranteefuture performance. Investors must keep in mind that the aforementioned statements/presentationcannot disclose all the risks and characteristics. Investors are requested to read and understand theinvestment strategy, and take into consideration all the risk factors including their financial condition,suitability to risk return profile, and the like and take professional advice before investing. Opinionsexpressed are our current opinions as of the date appearing on this material only.
We have reviewed the document though its accuracy or completeness cannot be guaranteed. Neitherthe company, nor any person connected with it, accepts any liability arising from the use of thisdocument. The recipients of this material should rely on their own investigations and take their ownindependent professional advice. While we endeavor to update on a reasonable basis the informationdiscussed in this material, there may be regulatory, compliance, or other reasons that prevent us fromdoing so. Investors and others are cautioned that any forward - looking statements are not predictionsand may be subject to change without notice.
This document is not for public distribution and has been furnished to you solely for your informationand must not be reproduced or redistributed to any other person. Persons into whose possession thisdocument may come are required to observe this restriction. This material is for the personalinformation of the authorized recipient, and we are not soliciting any action based upon it. Thisdocument is not to be construed as an offer to sell or the solicitation of an offer to buy any security inany jurisdiction where such an offer or solicitation would be illegal. It does not constitute a personalrecommendation or take into account the particular investment objectives, financial situations, orneeds of individual clients.
Statutory Details: Portfolio Manager: Kotak Mahindra Asset Management Company Ltd. SEBI Reg No:INP000000837- Registered Office: 27 BKC, C-27, G Block, Bandra Kurla Complex, Bandra (East),Mumbai 400051, Principal Place of Business: 2nd Floor, 12 BKC, Plot No. C-12, G Block, Bandra KurlaComplex, Bandra (East), Mumbai 400051 Address of correspondence :6th Floor Kotak Towers,Building No 21 Infinity Park, Off W. E. Highway, Gen A K. Vaidya Marg, Malad (E), Mumbai 400097. -Contact details:02266056825
