This article is part of Morningstar's "Perspectives" series, written by third-party contributors.
The Asian middle class is growing fast and they are more willing to pay for healthcare services and quality drugs than ever before. However, as the industry is still developing, companies in the sector can be a mixture of wheat and chaff. This means investors need to be careful in navigating the different healthcare stocks on offer.
From a bottom-up investment approach, three Asian pharmaceutical and healthcare providers have long-term growth potential. Among these are Aurobindo Pharma (524804), one of India’s most successful pharmaceutical companies; China Resources Pharmaceutical Group (03320), a leading drug distributor operating in China; and Bangkok Dustit Medical Services (BDMS), a network of hospitals and clinics in Thailand.
Hyderabad-based Aurobindo Pharma Limited has the potential to expand its business on a global basis by leveraging M&A opportunities. Historically, it has been good at bolt-on acquisitions to bolster its product line-up, such as Actavis’s Western European operations, Natrol in 2014 and Portugal’s Generis Pharma in 2017. Its strategy has slightly changed recently and it is now pursuing larger market share; its acquisition of American pharmaceutical company Sandoz US makes the company the second largest generic player in the US by number of prescriptions. In a commoditised US generic drug market, the company aims to stand out though its focus on R&D.
The Indian company has spent 4% of its sales on R&D in 2018 and forecasts that the ratio will increase gradually but steadily as it moves towards filing complex products. These include depot injections, which are slow-release, slow-acting form of medications; and biosimilars, a biologic medical product that is almost an identical copy of an original product that is manufactured by a different company, which enables them to secure strong margins under downside pressure to the price of generic drugs.
Our second investment case in the healthcare space is China Resources Pharmaceutical, one of the largest drug distributors to hospitals in China. This story isn’t about cutting-edge research but rather scale, financial strength and industry consolidation. The company is listed in Hong Kong and with 30-50% of its lending happening there, it has natural advantages against its competitors in mainland China in terms of financing cost. Cheaper finance enables the company to provide hospitals longer A/R turnover days than other distributors.
M&A Opportunities in China
China Resources Pharmaceutical also has deep knowledge and experience in concluding mergers and acquisitions to spur growth. The company envisions that there could be major M&A opportunities at provincial level in China in three to four years. Provincial leaders in the country have been gaining market share following the implementation of China’s two-invoice policy in 2017, which aims to cut multi-tiered distribution by mandating a maximum of two invoices between a manufacturer and a hospital. In a few years’ time, there could be consolidation opportunities when growth starts to plateau.
Our third stock, BDMS, is Thailand’s largest private hospital operator. It has benefited from the rise of the ageing population in the country and the increasing demand for a better quality of medical service, a trend supported by higher disposable income in Thailand and its neighbours Cambodia and Myanmar. Thailand is also becoming more competitive as a destination for medical tourism. This has allowed BDMS to expand from a single hospital in 1972 to a network of 47 hospitals as of December 2018, through both organic green-field expansions and acquisitions.
The keys to its success include an integrated healthcare value chain from preventive to curative and rehabilitative services and constant upgrades in its ability to offer more complex treatments, through initiatives such as conversion of its mature hospitals into “centres of excellence” with specialised fields of treatments.
Nonetheless, consideration of risk needs to be taken when it comes to investing in Asian pharmaceutical and healthcare providers, mainly due to governments’ budgetary constraints on healthcare spending. For instance, presently, Chinese patients only pay one third of the costs of their medical treatment out of their own pocket, with the government and their employer covering the rest of the bill. In other words, drugs, medical consumables and healthcare services are still heavily reliant on fiscal budget allocation to the healthcare space in Asian countries. However, healthcare spending to GDP is still much lower in Asia as a proportion of GDP than it is in the West, so there is plenty of scope for future growth.
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The views contained herein are those of the author(s) and not necessarily those of Morningstar.
