Quarantine Expectations – The Entire Series

Given the length of the note, I had posted multiple posts over the last 2 months under the Expectations series. Here is the long note of the quarantine expectations series of posts in one place.

The uncertainty right now is significantly higher than usual. From high inflation to deflation, low interest rates to high interest rates, slow to fast recovery etc. Every option is quite plausible in this interconnected world. If good forecasting is out, the best we can probably do today is figure out the right questions to ask about the economy and pay attention to those questions as reality plays out. 

The series captures thoughts around few lingering questions that many of us have been thinking about:

1) Are we seeing a repeat of the Global Financial Crisis of 2008 or the Great Depression of 1929?

2) What is Global impact of this pandemic?

3) What is the impact of Emerging markets and especially India?

4) What are the top trends going forward?

5) Risk mapping across Sectors- how will different industries be impacted

6) A dive into few sectors/subsectors that show resilience: Sector Trends: (a) Automotive; (b) Consumer Durables; (c) Platform Plays; (d) FMCG/ Food/Beverage; (e) IT Services; (f) Healthcare; and (g) Pharmaceuticals

So here we go:

1) THE CURRENT PANDEMIC IS DIFFERENT FROM GLOBAL FINANCIAL CRISIS (GFC) AND GREAT DEPRESSION of 1929

The GFC and Great depression were a financial shock or a credit shock, stock market collapse and housing bust. That led to a slowing economy, debt distress, unemployment, the wages going down, prices going down resulting in a collapse in aggregate demand, and deflation. Therefore, with quantitative easing and running deficits (in GFC), one essentially avoided the recession from becoming a depression with deflation. That policy response took care of the collapse of aggregate demand and the huge output gap.

Today’s situation is fundamentally different in one major way. In addition to other issues, we are having a negative supply shock across multitude of products including food produce. The breakdown of global supply chain may impact production and transfer of food produce and other products. If you cannot produce and transfer food, then you'll have a shock to food prices.

For e.g. if we revisit what happened in China last year, you had a small shock in the form of swine flu, and the swine flu alone led to culling of large number of pigs and pork output plunged. Consequently, price of pork went up 100%. This was just a little tiny swine flu in China.

Think about how these pandemics can disrupt a global supply chains in and around the world, and especially food supply chains. That's can be a huge negative supply shock.

 Monetary and fiscal measures can smoothen a financial system but may not be enough to manage the supply shock that is expected from this pandemic.

2) WHAT IS THE GLOBAL IMPACT OF THIS PANDEMIC?

The world is highly interconnected. E.g. Russia & Saudi oil price war leads t shut down of shale companies in North America and jump in credit spreads in junk bonds in the US. A lock down or shutdown in any country has a much wider global impact due to global inter-connectedness.

This pandemic seems to be the tipping point in the already fragile world order. The full magnitude of the aggregate demand shock may still be underappreciated by markets even with the substantial selloffs to date and the unprecedented policy interventions. Even the most sophisticated economic models cannot calculate what it means when people are stuck at home, cannot go to work, travel, movies, restaurant, stores etc. These are unprecedented massive shocks to the economy that are likely to reverberate for several quarters. There is no historical comparison for the extent of aggregate demand destruction and job losses.

If we were to indeed visualize the world once the pandemic stabilizes, there are a few very likely outcomes in this hazy environment

• Extended low interest rate environment: Central banks today cannot afford a high interest rate regime as deficits they are running and will do everything in their power to keep rates low
• Deglobalization, Protectionism and Nationalism: Trade wars were already leading towards deglobalization and this pandemic will accelerate the process. US and China would likely lead two different economic blocs. Individual countries will become inward looking and policy focus will be to ensure the local economy is more self-sustaining
• Reshaping of Supply chains: Companies and countries will ensure supply chains are redrawn to reduce global dependency and to ensure business continuity in various eventualities
• Social safety nets and public health investments: Given likely social unrest resulting from joblessness, politicians will likely push for social safety nets for people and governments will increase investments in public health infrastructure (E.g. Social security and large infrastructure spending started in the US during the great depression)
• Oil shocks: Very low oil prices currently may lead to geopolitical issues in the Middle East laying the ground for oil shocks (E.g. Low oil prices affects stability of Iranian regime and pushing up geographical tensions would help get popular support and sustain their rule)
• Remote IT infrastructure: We can expect a boost in spends for remote IT infrastructure, software and systems to manage teams and productivity, etc. as businesses get comfortable with work from home
• We may see a boost for climate change activism as economy normalizes. ESG investing will become more mainstream

These could be the bedrocks to plan one's portfolio allocation/ rebalancing strategy.

For e.g. Deglobalization and supply chain disruptions would lead companies to backward integration and maintaining higher inventory. Trade barriers would mean more focus on domestic markets and benefit import substitution firms. Spends on digital infrastructure like cloud, remote networks, ecommerce, etc would increase benefiting related companies.

3) WHAT IS THE IMPACT OF EMERGING MARKETS AND ESPECIALLY INDIA?

EMERGING MARKETS

The stresses for emerging markets are much more severe then listed above. Many of the emerging market economies are commodity exporters and the price of commodities like copper, aluminium, zinc etc. is collapsing because there is a recession. If you have any collapse of your export because there is a recession in US, Europe and the rest of the world, you have additional trade shock from low commodity prices and export volumes.

 The shock in the emerging market is bigger in their debt markets than just to their stock market. If you're an emerging market, you print money, and you're on a budget deficit, you're going to have inflation and collapse of your currency. Then you'll have balance sheet problems compounded by a rating downgrade and inflation.

 EMs have a delicate task of managing employment, social unrest and health on one side and fiscal stability and stable banking system to attract and retain investments on the other. India is no different and will attempt a look at impact on India, in particular, in the next post.

INDIA IMPACT

India has entered this phase on a weak wicket. While we have large reserves, we do not have the fiscal room to have large deficits. India’s country ratings are just a notch above junk and any ratings downgrade would mean loss of investor confidence and a plummeting of exchange rate, and high inflation.

The government has a very delicate task of managing deficit while ensuring enough firepower to support an economy that was already quite weak following the three shocks of demonetization, GST implementation and ILFS led financial crisis.

In addition to the global impact discussed in the previous post, some of the likely outcomes post stabilization of the pandemic, specific for India include:

• Unavailability and high cost of labour. Most companies do not expect labour to return from villages in the near term. They will face challenges in normalizing their businesses even after the lock down is lifted. They will need to pay higher wages and focus on automation.
• However, at the mid and high level, salaries will stagnate or reduce. With inflation, wages will take a hit in real terms. Job losses and under employment will rise as companies will need to tighten their belts in a weak economy in the near term.
• Large scale bankruptcies across SMEs- This is probably for the first time that most people in India will see all 3 together - Revenue, Margin as well as profit degrowth in the same year. Most SMEs are stretched, and a stressed and dysfunctional banking and shadow banking system is leading to severe working capital challenges and high bankruptcies. The SME sector will need some kind of financial support from the government soon to be able to emerge out of these tough times.
• Large businesses will win at the cost of smaller mom and pop stores. In the medium term, this ongoing trend will only accelerate as well-run large businesses have the balance sheet strength, access to financial resources, are digitally enabled, have better systems and processes and are more diversified across products and geographies
• Interest rates may not reduce as steeply as seen developed countries. FX volatility, sovereign downgrade risk and need for foreign exchange amidst slowing global trade will keep the pressure on rate reduction.
• Strong inbound M&A activities as MNCs with access to cheap capital look to acquire assets, manufacturing and distribution capabilities in India over the next few years.
• Inflation vs Deflation - There is much debate and no clear answer on whether this supply shock, fiscal largesse (debt creation and monetization of debt) and regionalization of trade dynamics will result in inflation or whether collapse in demand due to unemployment and falling incomes, reduction in velocity of money and aversion to debt will result in deflation. The worst of both worlds would be stagflation i.e. high inflation with weak economic activity. It will occur if money supply and velocity increases without supply side improvement of goods and services from businesses. Time will tell what patterns will emerge from these turbulent times and how the economy will react.

The view does look muted in the short term but as always, a crisis leads to new trends and opportunities. The best of innovations in human history have happened during times of crisis. The post pandemic times will present opportunities across multiple sectors to companies that can innovate, plan and execute well. More thoughts on different sectors in the subsequent posts.

4) WHAT ARE THE TOP TRENDS GOING FORWARD?

There are certain sectors that will take a long time to recover such as travel, live sports/events, restaurants, etc. At the same time there are certain trends that will enable few sectors and companies to recover much faster.

The top three trends that seem to emerge over the medium term include: 

1)     Accelerating offline to online migration - several sectors to benefit

The fear of infection has forced people to try new things e.g., buying groceries online, online courses, paying for online content, e-Doctor, fintech and online banking transactions, remote working etc. They may find some of the services convenient or rewarding and some of these consumer and business behaviors may stay. Government policies may also become more supportive of digital consumption.

a)      E-commerce: The pandemic has clearly demonstrated the advantage of e-commerce vs. offline retailing. One can expect online sales to continue to gain market share, benefiting online sellers and warehouses at the expense of brick-and-mortar sellers, malls and high-street shops

b)     Digital transformation by companies: This was a top corporate priority before the crisis and will emerge as an even stronger priority. This includes automation, cloud infrastructure, e-commerce, security, data mining and analytics etc. and should benefit IT hardware, software and services companies that can help companies accelerate the migration

c)      Remote working: There are two important aspects to remote working: working from home (WFH) and virtual long-distance business meeting. WFH may have a more lasting impact. Technologies that facilitate people working from home should benefit, including videoconferencing, VPN, digital workplace applications, cloud services, and internet security.

d)     Online education\learning: The pandemic has forced schools, colleges, universities, tutoring and training to move online and many people are experiencing online education for the first time. While school students will likely return to class once the pandemic is over, a part of education could stay online. Higher education and corporate/individual training and development, in particular, could move online to a significant extent. Personal training for fitness, yoga, cooking etc. could see extensive use of online technologies going forward offering new avenues to agile larger companies and brands. Organized players focused on online content and teaching would see significant opportunities at the cost of individuals and smaller firms.

e)      Online entertainment: Online entertainment, such as streaming, online gaming and social media saw a demand boost due to the lockdown. People are getting used to paying for premium content and that trend could continue to accelerate befitting the ecosystem around online content and the gig economy.

f)       Digital transactions and online banking: The pandemic has led to a dramatic increase in use of digital payment modes like Paytm, GooglePay, online banking etc. India has been behind the curve on digital transactions and this event should help increase adoption of digital transactions amongst the masses. For the wealthy, the pandemic has seen the least disruption in handling their finances including payments, wealth management, and stock trading. Businesses and services around online financial transactions and management should see market share gains.

g)     Insurance: The pandemic will encourage people to buy insurance products both life and health. Health insurance could see demand from new customers as well as increase in coverage by existing customers. Life insurance should also see commensurate growth opportunities. These opportunities will be captured by companies that have a wide digital footprint and ability to convert customers online. The ecosystem that supports improving this digital footprint should see benefits.

2)     Rural economy to drive consumption in short term

Rural India seems to have finally come out of a recession that started post demonitization in Nov 2016. Good monsoons coupled with better farm prices and lower Covid impact gives hope for a much better demand recovery in the coming year. If logistics and farm supply chain is well managed (timely sale and transport of farm produce), one can see rural economy and all related areas to do recover first. This would include consumer- staples and discretionary, consumer durables - brown and white goods like fans, refrigerators, AC, kitchenware etc , Motorcycles and PVs, farm inputs such as agro-chemicals and fertilizers, tillers, tractors and implements, agro processing units and various associated businesses.

a) Tractors and implements: Labour shortage in parts of India will lead to faster farm mechanization and we may see boost to tractors and implements. Additionally, government spending on infrastructure (expected to help prop the economy) to revive demand for tractors and implements. Ofcourse two caveats remain (i) State subsidies and DBT schemes to be streamlined and executed and (ii) NBFCs/Bank lending will need to restart funding farm mechanization loans

b) Agro-chemicals, seeds, fertilizers etc have already witnessed a strong revival with the current rabi crop. One could expect the agro-chemical markets to do better, subject to good monsoons

c) Consumer products- With better farm incomes, consumption basket around farm economy from staples to discretionary should do better and along with brown and white durables, 2Ws, PVs, etc. Large companies with strong reach and service network should benefit while unorganized and fragmented players may lose market share.

3)     Healthcare and personal hygiene spends to increase

Healthcare spending in certain areas could see higher growth from institutions and individuals, for example, traditional medicine like ayurveda and homeopathy, online pharmacies, medical equipment, sanitizers and soaps, R&D, etc.

a) Online pharmacies should see one of the biggest benefit as many people have tried and tested online purchases for the first time during this pandemic.

b) As people get accustomed to personal hygiene and cleanliness, one should see an increased usage of personal products such as soaps and sanitizers. Large and agile companies are already capitalizing on the trend and we have seen a number of brand extensions into sanitizers such as Nycil, Cavinkare’s Chik, Marico’s Mediker, Dabur’s Sanitise, etc. One may not be surprised to masks becoming a mainstream product with companies attempting an element of branding and fashion quotient around them

c) Government spending on healthcare infrastructure and insurance may get significant boost thereby supporting demand for medical equipment and ancillaries

d) Professions/businesses catering to mental wellbeing including therapists, fitness trainers, meditation and yoga teachers should see interesting opportunities. Businesses that can adapt online technologies with the right personalized content could seen significant scale up opportunities.

These trends should lead to opportunities across multiple sectors for companies that can adapt and have strong balance sheets. 

5) RISK MAPPING ACROSS SECTORS- HOW WILL DIFFERENT INDUSTRIES BE IMPACTED?

Even in these tough times, one can expect pockets of opportunities in multiple sectors around major trends mentioned in the earlier post. While every business is going through tough times, some segments will see a faster recovery and present investment opportunities. One may want to focus on sectors with high resilience and subsegments where the demand recovery could be faster.

 The following chart captures the risk mapping across sectors and potential for faster recovery.

 Note as we explore opportunities across sectors, a few aspects to keep in mind:

• Growth will remain scarce: Companies that demonstrate growth will do well
• Debt levels will be a challenge: Strong balance sheet companies will prosper
• Unorganized to organized to gather pace. Survival of the fittest, Larger companies to gain
• Margins under pressure: Companies with high margins have margin of safety
• Consolidation: Stronger companies will likely to be in a better position to acquire competitors and strengthen market.

6) A DIVE INTO FEW SECTORS/SUBSECTORS THAT SHOW RESILIENCE

 (A) SECTOR TRENDS: AUTOMOTIVE

Automotive – 2W Motorcycle (economy), Entry level PVs and Auto spares replacement market to see demand revival first

The auto industry that has borne the biggest brunt of the lockdown- right from OEMs to Ancillaries to dealers and financiers. The slowdown has been significant and impacted businesses across 2Ws, PVs, and CVs.

 2W economy segment to have a better outlook

• As experienced in China post SARS, preference for personal mobility may drive sales in the near-term as people prefer social distancing and would avoid using public transport and cabs. This should lead to a demand in 2W- both motorcycles and scooters in cities.
• Rural recovery should aid increase in demand for motorcycles. Note that repatriation of income to rural India has been impacted and to that extent rural demand is expected to get impacted, esp. in states like of Uttar Pradesh and Bihar.
• Customer’s preference would move towards low end models due to lower customer affordability and economic efficiencies.
• The EV story had high dependence on lithium batteries from China and hence, may take a back seat in the short term, giving respite to domestic manufacturers with strength in internal combustion engines.
• Exports to be a dampener: 2W exports are around 17% of the industry and exports to Africa may be challenge esp. as most African nations are oil/commodity export dependent and they may face FX volatility issues. Companies with significant exports (Bajaj Auto exports constitute ~47% of revenues) may see some challenges on volumes though INR depreciation may help.

 In short, domestic motorcycle segment (as against scooters) may see the fastest recovery in demand.

 PVs: Pent up demand

• ~60% of PV demand is replacement demand and hence easier to defer. While short term is difficult, there will unmet demand that has an aspiration value. When the recovery emanates, both economic and availability of finance, one can expect a demand to recover.
• Rural recovery should lead to demand revival in the entry segment for companies with strong network for e.g. Maruti has ~40% business from rural India.

 CV outlook looks weak 

The outlook for commercial vehicles does look weak, given they had low utilization rates (~50%) even before covid due to (i) changes in axle norms to allow higher tonnage and (ii) abolition of octroi nakas in favour of e-way bills. The change in axle norms itself increased industry capacity by 20%. CV’s would probably be the last to recover unless one sees the scrappage policy come into effect.

 Sustainable operating margins across the sector in medium term:

• While around 80% of cost (including 60-65% raw material cost) is variable, lack of operating leverage in the near term will have some impact on margins. Low commodity prices and strong balance sheets should help OEMs manage margin pressures.
• Working capital will also be challenged as OEs would need to support dealers and vendors.
• The other areas to watch out for would be the price increase due to BS VI migration and lower profitability of economy segment vehicles coupled with higher competitive intensity.

 Replacement/Aftersales segment should see good demand recovery:

• As owners stretch out the use of existing vehicles, one can expect demand in aftersales markets such as Tyres, Batteries and Ancillaries like shock absorbers, wiring harness, lubricants, etc.
• Branded companies with strong distribution networks should be able to capitalize on this demand and gain sustainable market share as commodity prices remain benign.

B) SECTOR TRENDS: CONSUMER DURABLES

Volume growth in durables was driven by increasing affordability, ease of consumer finance, declining interest rates, urbanization and last-mile electrification. The crisis has dealt a tough blow to the sector, but brand power and technological innovation should allow some companies to strengthen market share.

For consumer durables, the positives include

• In Urban areas, while downtrading will be visible, the lockdown has ensured kitchen appliance and small ticket home appliances demand would be prioritized.
• With migrant labour not expected back until post Diwali, one can expect demand for products with lower penetration in urban areas to pick up. This includes washing machines, microwave, and some extent refrigerators.
• For higher end products like dishwashers and robotic vacuum cleaners, one may start seeing a much wider use amongst the higher income strata
• Semi-urban areas, typically, see surge in demand for consumer durables around wedding season. Given a muted wedding season this year, one may see lower demand for refrigerator, washing machines etc. in these areas and downtrading would favour economy segments like single door refrigerators, semi-automatic washing machines etc.
• Rural recovery should help demand for entry level consumer durables especially with low penetration levels like single door refrigerators etc.
• Brown goods and small appliances like cookware, pressure cooker, mixer grinder, etc. would see demand uptick in urban as well as rural areas. The wider availability of LPG/electricity over the last few years in more parts of the country should support demand for these products.

 For the large ticket white goods, the negatives include

• Financing is going to be a challenge given the crisis in the financial sector esp. NBFCs. The consumer durable sales witnessed upgrades on the back of financing and that would take a longer time to recover.
• Demand will also get affected as households defer purchases of high-ticket items
• Peak summer is over and the cooling segment (AC/Coolers) summer season sales are severely crimped due to the lockdown. Dealers are stuck with high inventories which may even impact primary sales for the next season.
• The sector has strong large domestic and MNC players leading to competitive intensity. This could lead to a shakeout in the industry and margins would be impaired. Weaker players with lose share to better organized larger players with balance sheet and brand strength to support distributors and dealers

 Overall, one expects products with low penetration in rural and low-ticket size to do well. In urban areas, the higher end products (dishwasher/robotic vacuum cleaners) may gain better penetration while demand may suffer in highly penetrated high-ticket discretionary durables.

Competitive intensity will continue to be high and intensify and one can expect a shakeout in the sector. Companies would need continuous innovation to garner market share. for e.g. smart cooling in AC, food fresh in Refrigerators, stain expert in Washing machines etc. Online purchases may gain significant traction and companies would need better service network alongside strong online presence to retain the edge.

 Over the medium term, white goods may see significant challenges as discretionary spends falter, commodity prices strengthen, and competitive intensity accelerates.

Google search trends high for recipes during lockdown (Kitchenware demand?)

Google search trends improving for washing machine and refrigerators

C) SECTOR TRENDS: PLATFORM PLAYS

• Platforms can create a strong network effect and sustainable moat. Unlike the US, where you have the likes of Amazon, Google, Facebook, etc. listed, India markets do not offer access to such platforms. The closest proxies would include Infoedge (Naukri, 99 Acres, stake in Policy Bazaar and Zomato), Indiamart and Matrimony (not commenting on valuations of these companies).
• As an alternate to platforms with network effects, one could possibly look at exchanges that have growth potential from higher penetration and new products. Leaders like IEX, and MCX, and depository services like CDSL operate as a monopoly or duopoly, generate phenomenal cash flows and have long term sustainability. They have structural tailwinds in the form of increasing digital transactions and low penetration and opportunities to expand into adjacencies. 
• While near term disruptions will affect their market linked revenues, they have become ubiquitous and have strong cashflows to sustain through tough times. Over the medium term, they offer highly scalable business model with limited competition.

D) SECTOR TRENDS: FMCG/FOOD/BEVERAGE 

While FMCG has been an investor favourite in these times, one may want to peel the product portfolio across various brackets: essentials vs discretionary, value vs premium, foods vs household vs personal care, single vs distributed manufacturing, balance sheet strength, Raw material input price trends, advertising and promotion spends etc. to get a sense of the opportunity.

•  Eat at home has been a meaningful trend during lockdown and one can expect it to continue for a while. This should benefit the staples and packaged foods segment. From Maggi to Ready-to-Eat packets, biscuits and snacks, one can expect increased levels of demand in the medium term. As home consumption replaces eating outside, there is a significant savings for the consumer. This may lead them to explore premium branded products in categories like biscuits, snacks etc.
• Essentials like tea, coffee, staples, toothpaste, soaps etc should continue to grow at their normal pace with some degree of downtrading. Companies that cater across all price points should be able to retain market share and commodity correction should help them maintain margins despite downtrading. Discretionary (and seasonal) items such as hair care, skin care, cosmetics, ice creams, deodorants, have taken a significant hit as people focus on essentials. Their growth rates can be expected to remain muted as customer wallets get pinched and impulse buying is constrained in the short to medium term. Low-ticket discretionary items will probably see the fastest recovery in the medium term.
• Local brands/Private labels: There is a distinct possibility that local brands would do much better than national brands. The lockdown ensured that local brands/private labels that were nimble have been able to manage the supply chain and new customers have had an opportunity to try these products (lack of choices). Quite a few may be open to continuing with the local brand.
• Besides personal products such as such as hand washes, etc., demand for household products such as floor cleaners, disinfectants, and toilet cleaner are likely to move up and will structurally sustain going forward. Strong value brands likely to gain market share in the segment.
• Health and hygiene concerns will lead to market share shifting in favour of large organized players with a brand promise. The product remains the same, but the mode of delivery is becoming relevant - packaged goods will gain market share against loose products/smaller brands.  
• Consumers would incrementally show a preference for natural and health-based products. Traditional ayurvedic products for immunity like Chavanprash, tulsi drops, etc. could see rejuvenation.
• Food delivery to accelerate: The restaurant business expected to face severe headwinds post this pandemic in terms of new norms on hygiene and social distancing and customer caution against eat out in crowded places. There are estimates that over 40% of restaurants may shut shop. This should however lead to a surge in online ordering and takeaways. Delivery models of businesses like Dominos etc. should expected to do much better in the scenario alongside dark kitchens and online delivery aggregators like Zomato and Swiggy.
•  Alchohol beverages to do well: With liquor being the only revenue source for state governments and the business being more consolidated with organized players like Diageo, one can expect a lot more action in this space. Online delivery started in some states can likely become mainstream and a game changer for this business. While downtrading is to be expected, it is a structural shift and one can expect volume growth to revive in the medium term.
•  On the margin front, not only commodity prices have corrected, companies could also reduce ad spends to maintain their margins. Advertising remains a significant portion of the cost and as smaller companies struggle with cash flow management; stronger players will be able to manage ad spends smartly and maintain margins
•  Across businesses, cash has become king and working capital intensity has moved up. Companies with strong balance sheets will be able to support distributors, dealers and vendors. Strong brands will become stronger at the cost of smaller players akin to other industries.

To summarize, downtrading is to be expected and volume growth may not meet expectations for most products. Lower production costs and lower advt spends will help incumbents retain market share and margins, that will help negate the pressure on pricing. The three critical elements to look for in FMCG companies would be a) share of essentials b) market leadership in the category and c) distribution strength

E) SECTOR TRENDS: IT SERVICES

• While global demand for IT services will suffer across sectors in the short term, offshoring is a well-accepted norm in the industry. Work from Home (WHF) shall be quickly accepted as just another extension of offshoring and ongoing projects should not get disrupted.
• On the demand side, we may see budget constraints from clients, but as technology continues to become a backbone of enterprises and businesses focus on digital transformation, growth should recover.
• With the US fed providing a backstop, one may expect the US recovery to be faster. US companies remain the biggest customer base for Indian IT services. While the US recovery will vary between sectors, companies that cater to the least affected segments like large online/cloud/IT plays, telecom, etc. will benefit. 
• Within IT services, given multiple new technologies, products and platforms, companies with capabilities around multi-platforms and technologies will benefit. This essentially means larger companies with a wide breath of services offerings will gain further market share. The big will likely get bigger.
• BFSI is the largest customer segment and one would see budget pressure in this segment given low interest rate environment, but the pace of digitization would continue unabated.
• Margins will be under pressure as client cut budgets and working capital cycle will get elongated, but most IT services are cash rich and should be able to ride through it.

F) SECTOR TRENDS: HEALTHCARE

Healthcare can be broadly classified into Hospitals, Clinics, Diagnostic services, Pharmacies and Hygiene/wellness related services/products. The pandemic will have significant impact on the healthcare sector. While Government spending on healthcare infrastructure would increase, private investment in health infrastructure may be limited given low ROCE and long gestation. On the private side, certain segments could see higher growth, for example, online pharmacies, traditional medicine/immunity boosters, personal hygiene products like hand wash, sanitizers and soaps, medical equipment, R&D for vaccine development, etc.

• Online pharmacies should be one of the biggest benefits as more people have tried and tested online purchases during this pandemic. Government regulations may also see some softening towards e-pharmacies.
• Diagnostic companies remain a structural story. They would need to recalibrate their operations and home collections could become increasing relevant. As capital cost of sanitization and protective equipment increase, this highly fragmented industry may see acceleration towards organized chains. The near term clearly is weak for wellness and illness segment, but the long-term scalability remains intact and the move to organized segment may revive growth rates much faster though pricing will remain under pressure due to economic slowdown.
• Hospitals are currently operating at very low occupancy rates and elective surgeries are all being postponed. Given current scenario, hospitals may operate at lower than normal occupancy for a much longer duration. Unfortunately, PE led rapid expansion over the last decade has led to significant leverage challenges for many hospital chains and one can expect cash flow issues for many players. Hospitals with strong balance sheets may be able to survive but the sector may see significant consolidation given structurally low ROCEs, mediocre operating metrics and lack of pricing power for most players.
• Hygiene related categories should get a structural boost. Personal products such as such as hand sanitizers, hand washes, soaps, etc would capitalise on the change in consumer behavior. Agile companies are already capitalizing on the trend and we have seen several brand extensions, for instance Marico’s Mediker, Dabur’s sanitise Emami’s Boroplus, Marico’s vegetable cleaner etc. Wearing face masks may become mainstream and one may see new business opportunities around the product. The product caters rather well to brand extension opportunities.
• Professions/businesses catering to mental wellbeing including therapists, fitness trainers, meditation and yoga teachers should see interesting opportunities. Businesses that can adapt online technologies with the right personalized content could scale up opportunities.

Google trends during lockdown show pent up demand for mental wellbeing

G) SECTOR TRENDS: PHARMACEUTICALS

Pharmaceuticals have seen the highest level of investor interest post Covid. However, one needs to distinguish the nature of therapies and target markets to determine investment potential. The industry can be split based on revenue profile into Domestic market, Emerging market and the US/developed countries.

Investor interest has been higher given the defensive nature of the industry coupled with secular growth expectation but each of the markets has different dynamics.

 US Markets: On the positive side, pricing in US markets seems to have stabilized and companies that have FDA approved facilities may benefit with increasing sales to the large US market with stable margins. However, there is no reason to believe that US FDA inspections will be diluted in any form. The rigorous audits faced by manufacturing plants will continue and they need to constantly improve their practices to receive FDA clearance (EIR). In fact, due to the pandemic, there would be no FDA inspections in the coming months and any company that is awaiting FDA clearance may not get them soon. 

 Emerging markets: Most EMs are commodity exporters and the commodity meltdown is hurting exports leading to sharp economic slowdown and currency devaluation. Slowdown and FX issues may pose severe challenge to Indian exports in terms of pricing and collections in the medium term.

The only supporting factor begin the changes at WHO. Indian firms had been losing WHO managed tenders for the last many years to Chinese firms. With the changes at WHO post Covid, one may expect a more level playing field in the tender driven African markets.

 Domestic business: Within Pharma, acute therapies may see a demand reduction as people become more careful about personal hygiene. With more home cooked food and better sanitation, demand for regular antibiotics - cough cold fever medication, may see lower demand. In the short run, with clinics shut, one would actually see negative growth in this segment but over the medium term, the growth may at best come back to normal 7-8% p.a.

Chronic therapies saw significant spike during lockdown as people started hoarding medicines. While new prescriptions suffer in the near term, over the medium term growth will be back to normal levels of 10-12% p.a..

Across both segments, the digital wave on sales management is changing the business model. The traditional MR (medical rep) to GP/Consultants route is structurally changing to include more digital mode. Increasing usage of Zoom, tele medicine, webinars, etc. is clearly going to benefit large players. Brands with high market share may strengthen their position as customers seek shelter in known brands/companies.  

Balance sheet strength of larger companies and their strong distribution network will help them strengthen their branded portfolio and market share as companies focus on their top brands/products.

 Margins: Most of the key starting material for any API/formulation comes from China. Their pricing and availability pose a major challenge to manufactures both in terms of production volume as well as margins. It will remain volatile and practically difficult to predict in the medium term.

On the domestic side, as digital is picking up pace and MRs are unable to meet doctors, travel and promotion expenses are shrinking. This should also help companies maintain margins.

 In short, US price stability (still early trends) may benefit companies with FDA approved plants and exporting to the US. This is more of a cyclical upswing with no connection to the pandemic. On the other hand, domestic market may see muted growth in short term and normal growth in medium term. Here, firms with strong brands and strong balance sheets would benefit at the cost of smaller firms. EM sales especially LATAM and Africa may see pressures due to FX volatility and demand pressures but tender market may provide some support.

For the interested, here are the links to individual posts in the series:

1) Quarantine Expectations - Current Pandemic is different :https://www.dhirubhai.net/pulse/what-expect-bhavin-shah/

2) Quarantine Expectations – Global impact and EM impact https://www.dhirubhai.net/pulse/what-expect-part-2-bhavin-shah/

3) Quarantine Expectations – India Impact: https://www.dhirubhai.net/pulse/what-expect-part-3-bhavin-shah/

4) Quarantine Expectations – Positive Trends: https://www.dhirubhai.net/pulse/4-what-expect-part-positive-trends-bhavin-shah/

5) Quarantine Expectations – Overall Sector impact and dive into sectors - Auto https://www.dhirubhai.net/pulse/what-expect-part-5-sectors-bhavin-shah/ 

6) A dive into few sectors/subsectors that show resilience: Sector Trends

A) Automotive   https://www.dhirubhai.net/pulse/what-expect-part-5-sectors-bhavin-shah/ 

B) Consumer Durables and C) Platform Plays https://www.dhirubhai.net/pulse/what-expect-part-6-consumer-durables-platform-plays-bhavin-shah/

D) FMCG/Food/Beverage and E) IT Services https://www.dhirubhai.net/pulse/quarantine-expectations-part-7-fmcgfoodbeverage-services-shah/

F) Healthcare and G) Pharmaceuticals https://www.dhirubhai.net/pulse/quarantine-expectations-part-8-healthcare-bhavin-shah/

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