Asset light approach separates Narayana Hrudalaya from its peers
Narayana Health Ltd (NHL) is one of the leading healthcare providers in India with a network of 24 hospitals, 7 heart centers and 19 primary healthcare facilities across India with close to 6,000 operational beds, of which ~2,100 beds have been added over the past five years. The company has established itself as a leading player in the affordable healthcare segment and become a well-recognized brand in cardiology and renal sciences, especially in Karnataka and East India. Over the past few years, NARH has differentiated itself from peers by targeting affordable care, and by creating an asset-light business model, thereby positioning itself to capitalize on the market opportunity through bed expansion. We believe this focus on a scalable asset-light model separates it from peers.
In a conducive but challenging space of Indian healthcare delivery, plagued by longer gestation periods, low operating margin, leveraged balance sheets and low return ratios, we believe NH is best placed among peers to sail through. Its legacy model is based on affordability. Hence, conscious efforts towards cost & capital control are embedded in the management’s long term strategy.
Asset-light approach key differentiator versus peers:
NHL has a legacy model based on affordability over the years. Due to strict control over costs and capital, the company has been making reasonable profit. The company partners with government bodies, charitable trusts and other non-profit organizations to set up/manage hospitals. Only four hospitals in NARH’s network are completely owned by the company while others are on leased or operate-under-revenue-share or PPP model, resulting in NHL having the lowest capital cost per bed among peers at Rs.3.0 mn/bed in FY2017. Due to strict control over costs and capital, the company was making reasonable profit. Total 60-70% beds of NHL are in general wards, which is one of the highest compared to other private hospitals. Also, charges of general wards are 10-15% lower than other private hospitals, mainly due to the benefit of efficient procurements, which the company passes on to patients.
Given the aggressive expansion over past five years, NHL’s maturity mix has turned unfavorable, with 41% of operational beds having maturity of less than five years, compared to 22% for APHS. Despite this inferior maturity mix, NHL’s EBIT/bed increased to Rs.0.3 mn/bed in FY2017 from Rs.0.1 mn in FY2013. While this is much lower than APHS’s Rs.0.6 mn/bed (down from Rs.0.8 mn/bed), given its asset-light model, return on a per-bed basis increased to 9.6% in FY2017 (from 4.8% in FY2013), higher than Apollo Hospital’s 8.2% in FY2017 (down from 16% in FY2013).
Improvement in case mix to boost ARPOB:
Average revenue per occupied bed (ARPOB) at the blended level is Rs.76 lakh, which one of the lowest in the industry. The reason for such a low ARPOB is the high proportion of various government scheme patients in the payee profile (~20% vs. 5-10% for peers). This is in line with the company’s affordability philosophy. Hence, ARPOB for the first category hospitals (more than five years) is at Rs.80 lakh despite having a higher proportion of matured hospitals. With one of the lowest ARPOBs in the industry, NH has a substantial lever available as far as pricing is concerned. With the optimization of payee mix and case mix, the ARPOB can only improve from hereon.
‘International patients’ as a payee category are the highest in terms of realisation and are growing at a faster rate vis-à-vis other categories. This will further improve the blended ARPOBs as the product mix improves. NH has witnessed strong growth in the contribution of international patients to total revenues, which has grown from 4.8% in FY16 to 9% in Q2FY18.
Favorable macroeconomic factors:
Significant infrastructural gaps persist in the Indian hospital industry. The bed availability in India was at seven per 10,000 in 2012, significantly lower than the WHO guideline of 30 beds per population of 10,000. Out of pocket expenditure on healthcare in India is ~60%, one of the highest in the world. On the other hand, India has among the lowest health insurance penetration among developing countries with just 20% penetration.
Demand-supply mismatch with a combination of macroeconomic factors, including changing demographics, increasing affluence of the Indian population, greater health awareness, rising incomes, changes in the disease profile (towards lifestyle-related ailments) and rising penetration of health insurance are likely to lead to an increase in demand for quality healthcare services.
Fundamentals to improve strongly:
NHL’s gross revenues grew at a CAGR of 22.3% over FY13-17 to Rs.1878 crore on account of increase in occupancy rate to 61.0% followed by 12.2% increase in ARPOB to 76 lakh per share and 12% increase in operational beds to 5932. We expect NHL’s revenues at 18% CAGR over three years to Rs.3100 crore mainly due to an improvement in occupancy rate and ARPOB in less than five years hospitals and Cayman.
EBITDA margins contracted 51 bps to 12.2% over FY13-17 mainly due to addition of new hospitals. The company has added ~18 hospitals over FY11-17. We believe FY18 EBITDA margins will remain under pressure mainly due to the impact of government regulation on cardiac stents & implants and loss at newly commissioned hospitals. However, a gradual improvement in new hospital margins and occupancy rate is likely to improve EBITDA margins to 13.5% over the next three years. Net profit grew at 26% CAGR over FY13-17 to Rs.84 crore mainly due to a robust operational performance. We expect net profit to increase at 32% CAGR during the same period mainly on the back of robust operational performance and lower interest cost. We expect RoCE to improve to 19% by FY20 due to lower base improvement in ARPOB and lower pace of gross block addition.
Post its listing, NHL’s shares have struggled to perform, declining by 12% in the past one year, and still below the listing price. With the expected improvement in operating metrics, particularly the performance of recently commissioned beds NHL is better-positioned versus peers. Investors who are looking for long term wealth creation ideas can add this stock with decent allocation.