Public party - Part 2

It’s not just the financial sector, a clutch of companies from the healthcare industry have also floated IPOs. Narayana Hrudayalaya, Thyrocare Technologies, Dr Lal PathLabs and HealthCare Global Enterprises (HCG) together have raised around Rs.2,400 crore. 

Bangalore-based HCG though, has found the going tough because of its debt burden. For 4QFY16, the company reported sales of Rs.153 crore, posting a growth of over 16% YoY. However, its net margin was a measly 2.4% at Rs.3.6 crore. While it is better than the loss of Rs.25 lakh reported last fiscal, the debt of Rs.370 crore is an overhang. 

Moreover, aggressive expansion is taking a toll. Despite a capacity utilisation of 50%, the company is looking to add 12 new cancer centres. So, while HCG is looking to repay Rs.147 crore of its existing debt, the overall burden may remain the same. 

The company is also facing delays in executing projects due to government approvals, construction, technical and regulatory concerns. This has led to significant cost overruns. Between FY11-15, EBITDA margin has contracted 290 basis points to 14.7%. 

The valuation, thus, has come down, with the stock currently trading at 20.7x FY16 EBITDA. When the issue was launched on March 16, it was 24x (at the upper price band of Rs.218) FY15 EBITDA of Rs.76 crore. 

While the debt is hurting, it has the largest number of cancer treatment centres in India where the demand-supply gap is huge. A report by ICICI Direct claims that India has only 200-250 comprehensive cancer care centres — that’s just one per six million people. Moreover, about 40% of these centres are located in metros; there is a shortage of oncologists (one oncologist per 1,600 patients); and limited access, with only around 15-20% of cancer patients currently able to undergo radiation treatment. This augurs well for the company.  

Narayana Hrudayalaya is in the same boat when it comes to demand and profitability. On a consolidated basis, the hospital chain reported a net profit of Rs.30 crore in FY16, a margin of 1.8%. With debt coming down to Rs.200 crore in September 2015 (Rs.305 crore in March 2015), and most of the capex behind it, profitability is expected to improve. “We expect 20% revenue CAGR coupled with 450 basis points improvement in EBITDA margin to 16% (as utilisation improves) over FY16-20,” say analysts at Axis Capital. 

EBITDA, too, is expected to improve as more hospitals climb the maturity curve. As of now, hospitals over five years are yielding an EBITDA margin of 24% while those in the 3-5 year range are operating at a margin of 4%. Taking the current revenue of five hospitals in the 3-5 year range (Rs.209 crore), at 24%, additional EBITDA of about Rs.42 crore could be added. This could ramp up consolidated EBITDA margin from 11% to 13%. 

Moreover, the chain is run on an asset-light model, with investments in land and building coming in from the partners. During its IPO, at the upper price band of Rs.250, Narayana was valued at 42x EV/EBITDA (trailing FY15 earnings). While the correction in valuation to 35x EV/EBITDA on trailing FY16 earnings may reflect concerns over profitability, on a one-year forward basis the stock is trading at 20x EV/EBITDA (closer to Apollo Hospitals’ 19.6x). 

However, unlike Narayana Hrudayalaya, Apollo remains in expansion mode as it plans to add close to 1,000 beds to its existing network of 40 hospitals and over 7,000 beds (own hospitals) by FY19, with an additional capex of over Rs.1,000 crore. While Apollo’s EBITDA margin stands at 15.8% currently, analysts expect the margin to be hit due to its capex plans.  

Diagnosing the margin

The question, when it comes to diagnostic providers such as Dr Lal PathLabs and Thyrocare Technologies, is if they can sustain their margins going forward. 

Thyrocare’s stock is currently trading at 54x (trailing FY16 earnings), with EBITDA margin of close to 41%. While analysts expect revenues to grow at 25% and profit to ramp up to 30% over FY15-18, the possibility of margin deterioration cannot be ruled out due to its strategy of using disruptive pricing to drive volume. Also, significant portion of Thyrocare’s revenue come from the low-value thyroid testing business. In FY15, thyroid tests accounted for 29% of total volume and contributed 17% of revenue. 

“Within the pathological space, we need to assess undercutting is driving volume, as there are strong incumbents in this space,” says Sadanand Shetty, vice-president and senior fund manager at Taurus AMC. 

As for Gurgaon-based Dr Lal PathLabs, it is trading at 61x its trailing 12-month earnings. Over FY11-15, the company’s topline has grown at 29% and profit at 34%. Analysts at Citi Research expect this to temper down to 20% and 27% over FY15-18, respectively.  

Deven Choksey, managing director, KR Choksey Shares and Securities, adds that while margin deterioration is a concern, these firms could protect their margins by bringing in segmentation and increasing footfalls. The issue with the segment though, is that low capital requirement can attract more players, increasing competition. Dr Lal PathLabs also faces a concentration risk as 70% of its revenues come from North India, largely Delhi and NCR. While the company plans to open reference labs in the East and Central India, it remains to be seen if it can scale up business in those regions.

(This is the second of a four-part series. Read the first part here)