Hospital Chains Among Top Healthcare Sector Picks For Analysts. Here's Why...

Hospital is a branded business, and people are loyal to the brand and doctors.

<div class="paragraphs"><p>Source: Unsplash</p></div>
Source: Unsplash

Hospitals are among the top picks for analysts in the pharmaceutical and healthcare sector because of their consistent performance, improved operational metrics, growth, and earnings momentum.

This is when the overall Nifty Pharma was down 5% in the last three months, underperforming the benchmark Nifty 50, which was down 2%.

"Hospital is a very branded business, and people are loyal to the hospital brand and the doctors," said Aditya Khemka, fund manager at InCred PMS Healthcare, who prefers hospitals as his second bet.

While hospitals are the top bet for DAM Capital's Managing Director, Nitin Agarwal. Especially in the near term, he told BQ Prime, the fourth-quarter outlook for hospitals is always seasonally the strongest as compared to domestic pharma. Going forward, despite a higher base, he expects the sector to grow at a double-digit CAGR.

Nine-Month Performance

Max Healthcare and Krishna Institute of Medical Sciences reported the highest Ebidta margins of around 27% in the nine months through December followed by Global Health (Medanta) at 22.8% while Aster DM Healthcare has the lowest margin at 12%.

While Apollo Healthcare's overall Ebidta is at 13%, its hospital segment has earned an operating margin of 19%, while Fortis Healthcare's hospital division earned a margin of 13%. For Apollo, its online pharmacy segment is underperforming, and Fortis has an overhang from the ongoing court cases.

Once Fortis' diagnostic arm, SRL Diagnostics, gets demerged—as per recent reports—there is scope for a significant re-rating of the stock, said Abdulkader Puranwala, pharma analyst at Elara Capital.

Krishna Institute of Medical Sciences has also reported the strongest growth in revenue year-on-year. This is despite the fact that the company has the lowest average revenue per operating bed and a higher average length of stay. The company's performance is strong because it has developed an efficient business model that generates a high return on invested capital while focusing on smaller markets, said Agarwal of DAM Capital.

Max Healthcare reported the second-highest average revenue per occupied bed and outpatient volume, which is the highest occupancy rate, demonstrating the company's brand value in attracting customers. Its average length of stay is the highest among its peers. While most analysts view Max Healthcare as an outperformer, it is not a part of most of their portfolios as its current valuations are considered steep compared to the others.

Aster DM enjoys the highest ARPOB despite the lowest year-on-year growth while also having the lowest ALOS, which is the most favourable. However, the low ARPOB growth could indicate a slowdown in the growth potential for expansion on that front.

Healthcare Global, a specialist in oncology, has found its place in InCred's portfolio while DAM Capital has a 'buy' rating on the stock.

Khemka of InCred PMS Healthcare prefers super-specialty hospitals over multi-specialty hospitals. HCG's business is highly profitable, requires less capex, and enjoys high occupancy rates, he said. "The valuations are reasonable, and there are sufficient growth levers for the next three to four years." Agarwal, too, called HCG a turnaround story where he sees growth.

HCG's third-quarter occupancy rate was 65.7%, and its ARPOB was Rs 37,014.

HCG and Narayana Hrudalaya have not disclosed their nine-month operational metrics. Narayana Hrudalaya's third-quarter ARPOB, excluding the Cayman Islands, was Rs 35,068.

Narayana is a low-cost provider with an improving ARPOB, according to Puranwala of Elara Capital. "While a significant improvement in numbers is yet to be seen, it has the operating leverage, and the incremental growth could be higher." Also, it is a pure-play hospital player with no ancillary services, he noted. Elara Capital has investments in Narayana Hrudalaya.

Sectoral Growth Projections

Hospitals will continue their double-digit growth, early teens trajectory, according to Sriraam Rathi, India analyst for pharma and healthcare at BNP Paribas. This is even as occupancy is seeing some recovery but has yet to reach pre-covid levels, he said.

Puranwala of Elara Capital, too, expects the sector to grow in the 12–15% range in FY24. He is positive on the sector, as "companies have been paying off their debts, witnessing consistent cash flows, and seeing improved operational metrics such as higher average revenue per operating bed, reduced average length of stay, and higher specialty surgeries."

Khemka of InCred PMS Healthcare pegs the industry metrics at:

  • 8–10% volume growth

  • 2-5% growth in the average revenue per operating bed.

  • 10-15% topline growth.

While Agarwal of DAM Capital anticipates Ebitda growth in the 10-15% range. 

Investment Rationale

While hospitals are Agarwal's top picks, Rathi and Khemka pick hospitals as their second-best bet after domestic formulations in the whole pharmaceutical and healthcare space. "Hospitals enjoy a return on equity in the range of 15–25% as compared to branded generics that may earn anywhere between 20–50%," said Khemka. "Also, they require higher capex and the valuations are higher."

Khemka prefers companies that are in the pure-play hospital business to companies that have pharmacies, clinics, and diagnostics. "While the return on equity in the hospital segment is higher, the companies' relatively newly established diagnostics arms earn lower ROEs and may take time to scale up."

While Khemka prefers super-specialty hospitals to multi-specialty hospitals, Puranwala believes that a multi-specialty company enjoys good operating leverage. "Super-specialty is not as scalable since it's dependent on one disease." For multi-specialty, he said that it is possible to improve capacity utilisation beyond 70%, while for super-specialty, it may typically hover around the 50% range.

Rathi cited three other growth triggers to watch out for:

  • Improvement in bed occupancy rates

  • Brownfield capacity expansion—increasing bed capacity in the existing facility—and greenfield expansion will put pressure on margins and impact overall valuation.

  • Medical tourism, which has resumed post-Covid,