Hospital stocks: Lack of clarity on regulations acting as an overhang

Hospital stocks have been trading at their 52-week lows this month on regulatory headwinds and weak March quarter results. The goods and services tax regime, stent and kneecap prices, and regional competition have spiked worries among investors about the near-term prospects of the listed health care providers such as Apollo Hospitals, Fortis Healthcare, Max as well as some of the recent listings, including Narayana Hrudayalaya, Shalby and Aster DM. 

Investors' worries are not unfounded. The March quarter results indicate the pressure on realisations and margins as well as issues which were specific to health care chains. 

Despite revenues for the top players growing by double digit, led by new hospital additions, realisations have been in low, single digits. It is the reduction of profitability which has been responsible for the price correction in the hospital stocks. 

Apollo Hospitals, for example, reported operating profit below analysts' estimates, led by adjusted revenues at mature clusters growing by a muted 3 per cent. For Narayana Hrudayalaya, margins were 200 basis points below analysts’ estimates, led by losses at new hospitals. 

Max India’s hospitals business, too, saw its operating profit fall 58 per cent year-on-year affected by the shutting down of 32 beds at Shalimar Bagh facility, shift in mix to institutional business as well as the minimum wage rule.

Despite the muted performance and the regulatory overhang, analysts at B&K Securities believe that the recent price correction in hospital stocks is an opportunity. 

They believe that return ratios for the sector have bottomed out and expect operating profits to improve on the back of price-mix improvements and streamlined cost structures at mature centres. Binaifer Jehani, director at CRISIL Research, believes that while regulatory pressure will affect margins of major players, hospital chains focussed on providing affordable treatment (for patients covered under various healthcare schemes) could benefit. 

Most brokerages prefer Apollo Hospitals as the company is in the last leg of its capex cycle, which coupled with cost reduction and faster breakevens at new hospitals will drive margin expansion. 

Though there is a huge scope for growth of private healthcare companies both in metros as well as smaller towns and stocks have recovered a bit from lows, investors should await clarity over the next couple of quarters before taking any exposure to the sector, especially given the uncertainty on regulatory actions.