Hospital stocks may see a re-rating as investor confidence on the rise

After a weak performance over the last couple of years, hospitals are posting robust growth due to focus on utilisation and margins

Investor confidence in hospital stocks has been on the rise and this is evident from the 20 per cent gains reported by players such as Apollo Hospitals and Narayana Hrudayalaya since their May lows. Even Fortis Healthcare has been making gains this month as uncertainties over ownership and tight liquidity conditions during FY19 are now behind.
 
While other players in the listed space such as Aster DM and HCG have underperformed the broader market given multiple challenges, the Street expects their fortunes to improve in the coming quarters. The key hurdle for the sector was margin pressures brought on by expansions and regulatory issues such as pricing cap on stents, knee implants as well as medications. However, after a healthy March quarter performance and amid expectations of higher margins and improved earnings outlook, analysts have revised their profit estimates.
 
The country’s largest listed player Apollo Hospitals would be one of the key beneficiaries from the improved operating metrics. The company and its promoters have recently sold their entire stake in Apollo Munich Health Insurance. The Street is positive on this development as it helps the company bring down its debt while promoters can release their equity pledges. The company’s gross debt in FY19 stood at Rs 3,672 crore (net debt of Rs 3,256 crore).  Post the transaction, Apollo Hospitals is expected to receive total consideration of Rs 300 crore for its 10 per cent stake in Apollo Munich. Over FY09-11, Apollo Hospitals had invested Rs 35 crore in Apollo Munich and analysts now expect the cash inflow after tax to be used for debt repayment.
 
Also, the Apollo promoters are expected to realise Rs 1,330 crore from the transaction and utilise the same to reduce the promoter debt and share pledge. Analysts at Nomura say owing to investor concerns around the high proportion of pledged share, this transaction is an incremental positive.
 

The company has already witnessed improving performance in the past few quarters. While FY15-18 operating performance was muted due to expansions (new hospitals take time to breakeven), regulatory hurdles, too, played spoilsport. In FY19, however, operating profits jumped 34 per cent. Analysts expect operating profit to grow by a strong 18 per cent over the FY19-21 period. CLSA believes new hospitals, such as the one in Navi Mumbai, should help in margin expansion given the volume of high-end surgeries, pick-up in overseas patients and expansion of diagnostic services.
 
Fortis Healthcare, which faced different challenges during FY19, however, should benefit under new management with improved execution expected over the coming months. The hospital chain remains well positioned to capture future demand without significant investments as the current capacity ramp up (brownfield expansions) can help it meet the current growth requirements. Analysts at Nomura have cut target price to Rs 159 based on 17 times FY21 EV/Ebitda after factoring in the impact of a potential open offer. However, it still means some upside for the stock, which is quoting at Rs 129 levels now. 
 
Narayana, too, has seen better execution and improved margins over the last three quarters. While the company’s three new hospitals – in Gurugram, Mumbai and Dharamshala — are incurring losses, they are expected to breakeven in FY20-21. Moreover, they have seen average revenues per operating bed improve 13 per cent in the recent quarter. The company is not planning any further greenfield expansion. Given better positioning and management focus on execution, analysts at Jefferies remain positive and expect 180 basis points improvement in margin over FY19-21.
 
Aster DM Healthcare has ended FY19 on a high note with performance beating estimates. It has a unique business model with facilities in highly profitable Gulf countries, as well as the fast-growing Indian healthcare market. A strong track record of execution helped Gulf hospitals break even within one year of operations. Given this and growth in India, Kotak Institutional Equities expects Aster DM to post 11 per cent annual revenue growth and 20 per cent annual Ebitda growth over FY19-21.