Tuesday, December 22, 2015

Narayana Hrudayalaya IPO: Patience will pay off

Investors with a three to five-year horizon can take exposure in the initial public offer of Bengaluru-based hospital chain Narayana Hrudayalaya. Founded by veteran cardiologist Dr Devi Prasad Shetty in 2000, the company is well poised to achieve healthy revenue and profit growth over the next three years.

First, the pay-off from acquisitions made over the last four years should accrue over the next few years. Second, higher contribution from value-added therapies such as oncology, neurology and gastroenterology, should help Narayana Hrudayalaya improve its average revenue per operating bed (ARPOB).

Third, the strategy to focus on the mid-income segment should ramp up utilisation, given the large addressable market. Efficient use of capital (debt-equity ratio of about 0.3 times) is also a positive.

The company’s decision to adopt the lease/management contract/revenue share route to pursue expansion plans can give a leg-up to revenues and profits.

The issue is an offer-for-sale by its promoters Dr Devi Prasad Shetty and Shakuntala Shetty, and private equity investors — JP Morgan Mauritius Holdings IV, Ashoka Investment Holdings and Ambadevi Mauritius Holding. At the upper end of the price band of Rs.250, the offer discounts the company’s 2016-17 expected earnings by over 50 times. Though this implies an over 30 per cent premium to Apollo Hospitals’ valuation, Narayana Hrudayalaya’s revenue and earnings can grow faster than peers given the strong earnings visibility.

On other valuation metrics, such as enterprise value to sales (EV/sales) and EV/EBITDA (earnings before interest, taxes and depreciation), the stock is at about 7 per cent discount to Apollo Hospitals. While the upside in the short term may be modest, the stock has potential to deliver good returns over the long term.

Margins to improve

Narayana Hrudayalaya, through its network of 56 healthcare facilities, reaches out to nearly two million patients.

In the last four years, the company acquired 14 facilities (many on management contract basis). This led to a sharp decline in its consolidated operating profit margin — from about 12.7 per cent in 2011-12 to less than 10 per cent in 2014-15. This also led to a loss of Rs.10.9 crore in 2014-15.

But in the first six months of the current fiscal, the company has managed a turnaround and posted net profit of Rs.12.5 crore. The average lead time for hospitals to turn positive at the operating level is about three to four years. Hence, the benefit from investments made over the last four years should start flowing from 2016-17.

The company has indicated that the operating profit margin for hospitals with maturity of over five years was 23.5 per cent in 2014-15.

For hospitals with maturity of three to five years and less than three years, the operating margin stood at 4.8 per cent and negative 14.4 per cent, respectively.

Over the next two years, many hospitals with maturity of less than three years are expected to move into the three to five-year maturity bucket. This should lift Narayana Hrudayalaya’s profitability. The operating profit margin of 11.1 per cent in the first half of 2015-16 signals this.

The overall occupancy level for the company has been growing. From 44.8 per cent in 2012-13, it rose to 52.8 per cent in 2014-15.

This was largely driven by a marked improvement in the occupancy of its key hospital clusters — Karnataka and eastern cluster — which account for over 80 per cent of its overall revenue. The occupancy for its Karnataka cluster has risen to 55.1 per cent in 2014-15 from 48.6 per cent in 2012-13. For the eastern cluster, the occupancy has grown to 54.3 per cent from 53.9 per cent during this period.

Expansion plans

Focus on better margin non-cardio/non-renal therapies such as neurology, anti-cancer, orthopaedics and gastroenterology, should help the company improve its average revenue per operating bed over the next two-three years.

The contribution from the non-cardio/non-renal segment to the total in-patient revenue has gone up from about 32 per cent in 2012-13 to 38 per cent in 2014-15.

The company’s debt-equity ratio of about 0.3 times is lower than peers — Apollo Hospitals (about 0.6 times). This is largely on account of the decision to adopt the lease/management contract/revenue share route to pursue expansion plans.

Narayana Hrudayalaya will be adding four new multi-specialty hospitals over the next three years in Vaishno Devi, Mumbai, Lucknow and Bhubaneshwar. These again are on a public private partnership/operations and management/lease basis. This should add to profits without diluting margins.

While growth prospects are healthy, the improvement in performance hinges on the company's ability to turn around operations at its newly-acquired facilities; delay in achieving this could be a risk to growth.

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