Narayana Hrudyalaya: Not Just Another Hospital Stock

There are lots of reasons for investors to dislike hospital stocks. The business requires large up-front investments, long gestation period, regulatory overhang, cut-throat competition, and a perpetually high P/E multiple. However, I believe there is one exception to the rule. That company is Narayana Hrudyalaya (NH).

NH, founded in 2000 by Dr. Devi Shetty, is a 21-hospital chain. It started operations in Bangalore, where Dr. Shetty is a household name. Along the same time, the tech-boom in Bangalore was relatively in its infancy and NH got the benefits of scaling up along with the city. Similarly Dr. Shetty is very well-known in Kolkata, where he practiced for a long time in the 1990’s (even operating on Mother Teresa). These two regions form the heart (pun-intended) of NH’s operations.

After a hospital matures, the return ratios become far more attractive. In case of NH, mature hospitals (in south and eastern India) account for ~90% of revenues and ~110% of EBITDA (their newer units are losing money). Despite them operating at nearly full utilization levels, NH is able to grow revenues at ~10%. They are able to that by i) focusing on reducing the average length of stay (ALOS) ii) doing more complicated procedures iii) re-orienting the hospital assets to drive volumes and iv) taking strategic price hikes.

In fact, according to Ambit Research, NH currently is second only to DMart in “Same-store-sales growth”, a term used to describe revenue growth of the same store (in this case hospital). This metric to a large extent demonstrates the business acumen of the management. Mature hospitals have an RoIC (return on invested capital) of more than 20%.

NH also has 3 new hospitals:- 2 in New Delhi and 1 pediatric hospital in Mumbai. All three are currently losing money at an EBITDA level and are at different stages of turning around. The last three quarters have been encouraging as sequentially their losses have been reducing coupled with increasing revenues. According to the management, these units are following the typical maturity profile of a hospital. From a long-term thesis, tracking the performance of these hospitals are important for two reasons. Firstly, a turnaround here provides an immediate trigger for the profits and stock. Secondly, these are regions where Dr. Shetty’s name is relatively less known. If these units can make sufficient money, investors could be reasonably sure that the company has de-risked itself from the “key-man” risk and is on the path to creating a scalable and robust business model.

Finally, there is precedent of investors making money in hospital stocks. Between FY10-15, Apollo Hospitals EBITDA grew 2.3x from Rs.300 cr to Rs.700 cr. Its market cap in the same period increased 4.2x from Rs.4,500 cr to Rs.19,000 cr. For FY19, NH’s EBITDA is 300 cr, and is expected to ~Rs.500 cr in FY20. As NH’s profitability is expected to follow a similar trajectory as that of Apollo Hospitals, the market cap could also follow a similar direction. At the current market cap of ~Rs.6,000 cr, and reasonable valuations (on an EV/EBITDA basis), investors can look to make meaningful returns on Narayana Hrudyalaya.

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