India’s healthcare industry has yielded impressive returns of over 12% in the past month, surpassing the Nifty 500 by a good margin. Small-cap companies like Narayana Hrudayalaya and Global Health topped the charts in terms of their monthly gains. Most hospital stocks have either hit their 52-week highs in the past week or are trending near it. 

The industry has also caught the attention of foreign portfolio investors (FPIs) after a brief lull in the first three months of 2023. In May alone, FPIs poured in over Rs 2,800 crore in investments into healthcare stocks. 

What is fueling this optimism among investors? A combination of strong quarterly performances and promising long-term prospects has got everyone’s attention. 

India's health infrastructure faces a significant demand-supply gap

India is a largely underserved country when it comes to healthcare coverage. Consider these statistics – India had just 5 beds and 8.6 doctors for every 10,000 people, according to the OECD. These readings are among the lowest in the world. The situation is worse in north India, according to the management at Medanta.

During a Business Today conference, Suneeta Reddy, Managing Director at Apollo Hospitals, emphasized the need to focus on increasing bed capacity rather than on acquisitions. Reddy stated, “We need 100,000 beds for the next 10 years, but we are only at 25% of what we need to do.” 

#BTMINDRUSH | Whether it is healthcare, infrastructure or steel business, India is where the opportunity is, says a power-packed panel including Apollo Hospitals' @SuneetaReddy4, Tata Steel's #TVNarendran, and Nestle India's #SureshNarayanan#BTBestCEOAwards | @SaysVidya…

— Business Today (@business_today) April 27, 2023

According to the Ministry of Health and ICICI Sec, the life expectancy in India is likely to cross 70 years by 2031, leading to a rise in the ageing population. The share of senior citizens in the population is expected to rise to 13% in 2031, up from 8.5% in 2011. This demographic shift will drive domestic demand for healthcare. 

Another major driver of healthcare demand is the rise in non-communicable diseases, particularly cardiac ailments, with changes in lifestyle. 

And finally, India presents a favorable opportunity for medical tourism. According to Abhay Soi, Managing Director at Max Health, the cost of treatment in India is less than 5% of the cost in the US and lower than other South Asian nations.

India has a skilled workforce of doctors and nurses, making it an attractive destination for international patients. Private hospitals benefit from higher revenues per bed from international patients.

Abhay Soi sums up the long-term opportunity in healthcare, “Ageing population, rising costs, most government treasuries going bankrupt. This is not even the tip of the iceberg right now.”

Hospitals are gearing up by increasing their investments. They have lined up capex for additional beds, renovating facilities and acquiring the latest equipment. Most healthcare players, except Apollo and KIMS, have posted a robust rise in their free cash flows in FY23. This gives investors confidence in the spending power of healthcare players.

Healthcare players post stellar Q4FY23 results, end FY23 on a high

Leading healthcare companies clocked a revenue growth of over 20% YoY in Q4 due to a jump in occupancies and rise in average revenue per operating bed (ARPOB). With the exception of KIMS, other players saw their occupancies improve by a minimum of five percentage points in Q4, aided by a lower base of Q4FY22 and higher demand for elective surgeries.

KIMS faced lower occupancy due to the increased supply created by its acquisitions of Sunshine and Kingsway hospitals in FY22. In contrast, Rainbow Children’s saw a significant jump of over 19 percentage point jump in occupancy due to a higher incidence of viral infections.  

Hospitals posted higher ARPOB through improved payor mix and case mix. For instance, Max Health’s per-bed revenue got a boost from increased  international business and a reduced share of PSU business, as patients under government health schemes received discounts. 

Apollo Hospitals’ success can be attributed to a reduction in institutional business and a higher share of retail and insurance categories. Meanwhile, companies like Medanta took price hikes in Q4FY23. According to its management, the company undertook a series of tariff increases in its flagship Gurgaon facility from January to April. 

The majority of healthcare players also saw higher EBITDA margins YoY, driven by increased occupancy and realizations. However, Apollo Hospitals’ margins dropped to a multi-quarter low, owing to losses in the Apollo 24/7 venture and a poor show in the diagnostics business.  

While hospital chains closed the year with over 13% top-line growth, their bottom line growth varied. Apart from Apollo and KIMS, several companies saw a profit jump of more than 50% YoY in FY23. 

Hospitals to continue expansion in the medium-term

Healthcare chains have planned aggressive capacity expansion over the next 3-4 years. Apollo Hospitals aims to add 2,000 beds by FY27 at an outlay of Rs 3,000 crore. The additions will be made across key metros. They will be introduced gradually, starting from FY25. In FY24, the company’s focus is on improving its bed occupancy rate to 70%. 

Max Health and KIMS are looking to raise their bed capacities by over 40% in the next two years. While the expansions for Max are mostly restricted to metro cities, KIMS is also adding capacity in units in Nashik, Vizag, Anantapur, etc. Notably, its facility in Kondapur, Hyderabad, will see the highest number of bed additions.

KIMS has faced margin pressure due to recent acquisitions and now faces challenges in capital expenditure. Despite this, the management remains confident about improving margins from the scaling-up of operations at acquired facilities. In contrast, other chains have a cautious outlook.

Commenting on the margin trajectory, RVenkatesh, Group CEO at Narayana, said, “There are significant cost headwinds which we have only partially been able to address. Margin headwinds are mostly associated with India entering an election year. If exposed to government business, you'll be cautious due to growing receivables”. 

In addition, Narayana’s management expects upcoming greenfield projects in Kolkata and the Cayman Islands to affect its margins. The management of Medanta and Rainbow Children’s hospitals have also signalled a moderation in their operating margins, largely due to higher fixed costs from capacity building. 

Growth to moderate but stay strong, valuations are pricey

According to the management at Narayana, the exceptional revenue growth in FY23 will normalize going forward. The CFO of KIMS, Vikas Maheshwari, also confirmed that the top line growth rate could be lower given the higher base in previous years. However, analysts anticipate robust double-digit revenue growth for healthcare companies across the board in the next two years, with Max Health leading the way.

Despite the positive outlook, valuations for this space remain expensive. The weighted average profit CAGR for all companies, excluding Apollo, (growth is optically higher due to a profit dip in FY23), is estimated at 15%, according to Trendlyne’s Forecaster. The weighted average forward PE is around 32X, indicating that one would be overpaying for this level of growth. 

While the demand for quality healthcare in India is set to surge in the coming decade, investors are advised to wait for more attractive prices before making investment decisions in this sector. Hospitals are fully aware of the rare opportunity before them, which has come out of demographics and increased incomes (and indulgence). Their focus is on expansion. We will have to wait and see who does it better.

This analysis by Trendlyne is meant for investor education - to help understand companies and make informed investment decisions on their own. It should not be considered an investment recommendation.