How to analyse: Hospitals

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Health care is a sector that is here forever. It is seen as defensive sector, as people will never stop taking medicines or go to hospitals, whatever be the shape of the economy.

With that short introduction, let’s dive into the sector characteristics:

Characteristics of the sector

  • High capex: Hospitals are characterised by huge investments in buildings, equipments (surgical and diagnostic devices) and other related infrastructure.
  • High fixed costs: High capex leads to high fixed costs in terms of depreciation and interest costs. Further, staff costs are largely fixed in nature and constitutes a big proportion of total operating costs. Hence high capacity utilisation is required to break-even. This brings us to the question of gestation period, or maturity of the hospital facility.
  • Maturity profile: Hospitals take a few years to mature – i.e., to improve occupancy rates. Generally, hospitals take around 5 years to mature. If the company has higher proportion of new hospital facilities, it is most likely to be running at low profits, or even at losses, due to high fixed costs.
  • Bed count: The number of beds for in-patient division shows the size / capacity of a hospital facility.
  • Employee vs. Consultants: Some doctors are employed full-time, while others will be on consultancy basis. Doctors are the key talent of the sector, and having expert doctors in the hospital is critical to attracting patients. Higher proportion of employee doctors are preferred, as consultants can end services with the hospital at any time. This is a key operational risk.
  • Own vs. Leased vs. Managed facilities: Companies might either establish their own facilities, or follow an asset-light model by leasing or managing others’ hospital facilities
  • Mix of type service facilities: Based on the type of services provided, hospitals can be classified into four classes (detailed below). Primary care facilities earn lower revenues per patient, while tertiary and quaternary care have higher realisations. The mix of such facilities should be seen while analysing revenues and comparing it with peers.
  • Reputation and brand recognition: Commonsense. Who will go to hospitals with bad reputation?

Classification of hospitals based on services offered

Hospitals can be classified into four classes based on type of care offered:

  1. Primary care facilities: are mainly out-patient units that offer basic, point of contact medical and preventive healthcare services.
  2. Secondary care facilities: diagnose and treat ailments that cannot be treated in primary care facilities. These act as the second point of contact in the healthcare system. There are two types of secondary care hospitals – general and specialty care.
    • General secondary care hospitals: A general secondary care hospital is the first hospital a patient approaches for common ailments.
    • Specialty secondary care hospitals: Apart from the medical facilities offered by a general secondary care hospital, specialty secondary care hospitals treat basic ailments related to certain specific specialities
  3. Tertiary care hospitals: provide advanced diagnostic services and treatments.
    • Single-specialty tertiary care hospital: mainly caters a particular ailment, such as cardiac ailments and cancers.
    • Multispecialty tertiary care hospitals: Multispecialty tertiary care hospitals offer all medical specialties under one roof and treat complex cases such as multi-organ failure, and high-risk and trauma cases. Most of these hospitals derive a majority of their revenue through referrals.
  4. Quaternary care facilities: are similar to tertiary care facilities and focus on super-specialty surgical procedures, such as cardiac, neurological and joint-replacements. These facilities may also offer experimental medicine as well some types of specialised diagnostic and surgical procedures.

Revenues

Hospital revenues primarily come from two sources:

  1. Out-patients
  2. In-patients: These patients constitute bulk of revenues

Capacity utilisation

Due to high fixed costs (equipments, buildings, other facilities), hospitals need to operate at higher capacity utilisation to make decent profits. Two metrics need to be watched:

  • Footfalls: For out-patient
  • Bed occupancy rate: This is a measure of capacity utilisation for in-patient segment. Also ‘average length of stay (ALOS)’ of in-patients is another related metric. A shorter ALOS gives much more ‘average revenue per occupied bed (ARPOB)’, as the hospital can service more patients. Hence hospitals strive to have lower ALOS.

Costs

  • Capex & fixed costs: As discussed earlier, hospitals have high proportion of fixed costs. Such costs are especially high for super-speciality hospitals which need high-tech equipments.

Future growth prospects

Companies in the sector can growth revenues in the future by:

  • Adding beds in existing facilities
  • Increase capacity utilisation: Increase in bed occupancy ratio is key to revenue growth, as well as making profits (due to high fixed costs)
  • Building / acquiring new hospital facilities: represented in terms of number of beds shows the medium-term growth potential

Industry demand dynamics

At a macro-level, we need to look at the below factors while assessing the sector growth prospects:

  • Bed density in the country: Defined as the number of beds per 1,000 population, this is a key metric to identify the extent of hospital industry penetration. A lower number (in developing countries) means that there is scope for establishing new hospitals.
  • Healthcare expense as % of GDP: shows how big the industry is, currently. Low ratio shows scope for growth.
  • Health care expenditure by government of total healthcare expenses: If this is lower, it offers the private sector to fill in the gap.
  • Insurance penetration: In developing countries, due to lack of insurance coverage, many patients have to spend out of pocket. This results in lower spending, as they try to keep their expenses low. But, higher insurance coverage among the population means that, people will be willing to approach better quality and costly medical care. Hence growth of hospital sector is inevitably tied to level of insurance penetration.
  • Population and rising life expectancy: The higher these metrics are, the higher is the market potential. Older people will need more medical care, and hence ageing society is favourable to the sector.
  • Rising income levels: lead to more people accessing high quality healthcare.
  • Medical tourism: Emerging economies like India can provide high quality surgeries etc. at low cost. This has propelled the medical tourism sector.

Bottom Line

Select companies with good reputation, higher occupancy for older facilities, steady uptrend of occupancy in new facilities, and high proportion of employee doctors (as opposed to consultants). Look for lower ALOS and higher ARPOB.

Valuation

Fundamental: DCF

Relative: EV/EBITDA, EV/Sales, P/E


Major listed ‘Hospital’ stocks in India:

Apollo, Fortis, Narayana Hrudayalaya


Note: This post is part of “How to analyse” series. I will continue to update the post, as I learn new stuff about the industry.

Feedback: Your feedback is important to me. It helps me correct my mistakes and lets me learn new things. Please leave your feedback in comments.

Post last updated: January 2016


Sources:

Source of industry information: NHL IPO Prospectus

Image Source: Pixabay

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