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Organic growth outweighs questionable M&A; Initiate with OW

On a growth trajectory in an underserved industry. Cleopatra Hospitals Group (CHG) is one of Egypt’s largest private healthcare providers, where per capita healthcare spending sits 40% below EM levels, adjusted for income. Through its four hospitals, the Group has a 634 bed capacity, holding 7.7% and 1.9% market share of Cairo and Egypt’s private beds, respectively. Our valuation only factors organic growth, reflecting a 2018-20e EPS CAGR of 47%, well above the MENA peer average of 24%. CHG trades on a 2019e P/E of 22x, a 43% growth adjusted discount to peers. CHG stands out among Egypt’s listed healthcare plays, with its value added services, pricing power, and high operating leverage.

Synergies and economies of scale to drive earnings growth. We look for a 2018-20e sales CAGR of 26%, stemming from: i) a total patients CAGR of 5%, on strong foothold across Cairo, along with initiatives to up inpatient intake as a % of outpatients, on cross referrals, and ii) pricing power, on improving efficiency (3 hospitals within the Group generate c50% lower revenue/bed vs. Cleopatra Hospital), and unifying terms and discounts with contract clients across all hospitals, given CHG’s size. The consolidation story continues to unfold, in our view, on centralised procurement of medical supplies (32% of CoGS; already down as a % of sales to 20.8% in 1Q18 vs. 22.0% in 1Q17) and operating leverage. We forecast an EBITDA margin of 21.4% by 2019 vs. 18.8% in 2017.

Promising M&A pipeline, but deal execution a watch factor. CHG has 1 target on its M&A radar, a 92 bed hospital in West Cairo, potentially adding c2% to our valuation. CHG also entered into a JV to refurbish and operate a 160 bed hospital in Beni Suef. We opt not to include inorganic growth, given CHG’s slow pace of M&A execution, and delayed use of the IPO and rights issue proceeds. A recent bid by CHG for Al Nozha, a publicly listed, 110 bed hospital in Cairo, for EGP650mn (implying c14x EV/EBITDA), was rejected by the FRA.

Manageable risks. Unforeseen higher labour cost inflation (we assume 20% p.a. average growth in the wages bill) could pose a risk on CHG’s margins, given its labour intensive model (57% of cash costs). High acquisition multiples, given the limited options, could also turn value destructive. CHG stated that Abraaj Capital, which is reportedly restructuring its assets, indirectly owns <5%.