Company update: Narayana Healthcare (Outperformer) - Ready to run!

Indian hospital services have entered a new phase with most companies prioritising profitability enhancement over network expansion. A 34% outperformance in Apollo Hospitals (APHS; market leader) to BSE Healthcare index over last 6 months, reflects the upside potential of this turnaround. Narayana Hrudayalaya (NH) is poised for re-rating, as we expect its profitability across hospital units to improve steadily, with the company not intending to add new units. In addition to steady growth at its flagship Kolkata/Bengaluru hospitals and Cayman unit, profitability contribution from older hospital units too is rising. We expect losses from the 3 new hospital units to reduce gradually and drive 23% EBITDA CAGR with Rs7.3bn FCF over FY20E-22E. NH currently trades at ~11x FY21E EV/EBITDA (~50% discount to APHS), and we expect the stock to re-rate. Given the improvement in business momentum, we have raised our FY20E/21E EBITDA estimates by 11.7%/10.6%, respectively, and introduced FY22E estimates. Maintain Outperformer rating with an upgraded target price of Rs340.

Indian hospitals – New growth paradigm: As highlighted in our recent note , listed  hospital services companies have entered into a likely prolonged consolidation phase, with limited capex expected over next few years. We believe the regulatory environment too has stabilised, reducing the probability of negative shocks. As a result, operating margins and return ratios of most hospital operators are improving, which we believe should drive a re-rating of other sector participants.

NH – finally hitting the groove post a slow start: While NH’s 3 flagship hospitals have been delivering consistently for a while, slow scale-up of its other mature units disappointed until FY18. This segment is finally delivering, with performance across multiple units like Shimoga, Raipur, Guwahati, etc, improving over last few quarters. Additionally, a sharp scale-up in the profitability of Cayman unit and flattening out of losses from new hospitals seem to have driven sharp improvement in NH’s consolidated profitability Q2FY19 onwards (Q1FY20 EBITDA up 99% yoy). We expect profitability to gain further momentum, going forward.

In a sweet spot: NH’s differentiated and scalable business model focuses on quality and affordable healthcare. Operational turnaround combined with shift in management focus, from adding beds to enhancing efficiency of the current network to drive profitability is a long-term structural positive. Maintain Outperformer rating with a revised target price of Rs340. NH is one of our top picks in the hospital services space.