Healthcare Global Enterprises Ltd.- Data is God- Updates

In my last post on Healthcare Global enterprise (Click here) i forgot to cover the valuation exercise of Strand life sciences in the final chapter on Financial analysis of HCG. One reader pointed this out in the comment section. So i have updated this aspect in that article. Further some readers have put the query as to why we assign high valuation multiples to book value for some stocks and not for others. So i have also added a short note on this along with some other changes in that chapter. So i am reproducing the updated chapter here (updates highlighted in red):

Financial Analysis

It may appear on the surface that HCG is doing badly operationally when one looks at its financial performance- Turnover of Rs. 1100 (hit by Covid) cr in 2019-20 and Losses before tax of Rs. 119 cr. But just a little bit of scratching of the surface and things will unfold into a new dimension. HCG has done massive expansions in last 3 years by investing some 700 cr in creating new facilities across India. Numbers of beds under its network are at 2071 in Mar-20 as compared to 1364 in 2017. Its gross block is around 1200 cr in 2020 as compared to some 600 cr in 2017. It was a profitable company in 2017 with NP of 23 cr on revenues of 700 cr. Now, I think you can easily guess why its performance could have suffered after that- because of costs related to new expansions hitting the profits with relatively much lesser growth in topline. Like, its topline growth is around 50% from 700 cr to 1100 cr however depreciation is at 104 cr in 2020 (excluding lease impact) vs 57 cr in 2017, interest cost of 82 cr vs 23 cr, Employee cost at 208 cr vs 121 cr. Further there is an impact of Rs. 40 cr due to implementation of new lease standard 116 otherwise the losses are much lower than the reported figure of 119 cr (loss before tax). So as maturity profile of recently commissioned hospitals is low hence they are not contributing much to the topline but their expenditures are hitting P&L badly as turnover growth is just 50% but most of the expenditures have been grown up by more than 100%.

In Healthcare there is high operating leverage as most of the expenses are fixed so when a hospital is new, revenue will be lower but fixed charges like depreciation/lease rentals of building, machinery, staff payments hit hard. Healthcare uses very expensive medical equipment so upfront fixed expenses are high so this gives a false impression of losses. But as most charges are fixed so most of the incremental revenue goes to bottom line. We can look at the superlative performance shown by NH this year which will show the operation of operating leverage. I am taking the performance of 9 months ending Dec-2019 to eliminate the Covid impact in Mar-2020. Up to Dec-19 the topline of NH was Rs. 2385 cr vs 2096 cr growth of 14%. But its NP was 107 cr vs 22 cr…a massive jump of 500% as compared to topline growth of just 14%. And stock price of NH increased from 200 to 400 in Jan-2020 (click here for the post on NH). We can see similar impact of operating leverage on the performance of HCG anytime in this year.

For valuation, EBITDA can be used but as it has just completed a major expansion in last 3 years so I do not think it is wise to try to assign a valuation to it even on the basis of EBITDA. I have seen people using this metric blindly in all situations. Similarly I have seen attempts to value HCG on the same basis. But as I have told you hospitals are a very different business and it is not easy to apply traditional valuation models on it. Like, for EBITDA based valuation we can see that the value will be heavily distorted by the presence of newly commissioned hospitals (large numbers) which are having negative/break even EBITDA as of now. So these facilities which do not add anything to the EBITDA of the company will not get any valuation at all!! So if we try to value HCG on the basis of EBITDA (it shows some 135 cr for Hospital business in 2019, 121 cr in 2020) then the result will give extremely wrong valuation because it will not assign any valuation to the loss making/break even hospitals. In fact, loss making hospitals will further reduce the overall EBITDA of the company and this will result in the assigning of negative value to a hospital like -50 cr for its Nagpur hospital. But can a hospital has negative value or a zero value??

So I think the better approach to value these growing hospital chains is- use EBITDA for matured hospitals with positive EBITDA and use replacement cost based or revenue based approach for the loss making/breakeven facilities. Last year Max healthcare was sold at some 25 times EBITDA. But Cancer hospitals are much more expensive to set up and due to costly equipments the capital cost is very high. Further HCG is a young entity so I would take 30-35 times EBITDA for valuing HCG. Its mature center EBITDA is 160 cr (including IVF business) so at 30 times EBITDA the value is 4800 cr. I do not have the value for cost incurred on new hospitals but they have given the debt taken for new hospitals and the same is 432 cr as on mar-20. We can move ahead with this figure by adding some value addition in the form of expertise in setting up/planning and also in the form of first mover advantage in setting up a new hospital in a small city because this acts as a deterrent against new investments by competition. I think we can easily take the same at minimum 500 cr.

Let’s also try to value on the basis of revenue which is 150 cr for loss making centers. Max deal has happened at some 2.5 times of revenue that too of mature hospitals. So I think we can take this at 3-4 times for HCG loss making centers which will take the value at some 450-600 cr which is near to 500 cr we derived on the basis of cost. So Value of Mature hospital 4800 cr+ new hospitals 500 cr-Debt of 700 cr will make the value around 4600 cr. It is very high compared to the current market cap of Rs. 1600 cr. So let’s try to lower the EBITDA multiple to 20 thinking wrongly that this is due to covid. So at 20 multiple, the value of mature centers excluding debt is 2500 cr and by adding 400 cr (only debt no value addition) for loss making centers the value is 2900 cr still 80% higher than the current market capitalization which shows that it is way undervalued.

Further, other comparative players like Narayana and Apollo are trading at 6 times of their book value while HCG is trading at 3 times its book value. The likes of Fortis and Aster are trading cheap (at one time and 3 times) but Fortis is fighting its own set of problems and Aster DM i think gets more than 50% revenues outside India so i have left both. Further, as i have shared earlier Cancer hospitals require more capital investments but still if we take 6 times of book value as the basis the valuation of HCG will be some 3200 cr which is near to our other valuations so we can say that our valuation of HCG is on right track. Some people ask me why for some stocks market pays such a high valuation compared to its book value...5-6 times is a big value. Actually stock valuation is where market sometimes shows great creativity. Like, if we can see low book value in case of hospitals in their infancy is an illusion because hospitals are a high capital investment business so in the initial period (say 4-5 years) there are losses due to the impact of high depreciation and other high fixed expenditures which results in big losses and so reduction in the book value. But this reduction in book value is not real as company is building business and growth catalysts are still intact. And with better performance in future due to operating leverage book value will be restored to normal levels. That's why in the initial phase market assigns high valuation multiple to book value but as they are matured this valuation multiple is normalized.

Strand Valuation

But above valuation of HCG is excluding the stake of 38% in Strand life which for me will be one of the biggest growth catalysts. As I have told you earlier there is not much information about the revenues and valuation of Strand. Like, in Feb 2018 Quadria acquired stake in it for 80 cr but how much stake it acquired is not known. But as 38% is with HCG, then there are investors like Kiran Shaw, Reddy, and Promoters etc. So I think Quadria much have acquired somewhere 10%-20%. At 20% the value is some 400 cr and that was 2 years ago. After that Strand has acquired the diagnostic business of USA based Quest in India. But if you ask me sometimes it is better not to try evaluating something as revolutionary as Strand.

Once I was talking to a friend who wanted to make a career in Astrology. During our discussions I shared my view about Astrology that it has lost its credibility because it tries to answer (and change) everything. Further, most of the things look beyond its reach and illogical keeping in view its current technical/theoretical advancements. Like the sun we see in the sky is the sun that existed 8 minutes ago because it takes around 8 minutes for the light to travel from sun to earth. Same is for all the stars. A person comes into this world 9 months before taking birth. Similarly I always feel that equity investing starts to behave like Astrology when it tries to put a value on everything. Some things are unfolded only on time and it is better not to make a crude guess of what may unfold especially with outdated techniques. CAGR, DCF etc. have outlived their lives and for emerging businesses they have very limited utility. We need something better now (Even for settled businesses targets announced by brokerage houses do not hit 95% of times). The likes of Quadria has acquired stake in Strand so they have to put a value on it but most of the times that value is purely arbitrary and does not have much perspective. That’s why we see cases like Quess Corporations where Thomas Cook has made astonishing returns. Thomas cook invested in Quess in 2013 and by 2020 the value of its investment increased by some 25 times!! But in 2013 nobody could guess that by 2020 the same can be 25 times. In fact everybody would have laughed at. So the price paid by Thomas cook was just the funds needed by Quess for their future growth and so the valuation was arrived for the sake of valuation not out of some precise calculation. Nobody can evaluate a disruption and innovation early in its life. Same thing I feel for Strand and I think it is good that we are not required to put a value for strand. I only wish for HCG to raise its stake in Strand in the future.

CVC Investments will be a game changer

Further, to make the valuation exercise more confusing the company has sold 31% stake to a private equity player CVC at a valuation of 1600 cr. So, one can feel that the valuation offered is quite lower. But I think there may be some valid reasons for this. Main reason can be the devastating impact of covid on all businesses and healthcare was also badly affected and there are high chances that healthcare will remain stressed due to negative impacts on the incomes of people and this will hit their capacity to spend on healthcare services. HCG was having a debt of 700 cr (some 30-40% in foreign currency) and with not much help from government for healthcare sector I think even their survival was at stake. So there was high uncertainty in Apr-may-2020 about the impact of Covid and this might have affected the debt reduction plans of the management in 2020-21 as Covid will easily wipe out 2-3 quarters this year. HCG stock price was beaten down to some 60 levels in Mar-20. Hence, management realized the urgency to reduce the debt and this might be the reason for going for the stake sale. In May-20 price offered was 100 which was increased to 130 in June-2020. HCG has got some 500 cr from the stake sale and this they will use for the debt reduction and this will make things much better for them.

I also think that the present situation created due to Covid crisis will hit the business of many hospital chains and those with weak balance sheets will feel the more pain and this may help HCG doing much better even in tough times and we may see some management contracts happening with other local hospital chains. Further, the scope of deferment of cancer care is very less as compared to other healthcare problems so HCG should not face that much difficult time as may be felt by other healthcare services.

HCG is planning to sell its fertility business under Milann brand which is having revenues of 70 cr. I never liked HCG doing this unrelated business especially when the scope of growth in the core cancer care is so high which requires huge capital investments. Actually these types of unrelated acquisitions raise the doubt of fund leakages by the management because why a wise man would attempt this type of adventure when they are hard pressed in their core area. Still, I want to give them the benefit of doubt keeping in view the otherwise good reputation and credibility of the management and the fact that HCG did this in 2013 way before their IPO and most importantly the presence of marquee investors in the form of IFC, Tamasek, CVC raises the trust factor to great extent. Now, they have decided to sell this fertility business which is a good decision. So I hope that things are going to get better for them from hereon because HCG has already suffered quite a bit. They went for massive expansions but were hit badly by the onslaught of Covid. But current valuations are already discounting (over-discounting) all such sufferings and it is one of the best play on the growth of Genomics, Genomic diagnosis and Cancer care in India.

(Views are personal and should not be taken as a recommendation for buying or selling a stock. Stock markets are inherently risky so kindly do your Due Diligence before investing. I am not a certified SEBI Analyst and holding the shares discussed in this Post. reach me at oscillationss@yahoo.in).