Health is profit!

The first equity IPO of this year is now announced. Interestingly, it is the first time a company from the Ratnapura District is coming for a listing on the CSE. (Which is a good thing as this is exactly what we need in order for us to develop the capital market). As I always mention, the other good thing is that this is a productive business (not a shell company with some investment holdings which are not generating cash!) and hence there is tangible business.

Singhe Hospitals

As mentioned in the Prospectus (page no. 25), “The Company was incorporated on 16 December 2009 as a Board of Investment (BOI) approved project to carry on a Private Hospital, including Laboratory and other connected Services in Sabaragamuwa Province. The Company started commercial operations in June 2012. Singhe Hospitals Limited (SIHL) is the only private hospital operating in Ratnapura District with modern health care facilities. SIHL is a fully equipped tertiary care hospital presently with 50 beds to accommodate patients and a range of medical specialists are available throughout the day for consultation. Patients for indoor treatment are admitted under the care of the visiting consultants and qualified doctors.”

Healthcare in Sri Lanka

Healthcare services are provided by both public and private sectors in Sri Lanka. The public sector plays a predominant role in the healthcare industry in Sri Lanka with a total bed strength of 74,636 and 1,084 hospitals (including 481 Primary Healthcare Units) around the country.

However, the public sector is unable to keep pace with the growing demand due to capacity constraints and limited funding availability from the government. Increasingly, people rely more on private healthcare organizations to meet the needs due to perceived higher quality of services and convenience. Hence, the demand for private health sector is growing at a rapid pace. This tendency is expected to continue as a result of certain other fundamental factors like ageing population, increasing household disposable income levels, the high prevalence of Non Communicable Diseases (NCDs), and the re-emergence of communicable diseases. Have a look at the below graph which gives a quick glance at what drives the overall healthcare market in Sri Lanka.

Like in many parts of the world, the private health sector in Sri Lanka is also fragmented to a large extent with small practices owned by medical professionals. By end 2013, 206 registered private hospitals with approximately 5,309 beds were in operation in Sri Lanka. (this was just 186 hospitals with 4,784 beds in 2011) Most of the private hospitals are concentrated in Colombo the main commercial city of the country. Apart from hospitals business, the private health care sector is characterized with other businesses like elderly and residential care, traditional medicine, ambulance services, diagnostic services and alternative medicine.

Demographics in Ratnapura

Ratnapura is a district in Sabaragauwa Province (SP) and as the name suggests it is the city of precious gems. The total population of Sabaragamuwa Province is c. 1.941 million of which majority lives in Ratnapura District (about 57% or c. 1.097 million). The gender split in SP is 51.9 female and the balance male. SP has the fourth highest elderly population (just behind Western, Southern and Central provinces) and that number is higher than the island’s average as well. Average household income in the province was only behind Western Province at LKR36,173 and it recorded the second highest income disparity in the island with the richest 20% earning 57.9% of the income. In SP, total Personal Care and Health Expenses as a percent of total household income was just 3.9% (this is at 5.7% in Colombo. May be people in other parts of the country are healthier than people in Colombo where in Colombo, people’s lifestyles are significantly different to the others).

Healthcare delivery in Ratnapura

Healthcare Delivery in Ratnapura is predominantly done through the public sector institutions, like any other part in the Country. The table below shows all the delivery points across Ratnapura District. (please note that these bed figures are based on CY2010 and I believe that the bed numbers must have increased over the period from then to now) Refer this report for more info:

Looking at above figures I estimate Hospital Beds per 1,000 people in Ratnapura to be c. 2.91. (Note that this is only considering the public sector institutions. However, the Central Bank of Sri Lanka Annual Report says that islandwide this figure is 3.6 beds per 1,000 persons) This I can contrast with figures from other countries as per this link. If we go by the WHO standard of 3.5 beds for a population of 1,000, Ratnapura District needs c. 3,840 beds to serve the current population of 1.097 million inhabitants in the District. (which is a 646 bed shortfall, going by the public sector no of beds of CY2010). Currently, it looks that the numbers are about right. But, if you look at this chart it is evident that as the population age, the need for beds increase. (Japan, Germany are countries with very high elderly population and similarly higher bed ratios). But, for Sri Lanka and hence Ratnapura, need for higher no of beds will not arise in the short to medium term. (may be in another 15 – 25 years!)

Singhe Hospitals Market Opportunity

Geography - Ratnapura is located fairly close to Colombo. It’s about a 2 – 3 hour trip one way. Hence, the well-to-do has always travelled to Colombo for private healthcare, mostly in case of acute illnesses. This distance (between Colombo and Ratnapura) would probably be further reduced if the planned highway becomes a reality.

Moreover, Ratnapura District is spread across a large extent of land and as a result cities like Kuruwita, Eheliyagoda and Awissawella are more closer to Colombo. Hence, people from those areas would most likely travel up Colombo rather than down to Ratnapura. Moreover, people from Embilipitiya would most likely travel to Matara or find it worthwhile travelling couple of more hours to Colombo rather than stopping half way down at Singhe. Hence, I believe that the addressable market for Singhe is a very captive one within a certain radius of the hospital.

However, as mentioned in the prospectus, SHIL is the only private hospital with modern facilities at the moment. (why I’m saying at the moment is because there is another hospital that is coming up very close to it. (have a look at the below map)) However, SHIL also enjoy location benefit so far as it is located very close to the Ratnapura General Hospital.

Average Length of Stay (ALOS) – Mainly due to geographic closeness of Colombo private sector providers and the abundance of physicians in Colombo, people from areas like Ratnapura would only make use of facilities in their locality as a make-shift venue. Thus, the ALOS in a Ratnapura facility would be very short compared to ALOS in Colombo based operators.

Feeder position – These operators in areas like Ratnapura actually act as feeders to Colombo based operators. Anyone, who can afford to go to a private operator in Ratnapura will go there for only OPD type treatments and initial screenings or testing. Afterwards, they would proceed to Colombo.

Bed Occupancy Rate (BOR) – One other thing that affects badly the local operators are the low level of BOR. This is in fact as a direct result of above two points, i.e., ALOS and feeder position.  

Perceived grandeur -  Still people in these parts of the country prefer to visit Colombo for treatments due to perceived grandeur in it. Hence, their first preference will be to visit so called ‘Navaloka’, ‘Appollo’ or ‘Asiri’.

Technology availability – That said it has to be also mentioned that people are also forced to travel to Colombo as some of the technology available in Colombo are not available locally. Hence, local availability of some of the latest technology might help retain some of the patients visiting Colombo, especially elderly who do not want to travel or those who want to save some time (well anyone wants that).

Supply issues – Connected to the above point is the limitations on supply side. For instance, I understand that lack of properly trained nursing and other staff at private sector has been a disadvantage for private operators (this problem is severe when you go out of Colombo). As a result, patients prefer to go to public sector hospitals and added to this is the advice given by doctors to always go to public hospital. The map below shows the density of nursing and midwifery personnel across the globe. 

As per this Sri Lanka has to go a long way to develop to other emerging nation status. Further, the low density of physicians in Sri Lanka is another supply side constraint which is again even worse when it comes to Ratnapura and the like. For instance, physician driven business will always be generated in Colombo unless some structural change happens in the country likelihood of which is zero as per my reading. As per the below map Sri Lanka’s density of physicians is very low at 0.68 for population of 1,000 (You can do a comparison through this interactive map given by WHO here). Supply side factors are common to all the operators including large players, however situation is comparably poorer in Ratnapura, I estimate. Which is a drawback for SHIL.

With that I wrap up on the industry and market opportunity and move on to value the equity of SHIL.

The intrinsic value

In order to value SHIL, I made use of the forecasts (for the first five years) that were given by the firm that did an equity valuation of the shares of SHIL. That valuation cannot be considered an independent one as the entity that did the valuation happens to be the auditors of the company (meaning that they are biased towards the management of the company and hence the valuation itself is biased upwards, technically). From the year 5 onwards, I’m using my own assumptions.

In terms of revenue growth I assume that over the long term it has to settle in at normal economic growth rate which I assume to be around 6%. Even if I assume that it grows at average inflation rate of the country that will be the case as I assume. Further, I assume that their EBIT margin will be at 11.5% which is similar to average margins recorded by Lanka Hospitals, Durdans over a five year period. Then beyond the explicit forecast period I assume the EBIT margins to settle at 9% (for the infinity) similar to current margins of Lanka Hospitals. As per the BOI agreement company will start paying tax at 10% for two years from year 6 to year 7 and thereafter at the rate of 20% for the infinity.

In terms of discount rate, I use a cost of capital rate of 11.98% for the first six years and thereafter a cost of capital rate of 12.5%. From year seven and beyond I assume that long term debt to capital ratio to sit around 30%. A risk free rate of 7.89% which is equivalent to current 5 year Sri Lankan government bond rates is used. Currently, the company is assumed to borrow at 11% from the banking system in Sri Lanka.

Based on all these assumptions, (assuming that it will generate Lanka Hospital like margins and Sales to Capital ratio of 2x) I get a value per share of LKR0.60. The offer is hence priced 318% over my valuation (which anyone can argue otherwise and I welcome anyone to do that) In fact, if you have different assumptions as opposed to mine I’m happy to run them through my model and see the impact on the value.

Missing by miles

At LKR2.50 per share the Investment Bankers of SHIL are valuing the entity at LKR995.6 as opposed to mine of LKR238.1. So, am I missing the value by miles or am I right? Well that is not a question that anyone can answer. Because, valuation is not a science!

Bottomline

Going by my valuation, I reckon that the IPO is overpriced and that is evident if you look at who valued the company and in which direction the biasness is (as any valuation is biased as far as what I learnt and what I believe). That said I welcome the entry of local business to CSE as it is exactly what the country needs.