Narayana Hrudayalaya – Building an affordable model of healthcare at scale

Hospitals provide a necessary service and are hence relatively immune to economic cycles. On the other hand, it is a highly capital intensive business and is inherently riskier to that extent. For capital intensive businesses such as hospitals, the capital expenditure required is more than the cash generated from operations especially during the growth phase of the business. Most of the hospital chains currently in India are in their growth phase and hence have negative free cash flows as can be seen from the table below. Kovai has a positive cash flow as they derive a majority of their revenues (88%) from one single multi-specialty hospital.

NH (2011-18) NH (2011-18) Apollo (2005-18) Apollo (2005-18) HCG (2011-18) Kovai (2011-18)
Consol[1] Std[2] Consol[3] Std[4] Consol Consol
CFO 888 950 3,515 3,342 455 597
Capex 1,660 1,493 6,577 5,790 1,113 473
CFO-Capex -772 -543 -3,062 -2,448 -658 124
[1] NH consolidated includes NH standalone plus the overseas hospital at Cayman Islands
[2] NH standalone includes all their Indian hospitals
[3] Apollo consolidated includes Apollo standalone plus their insurance operations
[4] Apollo standalone includes their hospital operations plus the pharmacy operations

Because free cash flow is negative for all hospitals except Kovai, these companies will need to raise outside capital in the form of either debt or equity to bridge the gap. Too much of either is not a good thing for a business. Hence, for capital intensive businesses, it is generally a good policy to be disciplined and expand in a calibrated manner so as to minimize the need to raise outside capital.

Also, as most of the hospital chains are in growth phase, their current profitability is diminished and is not a true reflection of their steady state profitability. That is because when you start a new hospital, all the capital and operational expenditure has to be done upfront to build the hospital. But the revenues in the initial few years gradually build up as patients learn about the new hospital and footfall gradually increases. Hence new hospitals operate at a loss in the initial few years before they reach maturity and start generating profits. Hence a better approach to understanding their business efficiency is through their cash flows.

First of all, we need to understand where their cash is coming from. Majority of the cash will come from business operations, debt and equity. The table below provides the percentage of cash flow coming from each of these sources.

NH (2011-18) NH (2011-18) Apollo (2005-18) Apollo (2005-18) HCG (2011-18) Kovai (2010-18)
Consol Std Consol Std Consol Consol
CFO 49 59 36 38 34 83
Debt 33 24 40 42 24 13
Equity 12 12 21 16 38 0
Others 6 5 3 4 4 3

As we can see from the table, Narayana Hrudayalaya (NH) is getting more of their cash flows from operations and as compared to either debt or equity in comparison to their peers. (Kovai is not relevant here as they have limited capex requirements as they are operating just one major hospital.) As discussed above, NH has been the most disciplined in raising outside capital. As a result, we would expect their growth to be lower than the peers. Let’s have a look at their growth. The table below provides the revenue CAGR for select hospitals.

NH (2011-18) NH (2011-18) Apollo (2005-18) Apollo (2005-18) HCG (2011-18) Kovai (2010-18)
Consol Std Consol Std Consol Consol
Revenue 25% 22% 18% 17% 21% 19%

Well, it turns out that they have been able to grow their topline at higher rates despite using lesser outside capital. Which means that they are generating more “inside” capital i.e. cash flow from operations. Lets see if that is backed by numbers. The table below provides cash flow from operations generated by the business per unit of capex.

NH (2011-18) NH (2011-18) Apollo (2005-18) Apollo (2005-18) HCG (2011-18) Kovai (2010-18)
Consol Std Consol Std Consol Consol
CFO/Capex 58% 66% 46% 49% 41% 126%

So, from the above figures, we can see that NH is indeed running a tight ship. They are generating more cash flow from operations per unit of capex when compared to their peers. As a result, they are able to grow their business at better rates even though they use lesser outside capital.

Finally, because they use lesser debt, they are able to reinvest majority of their cash into the business. The table below shows the percentage of cash outflows for capex, interest and dividend.

Nh NH Apollo Apollo HCG Kovai
Consol Std Consol Stad Conso Conso
Capex 90 91 80 80 83 76
Interest 10 9 13 12 16 21
Dividend 0 0 7 8 1 3

The macro picture for NH is better than peers. But how are they able to run a more efficient organization and be more disciplined than their peers. To understand that, we will need to get an understanding of the micro picture.

The results are due to their strategic choices. For NH, their strategy is to provide healthcare services at affordable cost and at scale. Two keywords here are – affordable and scale. In their own words – “Affordability is the epicenter of the group’s strategy.” On an average, NH charges patient much less than their peers. The image below provides average revenue per occupied bed (ARPOB) for select hospitals.


Source: Jeffries; Healthcare Services Unmet Demand Conundrum; Initiating Coverage; August 2017

As we can see that the ARPOB for NH is significantly less than their peers. But if their performance is better than their peers, that means that their expenditure also must be significantly less. As we will see NH has significantly lesser capital expenditure compared to peers but don’t fare as well on the operational expenditure.

The capital expenditure per bed for NH is also significantly less than their peers as can be seen from the figure below. This is because they don’t own all of their hospitals. Their hospitals are equally divided into hospitals which are owned by them and hospitals which are on revenue share/ rental basis. For the hospitals which are on revenue share, the partner own the fixed assets including land and building while NH owns the medical equipment and operates and manages the hospitals. In return, NH pays a revenue share/ rent to their partners. This saves them the initial capital expenditure in setting up the hospital. The partner benefits from their expertise in running the hospital and gets an annuity revenue.

Average capital cost

Source: Jeffries; Healthcare Services Unmet Demand Conundrum; Initiating Coverage; August 2017

The operational expenditure of various hospitals is given in the figure below. As we can see that there are four components of operational expenditure – consumables, doctors fee, other employee expenses, and Other expenses. In terms of operational expenditure, while NH is better than peers on consumable expenses but it has higher other employee and other expenses. On the whole, they are behind most of their peers in terms of operational economics and are only ahead of Fortis. To be fair, most of the expenses including doctors’ payments, other employee payments and other expenses are fixed in nature. NH has recently added 3 new hospitals and these expenses should reduce in percentage terms as the hospitals mature. But this will need to be monitored and remains a concern.

At NH the doctors work on a fixed salary. At most other hospitals, part of the compensation of the doctors is linked to the amount of revenues they generate. This gives rise to lot of malpractices because it creates a conflict of interest between what is good for doctors and what is good for patients. Charlie Munger famously said – “Show me the incentive and I will show you the outcome.” In NH, because doctors work on a fixed salary, they have no incentive to prescribe unnecessary tests or procedures for the patients to earn extra money. That completely eliminates the egregious behavior prevalent at other hospitals. But, this also means much higher fixed cost during the starting phase of the hospital.

Cost structure

Source: Jeffries; Healthcare Services Unmet Demand Conundrum; Initiating Coverage; August 2017

The second cog of their strategy is scale, and the results here have been mixed.

Their vision is to have 30,000 rooms across their hospitals (current bed 6,228 operations beds as of September 2018). The vision was announced in 2012 and to be reached within 5 years i.e. by 2017[5]. They have fallen short on that measure by a huge margin. They plan to reach the vision by having 2,000-5,000 bed health cities in multiple locations. Currently they have a ~1,500 bed health facility in Bangalore and ~700 bed health facility in Kolkata. These are also their oldest facilities which are doing very well. Together these facilities comprise ~50% of their total revenues from India. Based on their experience, their vision was to have similar facilities with 3,000-5,000 beds in other parts of India. However, they have not found same success in other parts of the country. They have tried and failed in two locations – Hyderabad and Ahmedabad.

  • The Hyderabad hospital was started in Feb 2010 on a lease of 20 years from Chandramma Educational Society. At the time the aim was to convert this 150-bed hospital to 5,000 bed within 10 years.[6] However, the demand for the hospital failed to materialize and they had to shut down the hospital in April 2016.[7]
  • The Ahmedabad facility was started in May 2012 and had 300 beds. The plan was to gradually increase the bed capacity and turn this into 5,000-bed health city over time.[8] However, the facility has failed to scale up and the management considers it to be a major disappointment.[9]

NH has failed to replicate the success of their first two hospitals in Bangalore and Kolkata elsewhere. However, despite the setbacks it is still one of the most efficient hospital chains in India. The vision of NH is to provide affordable healthcare at scale without compromising on the quality. This is a goal worth striving for especially in a country like India where majority of the population find it difficult to afford quality healthcare. But it is not easy and that is why almost all the hospital chains in India are focused on premium segment of the market. NH is trying and I think we should all cheer for them. If they are successful they will change the face of healthcare in India and perhaps globally.

In a separate post, I will look into the detailed financials of NH.

[5] Narayana Hrudayalaya to create 30000 beds

[6] Narayana Hrudayalaya Malla Reddy hospital unveiled

[7] NH Exits hospital operations in Hyderabad

[8] Narayana Hrudayalaya’s Ahmedabad hospital opens doors

[9] Earning call transcript Q4FY18

Value investor


    • kashifkidwai

      One of the lessons which i have learned many time is that business is more important than valuation. Hence, valuation is secondary to the strength of the business for me. A lot of the optimism was built into the stock price. But the price has been correcting as reality has fallen short of expectations. Although valuation seems reasonable at this stage. But everything depends on how they are able to grow the business from here. And I don’t have a strong conviction in the future as of now.

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