Covid-19 May Affect Free Cash Flows Of Health Sector: Ind-Ra
The Covid-19 pandemic will negatively impact the free cash flows (FCF) of healthcare companies till end-1HFY21. This is backed by a lower-than-expected appetite of market participants, which could lead to a decrease in average revenue per operating beds resulting in lower revenue and thus higher fixed costs as a percentage of revenue, said a India Ratings and Research (Ind-Ra) note.
The Covid-19 outbreak has severely impacted the revenue generation of hospitals across the country; this is likely to continue till 1HFY21. The out-patient division (OPD) segment of the companies in Ind-Ra’s domain is operating at 20% of the earlier base case expectations, majorly on account of the lockdown, coupled with the inhibitions of the general public to avoid going to hospitals as a precautionary measure.
Similarly, the in-patient division (IPD) segment has been impacted by the government’s notification to postpone non-essential and elective surgeries. The segment is operating at around 25% of the base case assumptions and it is believed the trend will continue till 1QFY21. Also, the medical tourism has taken a hit, with nil revenue expected till 1HFY21.
The lower-than-expected FCF, along with non-deferrable fixed costs, will affect the short-term liquidity of the segment and stretch the debt service coverage ratios (DSCR). This will result in the companies depending highly on refinancing and parent support. The cash flow generations of the hospitals rated by Ind-Ra have been impacted in the last 30 days due to the decline in the scale of operations.
Fixed costs such as doctor salaries, employee costs, and consultation charges, which contribute 50%-60% to the overall costs for a hospital, may not be deferrable for the healthcare segment, unlike other sectors, as one of the major challenges for hospitals is to retain their resources. Hence, the margin profiles are expected to be impacted negatively compared to Ind-Ra’s earlier base case expectations.
According to Ind-Ra, although the regulatory moratorium period of two months will provide the much-needed liquidity buffer to the sector, the agency expects operations to normalise not before 3QFY21.
Hospitals’ net working capital cycle could elongate in FY21, majorly due to the issues pertaining to inventory management and higher debtor days. An increase in the procurement cost of consumables such as medicines and sanitisers from the pharmaceutical sector for healthcare companies would impact the margin profiles.
Active pharmaceutical ingredients (APIs), which form the major portion of raw materials for drug manufacturing, are majorly imported from China (around 70%) due to the low cost of imports. Though the government has classified pharma operations under essential services, the scale of operations has declined due to the lack of API imports from the Chinese markets along with the fall in consumption. However, this could result in incremental price risk on the entire supply chain for the sector, the note added.
Moreover, pharma players are exploring an alternative source of procuring APIs in the meanwhile. While it may create growth opportunities for domestic API manufacturers, meeting the required capacities and standards would be a challenge. The decline in the scale of operations of healthcare service providers has also resulted in a dip in the inventory consumption since March 2020 and this is likely to stay low till 1QFY21 which would provide the much needed time for the pharma players to build the required inventory levels.
Furthermore, any delays in restoring to original capacities of the pharmaceutical sector would impact the healthcare segment due to high correlation among the two sectors.
Also, moving ahead the incremental growth in Covid-19 cases will be the key factor to assess the sector dynamics. Domestically, the expenses required to test for Covid-19 symptoms are covered by state governments whereas for the Covid-19 positive cases, the existing insurance schemes are covering the expenditure. For below poverty line cases, Covid-19 positive individuals will be covered under Ayushman Bharat Health Insurance Scheme, a central government scheme.
Though these insurance schemes offer the required funding support for the hospitals to carry on their treatments for Covid-19 patients, an increase in such patients compared to its cash patients will result in increased debtor days and an elongated net working capital.
Generally, the percentage of cash:private insurance:government insurance in the companies rated by Ind-Ra domain is around 40:35:25 with debtor days from private insurance 30-60 days and from government schemes ranging 90-180 days.
Healthcare companies generally have high net leverage ratios due to their high capex requirements, majorly for new bed additions. However, with no new major bed additions planned in FY21, the majority portion of the capex will be on maintenance that could be deferred based on individual priorities. Hence, Ind-Ra believes there would not be any material impact of the incremental bed additions as envisaged earlier due to the outburst of Covid-19; however, the maintenance capex plans will be deferred by a year, based on the liquidity position of the entities.
According to Ind-Ra, the creation of the isolation wards, as per the Union government’s instruction, will not require much additional capex and the hospitals can achieve the same by managing its unutilised spaces.