Hospital stocks: can strong demand offset regulatory risks?

Stocks of hospital companies have come under pressure after the Supreme Court raised concerns over high mark-ups on cancer medicines while hearing a petition on drug pricing on 22 September. The Supreme Court has asked the central government why the 16% trade margin applicable to scheduled drugs could not be extended to non-scheduled drugs. The next hearing is scheduled for 12 October, and that’s what investors would be tracking closely.

Earlier, Maharashtra Food & Drugs Administration (FDA) had written to the Department of Pharmaceuticals after finding large mark-ups in medicines and other consumables sold through hospital pharmacies in its survey, and sought monitoring of prices. The Maharashtra FDA found mark-ups of more than 28 times on intravenous infusion sets, around ten times for catheters, and similar mark-ups for various other medicines.

JM Financial Institutional Securities estimates a 2-4% hit on profit margins if the government caps trade margin at 16%. Medicines contribute 20-25% of hospital revenue, according to the brokerage. Hospitals with higher exposure to oncology, such as Max Healthcare Institute and Artemis Medicare Services, may see a larger impact given their higher revenue contribution from pharmacy and consumables.

However, it may not be easy for the government to implement the price cap given the complexity of the issue. “We do not expect a blanket cap on drug margins as such, given the executional/ operational challenges in covering non-scheduled drugs across ecosystems (pharma, distributor, supply-chain companies),” noted Emkay Global Financial Services.

Hospitals have faced regulatory scrutiny over pricing for several years. In 2017, the government sharply reduced the prices for cardiac stents and orthopaedic knee implants by 70-85%. Separately, the Supreme Court is hearing a public interest litigation concerning transparency in hospital charges, which seeks central government intervention to fix charges for various medical procedures.

The Parliamentary Standing Committee on Health and Family Welfare proposed capping hospital room rates and standardising pricing for treatments, in its report submitted to the parliament in August. Emkay noted that the regulatory overhang on the sector, in some form or another, remains, given the socio-economic impact the sector is inherently exposed to.

The regulatory concerns come even as the sector continues to see strong demand. “We believe sector fundamentals remain strong with robust demand for quality tertiary care beds,” noted Jefferies India.

It added that previous regulatory overhangs have led to stock consolidation but have typically proved attractive entry points in a sector with strong fundamentals. Also, hospitals were able to recover their margins through price increase for medicals procedures and cost rationalization after the government action in 2017.

Shares of Global Health (Medanta), Apollo Hospitals Enterprise, Max Healthcare and Fortis Healthcare have declined 8-12% since 22 September. All eyes will now be on the 12 October court hearing. The government’s response on the proposed trade-margin framework would determine the stocks’ trajectory ahead.

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