Kovai Medical Center and Hospital - Health and Wealth

dineshssairam · August 11, 2019, 2:01pm

Interest Capitalization

Most of us are aware of the interest capitalization. So, when you calculate Book Interest % (Interest Paid / Debt), you are double-counting the capitalized interest. For instance, Debt has increased drastically only in the last 2 years. If you look at the Financing Cash Flow, you will see that the combined value for 2017 and 2018 is Rs. 220 Crores (Dividends not adjusted, but those are small anyway). But Book Value of Debt actually increased by Rs. 253 by the same period. Conceivably, the extra Rs. 33 Crores will probably be the capitalized part. So in a sense, actual interest paid will be ~Rs. 20-22 Crores (9-10% of Rs. 220 Crores), as opposed to the Rs. 12 Crores being shown right now. I’m personally against this twisted Accounting by KMCH, by the way.

But my point was, since there is no need for Debt anymore, it will be pared down once the Medical College starts producing cash flows. This has indeed been the case in the past. The 4 years leading up to this huge Capex (2014-2017) have been years where KMCH paid off a substantial amount of Debt on the books (Almost ~40% reduction).

Depreciation Capitalization

In my very limited understanding of Accounting, ‘Capitalize’ means adding something to the B/S and ‘Depreciate’ means reducing something from the B/S. So I don’t think ‘Capitalizing Depreciation’ makes sense. KMCH does not have any accounting policies indicating the same. If you are aware of any, please enlighten me.

Once again, if you look at the “Depreciation / Net Block” or “Depreciation / Sales” Ratio, there has been a pronounced increase in the last 2-3 years. I don’t see any reason why it should increase even further. In fact, some PP&E were revalued last year and increased in value. So it is highly unlikely that Depreciation will be even higher in the coming years (Unless, of course, some new Capex is in the cards).

Rupinp · August 11, 2019, 5:45pm

Interest Capitalization

Your explanation regarding debt levels of KMCH and capitalization of interest seems absolutely fine, however, you might be missing the impact this will have on the accounting profits of the Company. I will try to explain this below:

As you have mentioned, actual interest paid is likely to be much higher than the Rs. 12 cr shown on P/L, the difference being the portion of interest which is capitalised i.e. added to the cost of the asset (Medical College). As per note 3 - Capital Work in Progress (page 106) of Annual Report for FY 2019, the interest capitalised is Rs. 11.93 cr. which was added to the CWIP

Now, this interest will be charged to P/L from current year, as the Medical College is now complete and ready for use, which will result in higher interest expenses in P/L from current year. Of course from cash flow perspective, there is no difference, even the interest which was capitalised till last year was actually paid out in cash, just that it was added to cost of fixed assets rather than showing it in P/L.

By the way, the entire accounting treatment regarding capitalization of interest is perfectly legitimate, and in fact recommended by the accounting standards, for the simple reason that in case of assets which take a long period (say 2-3 years) for construction, interest on the loans taken for financing the cost of these assets is capitalised i.e. added to the cost of these assets, simply because the asset is still under construction and is not generating any revenues or profits, hence the interest attributable to borrowings for such asset should also not be shown in P/L, rather it should be added to the cost of the asset. So, to that extent, I wouldn’t call this twisted accounting, rather it is the correct way of accounting, followed by most companies.

Depreciation Capitalization

You are right, there is no concept of Depreciation capitalization, however, the asset which has been newly constructed (Medical College in our case), will now be depreciated every year, just like all other assets. The depreciation begins only when the asset is ready for use or has commenced commercial operations, i.e. it will begin from current year for the Medical College, and last year’s P/L will not have depreciation pertaining to this new facility (Medical College). Hence, depreciation should, logically, be much higher in the current year and future years, considering the depreciation charge for the Medical College. How much higher I cannot say (depends on rate of depreciation), but higher it should certainly be.

The net effect of the above is that current year (FY 2020) P/L statement will have higher interest cost and depreciation, though capex will be much lower, and debt levels should also start trending downwards in the current year from the peak of Rs. 380 cr. achieved on March 31, 2019. This will have the effect of pulling down the accounting profits, unless the profits from the newly created asset (Medical College) are adequate to offset the higher interest and depreciation.

dineshssairam · August 11, 2019, 6:22pm

Agreed on the interest part. The capitalization is a slight bother, nothing deal-breaking. There’s nothing to discuss there.

About the Depreciation, I don’t understand how Depreciation will only begin after the commencement of the course. Parts of the building were already finished throughout he 2-year period (We got a couple of updates during the period). But let’s look at the numbers:

It’s not an exact match. But we can see that the change in Gross Block (So, including Depreciation) for the past 3 years, which we have to assume came largely from the Medical College matches up with the Cash outflow from Investing. So the Depreciation for the Medical College is already on the books.

But let’s just say this is not the case. Let’s say the Depreciation of the Medical College building is still on the cards. Why did this happen then:

Why would there be a pronounced increased in Depreciation, if they have only been Depreciating the same old Assets all along?

Even I don’t have the answer to these questions. But it really doesn’t matter for the cash flows. It only impacts the Accounting Profits, which I care the least about. I guess we’ll see what’s what in the next year’s Annual Report.

IMHO · August 12, 2019, 10:46am

Thanks Dinesh and Rupinp for an informative exchange on finance costs and depreciation.
Depreciation estimates are never simple and in the case of Kovai it is compounded by constant upgradation of medical equipment and addition of 60-100 beds almost every year. Add to this the adjustments to meet the Ind AS during the previous years and it becomes even more complex to correctly estimate the charge. The saving grace though is that Dep is just 7% of the total cost allowing for a big margin of error in estimates.

Now that the expansion is almost over Kovai needs to focus on improving occupancy rates if it wishes for a quantum leap in the bottomline. Current occupancy levels of 69% leaves enough room to raise it to 80+% levels.(This is the max a hospital can practically have as there are a lot of non-billable hours during the course of discharge and admission…this is where longer length of stay helps hospitals. The biggest culprit being the time taken in getting Insurance clearance which takes minimum 4 to 5 hours even when all docs are in order!! One of the most frustrating processes for the patient as well as the hospital)

suru27 · August 14, 2019, 3:11am

One correction , on longer length of stay, ALOS (Average Length of Stay) , it’s not that longer stay helps. If there is enough demand for inbound patients, shorter ALOS is better as it helps to generate higher revenue on per day basis . The reason being bulk of revenue is made in initial days of stay like for operations etc, so, the quicker they get the bed released the more operations they do and hence the more revenue they generate . That is why companies want to reduce ALOS using technology n various methods

Irs007 · August 14, 2019, 11:37am

Any estimate on the avg revenue per bed for the 300 teaching beds?

Assuming 10lacs/student for FY19-20, college will add 15 crore to topline this FY(150*0.1 = 15 crore.)

dineshssairam · October 7, 2019, 11:00am

MCI-Students-Admitted-List-2019-20.pdf (661.4 KB)

Revenue from the first batch seems to be only ~Rs. 12 Crores. A little disappointing, considering that the Capex was almost Rs. 600 Crores. But it remains to be seen how much Revenue will come from the additional beds.

dineshssairam · November 9, 2019, 10:46am

Excellent results all around.

But looks like Capex is still not done and Debt is still being raised. Hopefully should break out of this in a couple of quarters. I would personally love to see the Debt being paid down as soon as possible.

Ram · November 10, 2019, 11:10am

Thanks & appreciated, please help us to understand on growth opportunity. What is understandable on price hike based on inflation and increase in volume of adding beds in the existing asset!
What will aid PE re-rating?

dineshssairam · November 10, 2019, 2:02pm

My understanding is that the following could be the new revenue streams:

As we’ve seen, the revenue from fees alone is around Rs. 12 Crores. I’m sure there will be other charges throughout the course. But I don’t have enough information to guess how many.
The extra beds are 700. Current ARPOB is Rs. 15,240 and occupancy is 69.01%. So we can expect Rs. 270 Crores in revenue from the extra beds. But of course, some of these beds are on a subsidized basis (I guess CSR thing) and some of them may be used for teaching. So, we can conservatively say that at least Rs. 200 Crores in recurring revenue can be expected from the beds.

Capex for this has already crossed Rs. 600 Crores and is likely to end up closer to Rs. 700 Crores. So, a Rs. 700 Capex is providing a recurring revenue of Rs. 212 Crores+. In net income, that’s at least Rs. 21 Crores+ in perpetuity. Even if we use a 15% Cost of Capital (Quite high), that’s Rs. 140 Crores in PV terms, indicating a RoIC of 20%, which is more than enough.

This is not considering any inflation in prices (Which will further increase the PV of those future 21+ Crores). In addition to this, the Medical College will also decrease Salary Expenses for the doctors. That’s another added benefit. These two put together may add another Rs. 5-10 Crores in perpetuity.

My only concern is that the management is very comfortable with having Debt on the books (As it is evident from their historical D/E mix). I’m okay with Debt during an expansionary phase like now, but would be disturbed if they continue to have it even after the expansion.

sonman · November 16, 2019, 10:56am

Cyclical businesses should pay out debt as early as possible to reduce risk , but for steady cashflow business like hospital , debt is not a problem ; actually it helps to increase return on own capital. There is no need to hurry debt repayment and that seems to be reason management is comfortable with debt on balance sheet.

dineshssairam · November 16, 2019, 3:17pm

Acquisition of 0.17% of the company by a Private company held by the promoters (Kovai Purani Finance Private Limited)

saninv · January 22, 2020, 8:19am

Nice article on how Kovai’s teaching hospital has been constructed.

Construction of Kovai Medical college and cost

ayushmit · January 22, 2020, 8:50am

Pretty interesting read! Never knew that hospital of this size can be built quickly like this.
Kovai has a way of adopting new technologies and keep adapting in its area.

dineshssairam · January 22, 2020, 12:47pm

The results are on February 8th. So there would likely be a silent period of a few days (Say 15) leading up to the results. I don’t think the Promoters or anyone directly associated with KMCH will be buying shares now.

2fthurdle1 · February 3, 2020, 11:57pm

Inpatient volume growth declining. Any experts on this stock have any clue ?..how will we fill up the new hospital …sorry being devil’s advocate as illiquid small caps need all the help.
In above discussion 700 cr capex giving 200 cr revenue makes sense based on lower ARPOB.and occupancies .and hence 20 cr PAT…ROIC becomes quite pedestrian no…can someone tell me 20 cr is wrong , profits will be higher on new hospital/wing ?

Disc: invested

Chandragupta · February 4, 2020, 3:39am

A decline in one year does not become a trend, need to see this year’s figures as well.

The more important thing is how the new college and hospital (not just the hospital) pans out. My understanding is that the new hospital is a low cost hospital targeting a different segment than the existing one. We cannot conclude anything about the new project from the above numbers. It will take a couple of years for both college and new hospital to stabilize.

These projects are a leap of faith – we have to assume the management has done these calculations and they know better than us. Only time will tell if they are right.

Just adding my two cents though I don’t know this stock all that well, am tracking it however. May be someone like @dineshssairam can share his thoughts.

dineshssairam · February 4, 2020, 11:19am

Unfortunately, KMCH does not provide Occupancy / ARPOB details historically. They have only been doing it since the last 2 years. One point to note is that the new beds are being added in installments since the last 1-2 years. So that may have contributed to the decrease in Occupancy.

It will take at least 2-3 years to judge the Returns from the new beds added together (Same goes for the Medical College I guess).

suru27 · February 5, 2020, 6:09pm

Look at ALOS n it’s not a 1+1 =2. Let’s say in a year there r 360 days (for the sake of it ) you had 4 people occupying 1 bed for 90 days each n hence 100% utilization n your ALOS is 90 days . Scenario 2, u had only 3 patients but for 120 days each. Your inpatience goes down but your ALOS went up but u r still at same 100% utilization. Question is how much patients paid when they were for 90 vs 120 days in terms of core bills plus add in bills plus daily bills. Hospital business revenue no r driven not only by inpatient count but alos, revenue per unit bed, case mix, core operating charges, non operating charges n multiple factors . If really one wants draw insight , one needs to look through all. For me, bigger concern is not lower patient count but higher ALOS. A lower ALOS is generally (not specifically ) good as it shows 1. Technology advancement 2. Ability to get more inpatients 3. More core operation fees , bulk of money is made by more operations rather than holding patient for more days etc. So, is high ALOS reason for low patient count or vice versa (which means patient ko lamba tikao nahi to bed khali reh jayega) is something to ponder n deep dive , keeping all other revenue driver factors still in mind

dineshssairam · February 8, 2020, 10:05am

Excellent Results all around once again. But it’s a bummer than we have to wait until the next Quarter to understand the Cashflows and probably more to get a hint on how the new Beds and the Medical College are turning out.

Quarterly

Revenues up ~15.81%
PBT up ~47.40%
PAT up ~45.07%

Nine Months

Revenues up ~14.11%
PBT up ~43.48%
PAT up ~36.67%

Also QoQ, Depreciation as a Percentage of Sales has gone down from 5.69% to 5.40%. It’s a tiny difference, but could hint at Capex finally stabilizing.