PRIVATE PILLS FOR PUBLIC PAINS

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1 March 2013 PRIVATE PILLS FOR PUBLIC PAINS THE PRIVATE HEALTHCARE SECTOR OF SRI LANKA Published by : RAM Ratings (Lanka) Limited (P B ) No. 11, Melbourne Avenue, Colombo 4 Sri Lanka T F E [email protected] W

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3 MARCH 2013 THE PRIVATE HEALTHCARE SECTOR OF SRI LANKA Analytical Contacts: Prashani Illangasekera Manager Ratings (94) Nilusha Fonseka Financial Analyst (94) SUMMARY Resultant from the free healthcare policy of successive governments, Sri Lanka s healthcare arena continues to be dominated by the government sector. Meanwhile the private sector, although still relatively insignificant in size compared to its public counterpart, has increasingly contributed towards serving the healthcare needs of the country. The private sector s presence is seen most prominently in out-patient care, catering to an estimated share of 50% of total outpatient volumes. On the other hand, the private sector caters to a smaller 5%-10% share of the country s inpatients. Generally, the private healthcare sector is the choice of higher-income earners and individuals with access to medical insurance. As such, demand for private healthcare has stemmed mainly from urban areas, with a significant concentration in the capital where disposable incomes are high. Sri Lanka s total expenditure on health has increased by a compound annual growth rate of around 11% in the 5 years up to 2010; this has been driven by both private- (+12%) and government-sector (+10%) spending. Notwithstanding the state sector s dominance, private sector expenditure on health has continued to rise, contributing an estimated 55% to total expenditure. This is reflective of strong demand for private healthcare as well as persistent increase in consultation fees, room rates and ancillary costs attached to private healthcare. Overall, we view the private healthcare industry as favourable to existing players. Industry risks are balanced by the growth potential of the sector, against the backdrop of rising health awareness and the limitations of the public healthcare system, relatively resilient demand, high entry barriers and flexibility in pricing. That said, intensifying competition among players and the need to provide appropriate quality of care to preserve brand name, coupled with the capital intensive nature of the business may act to increase the level of risk in the industry over the longer term. Published by : RAM Ratings (Lanka) Limited (P B ) No. 11, Melbourne Avenue, Colombo 4 Sri Lanka T F E [email protected] W

4 With regards to the performance of the existing players, the listed private hospitals have recorded steady compound annual growth rates in revenue over the last 5 years, ranging from around 13% to 25%. Meanwhile, the industry s profitability margins are healthy, upheld by the relatively inelastic demand which has enabled operators to consistently elevate charges. Despite the capital intensive nature of the business, the majority of players assessed have moderate gearing levels generally below 0.50 times. The debt protection metrics of industry players are also strong, reflective of healthy cash flow generation. Furthermore, healthy profitability coupled with relatively good profit retention has enabled these hospitals to generate capital internally. Looking ahead, the sector is anticipated to record steady growth as a multitude of factors propel demand for private healthcare. Demographic changes such as the increasingly ageing population and the rising prevalence of non-communicable diseases, as well as increasing health awareness is anticipated to drive demand for healthcare as a whole. However, given certain limitations in the state sector, particularly inadequate capacity, limited availability of specialty treatment and disparities in service quality, the rising demand is anticipated to provide an impetus for the growth of the private sector. On the other hand, the sector continues to be challenged by a shortage of skilled medical personnel. Private hospitals are essentially dependent on visiting specialists to attract patients, given the doctor-centric nature of the country s healthcare industry. The bulk of the graduates from local medical facilities are absorbed by the government sector, and these doctors practise a limited number of hours in the private sector subsequent to completing the required number of hours at public hospitals. Meanwhile, migration of medical professionals also remains high, adding further strain on the industry. On a separate note, intensifying competitive pressures over the medium to longer term could challenge the existing players. This is particularly true in the capital, where most private healthcare sector operators have expanded capacity in recent years. Although occupancy levels in the main private hospitals in the capital are still estimated to be good at around 80%, pronounced increases in room capacity could result in price competition among players which could eventually insert pressure on profitability margins over the medium to long term. I NDUSTRY OVERVIEW : Sri Lanka s healthcare needs are served in parallel by both the public and private sectors. Given the free healthcare policy of successive governments, the public sector dominates the local healthcare arena through a widely-dispersed network of general hospitals, teaching hospitals, provincial hospitals and base hospitals, among others. The private sector, on the other hand, is still relatively small in terms of bed capacity but has seen demand growth since the early 1980s, when government doctors were permitted to work in private hospitals subsequent to completing their daily official working hours at public hospitals. In terms of total bed capacity, the public sector accounted for close to 93% of total hospital beds in 2011, serving around 90%-95% of in-patients. The rest were served by the country s private healthcare sector, primarily the choice of higher-income earners and individuals with access to medical insurance. With regard to out-patient facilities, the private sector is 2

5 estimated to cater to around 50% of out-patients 1. Overcrowding, long waiting times and the limited availability of medicines in government hospitals have propelled demand for private healthcare, despite the higher cost. Demand has stemmed primarily from urban areas, with a significant concentration in the capital, Colombo, where disposable incomes are relatively high. Trends in healthcare expenditure Sri Lanka s total healthcare expenditure ( THE ) is estimated to have increased by a compound annual growth rate of just over 11% 2 in the 5 years up to 2010, upheld by both private- (+12%) and government-sector (+10%) spending. Nonetheless, total expenditure as a percentage of gross domestic product ( GDP ) has trended down as expenditure in other areas of the economy has risen at a faster rate. The ratio clocked in at 2.90% in (2005: 3.90%), a level somewhat lower than that of regional and more developed economies (Chart 1). Chart 1: Comparison of THE as a % of GDP Source: World Health Organisation (2010) In-patient care accounts for the bulk of total healthcare expenditure at 36% 4, followed by expenditure on medical equipment and supplies (25%) and out-patient care (21%). Meanwhile, notwithstanding the public sector s dominance of healthcare (particularly in terms of bed capacity), private sector expenditure on health has continued to rise, contributing an estimated 55% of THE in 2010; this stemmed mainly from out-patient costs and medical equipment and supplies. In addition to stronger demand, this is reflective of the persistent increase in consultation fees, room rates and ancillary costs attached to private healthcare. It is also indicative of patients purchasing drugs from private sector pharmacies despite government hospitals providing drugs for free, which could point towards limited stocks in the public sector. Private sector expenditure stems from several sources including out of pocket ( OOP ) expenditure which consists of household medical expenditure, health insurance, not-for-profit organisations and employer arrangements. In Sri Lanka, OOP expenditure dominates private healthcare spending, accounting for over 80%, (Chart 2), reflective of relatively low health insurance penetration levels in the country. In economies with higher penetration levels, OOP expenditure can be as low as 25% of total private healthcare spending. 1 Central Bank of Sri Lanka Annual Report Institute of Policy Studies ( IPS ) Sri Lanka National Health Accounts ( ) and World Health Organisation 3 World Health Organisation ( WHO ) 4 IPS Sri Lanka National Health Accounts ( ) 3

6 Chart 2: Sources of private sector expenditure Source: IPS (Sri Lanka National Health Accounts) I NDUSTRY RISK FACTORS: The private healthcare industry s dynamics are driven by a range of factors including trends in patient volumes, the level of competition, pricing flexibility, technological changes and ease of entry. Despite consistent increases in the cost of private healthcare, in-patient admissions at private hospitals rose more than 3-fold and out-patient admissions more than 10-fold during the period from 1990 to As such, as reflected by the earnings of listed hospitals, private healthcare operators have continued to demonstrate strong cash inflows over the past decade or so. On the other hand, competitive pressures in the industry have continued to intensify, particularly in the capital where supply largely lies with 4 large players. The key factors driving competition include the number and quality of resident and visiting medical practitioners, the quality of services offered and hospital charges. The Sri Lankan private healthcare system is essentially doctor-centric rather than institution-centric patients seek out the services of particular medical professionals and patronise hospitals at which the latter serve. Hence patient volumes are largely dependent on the number and quality of the consultants visiting a hospital, which in turn are dependent on factors such as location, convenience and facilities. Several hospitals have attempted to address this constraint by specialising in a particular area of medicine such as maternity health and cardiac care, which provides some insulation from competitive pressures. Competition in private healthcare is also driven by hospital charges and room rates. For the most part, industry players enjoy flexibility in pricing as it is not regulated; although the government has recently announced its intention of regulating prices of medical care, drugs, medical equipment and tests. Out-patients pay a consultation fee (depending on the medical professional) as well as a fixed hospital charge. While the fixed charge imposed by the 4 main private healthcare providers in Colombo is generally comparable, averaging 5 IPS Census of Private, Co-operative and Estate Hospitals

7 around LKR 450, the rates on in-patient facilities tend to vary within a range of around 10% (for standard rooms) (Table 1). The prices of rooms offered in higher grades of quality can vary significantly. Table 1: Comparison of room rates at selected private hospitals Class 1- Standard Class 2 Class 3 Class 4 Class 5 and above Nawaloka LKR 5800 LKR 6500 LKR 12, Asiri LKR 6500 LKR 8000 LKR Asiri Surgical LKR 6500 LKR 8500 LKR 16,000 LKR 17,000 - Asiri Central LKR 6500 LKR 8500 LKR 11,000 LKR 17,000 LKR 25,000 Lanka Hospitals LKR 6000 LKR 8000 LKR 10,000 LKR 14,500 LKR 18,500 Durdans LKR 5850 LKR 6500 LKR 6850 LKR 7,850 LKR10,850 to LKR 17,500 Source: RAM Ratings Lanka industry research in January 2013 Nawaloka= Nawaloka Hospitals PLC, Asiri=Asiri Hospital Holdings PLC, Asiri Surgical= Asiri Surgical Hospital PLC, Asiri Central=Asiri Central Hospitals PLC, Lanka Hospitals=Lanka Hospitals PLC, Durdans=Ceylon Hospitals PLC Most private healthcare providers have attempted to strengthen their competitive position through consistent capacity expansions. The expansion strategies pursued by players have varied, with some players opting to extend their geographical reach outside the capital, either via fully-fledged branches or mini hospitals. Others have focused on expanding capacity within Colombo. Certain healthcare providers have also expanded via acquisitions; as such, the industry has seen consolidation and ownership change in the last few years. The total number of private hospital beds is estimated to have risen 70% to reach around 4,700 beds in the last 7 years 6. The increase primarily stems from the main cities of Colombo, Kandy and Galle. In addition to capacity expansions, private hospital operators have in recent years invested heavily in upgrading existing medical equipment as well as introducing new technology. Several players have, for instance, introduced state-of-the-art radiation and cardiac treatment, liver and lung transplant procedures, among others. In addition to retaining patients who would otherwise seek treatment abroad, these enhancements would have the indirect effect of curbing the brain drain of medical professionals who seek training in more advanced healthcare systems globally. The industry is relatively capital intensive, given the high costs of medical equipment, infrastructure and technology. For instance, considering the 4 listed private healthcare providers, capital expenditure on capacity expansions and medical and hospital equipment upgrades has averaged around LKR 250 million per annum. According to the IPS 7, total capital expenditure in the private healthcare sector amounted at LKR 2.20 billion in 2008, compared to around LKR 500 million in The magnitude of the capital investment required and the lengthy gestation period, however, serve as effective entry barriers. The relatively strong brand names of existing operators may render it challenging for a new entrant to capture market share within a short time period. Given the capital intensity of the business, funding constraints may also pose a barrier. 6 IPS and Central Bank of Sri Lanka Annual Report IPS Census of Private, Co-operative and Estate Hospitals

8 Overall, we view the private healthcare industry as favourable to existing players. Industry risks are balanced by the growth potential of the sector, against the backdrop of rising health awareness and the limitations of the public healthcare system, relatively resilient demand, high entry barriers and flexibility in pricing. That said, intensifying competition among players and the need to provide appropriate quality of care to preserve brand name, coupled with the capital intensive nature of the business may act to increase the level of risk in the industry over the longer term. P ERFORMANCE DRIVERS: We envisage the following key factors upholding the demand for private healthcare in Sri Lanka: Demographic changes Demographic changes have a direct impact on the potential demand for healthcare services. Around 13% of Sri Lanka s population was aged more than 55 years in 2011, compared to half the number around four decades ago (Chart 3). Looking ahead, the World Bank 8 estimates that individuals over 60 years will account for 16.7% of Sri Lanka s population by 2021, compared to around 12.5% currently. Furthermore, it estimates that by 2041, 1 out of every 4 individuals will be an elderly person, making Sri Lanka s population the oldest in South Asia. The prevalence of chronic diseases and disability increases in an ageing population, propelling the demand for healthcare, both in the public and private sectors. Healthcare expenditure per capita accordingly trends upwards. Chart 3: Sri Lanka s population ageing patterns Source: Central Bank of Sri Lanka Key Socio Economic Indicators 8 World Bank (Human Development Unit South Asia Region) - Sri Lanka Demographic Transition (2012) 6

9 Limitations of public healthcare The limitations of public healthcare, particularly inadequate capacity, limited availability of specialty treatment and disparities in service quality, have provided an impetus for the growth of the private healthcare sector. Sri Lanka boasts a wide public healthcare network with primary and tertiary care units; most residents live within about 3 kilometers of a public healthcare facility. That said, the lack of a formal referral system coupled with disparities in service quality between rural and urban hospitals has compelled rural patients to seek treatment in base and provincial hospitals. As a result, the out-patient departments of base and provincial government hospitals frequently see long queues and waiting times, exacerbated by unnecessary patient arrivals and inadequate facilities to support the demand. The in-patient divisions of the main government hospitals also record high bed-occupancy and bed-turnover rates, whilst floor patients are a common occurence. The lack of specialty treatment in rural areas (Table 2) has also led to patients opting for private healthcare. Although public hospitals in urban areas remain the main alternative, they lack capacity and have extended waiting periods (particularly for surgeries). Table 2: Specialty bed capacity in select districts (2008) District Specialty Beds per 1000 people Surgery Cardiology Neurology Cancer Eye Colombo Gampaha Kandy Anuradhapura Polonnaruwa Trincomalee Mannar Sources: Annual Health Bulletin (2008), RAM Ratings Lanka In addition, the limited availability of drugs and inadequate capacity for laboratory services in the government sector has compelled patients to seek these services in the private sector, thereby providing private hospitals with alternative revenue sources. Public hospitals (for instance, periphery and rural hospitals) tend to maintain low drug stock levels, which are controlled through administrative procedures to minimise cost. Looking ahead, private healthcare is likely to see rising demand as the public sector continues to face funding and capacity constraints. Increase in non-communicable diseases An increasingly sedentary lifestyle, rapid urbanisation and an ageing population have increased the prevalence of non-communicable diseases ( NCDs ) in Sri Lanka (Chart 4). According to the WHO, NCDs such as heart disease, asthma, cancer and diabetes account for nearly 85% of ill health, disability and early death in Sri Lanka. Furthermore, changes in lifestyles have contributed towards intensifying risk factors of NCDs such as obesity, increased alcohol consumption and unhealthy diets. Although an increase in NCDs is common with demographic and epidemiological transitions, it could pose a challenge to Sri Lanka s public healthcare sector which is faced with funding constraints. This is exacerbated by the fact that NCDs typically require specialised treatments which entail longer hospital stays. The private sector is, therefore, poised to benefit from the resulting anticipated demand for treatment of NCDs. 7

10 Number of hospitalisations per 100,000 population Chart 4: Increasing prevalence of NCDs in Sri Lanka Diabetes mellitus Ischaemic heart disease Asthma Hypertensive disease Sources: Annual Health Bulletin (2008), RAM Ratings Lanka Increasing health awareness and use of medical services Also expected to drive demand for private healthcare is an increasing health awareness and tendency to seek medical treatment when needed. This is reflected in the utilisation rates of government hospitals, particularly that of in-patient services. The number of in-patients treated in public hospitals (per 1000 population) has risen more than 50% over the past 30 years (Chart 5). On the other hand, per capita out-patient utilisation of government hospital services has leveled off in the past decade; this could be partly attributed to capacity constraints which have resulted in long waiting times and queues. In contrast, although lack of information remains a constraint, our estimates 9 indicate that out-patient utilisation of private hospital services has been on the rise. Per capita out-patient visits to private hospitals are estimated to have increased nearly 10-fold in the last 2 decades. Meanwhile, the number of in-patients treated (per 1000 population) in the private sector is also estimated to have increased nearly 3-fold to around in the 2 decades to Looking ahead, these trends are expected to support demand for private healthcare as per capita income widens; global experience indicates a positive correlation between per capita income of a country and healthcare utilisation rates. 9 Based on information provided by IPS and the Central Bank of Sri Lanka 8

11 Inpatients treated (per 1000 population) Outpatient visits (per capita) Chart 5: Utilisation levels of government hospitals Inpatients treated (per 1000 population) Outpatient visits (per capita) Sources: Annual Health Bulletin (2008), RAM Ratings Lanka I SSUES AND CHALLENGES : Shortage of skilled personnel As a multitude of factors point towards increasing demand for private healthcare, the shortage of skilled professionals in the industry may act as a constraining factor in exploiting such demand. The number of medical professionals in Sri Lanka, although progressively higher over the past several decades, is still relatively lower than the number in regional countries and those with equivalent levels of income (Chart 6). 9

12 Chart 6: Comparison of medical personnel to population ratios Sources: Annual Health Bulletin (2008), RAM Ratings Lanka The shortage of medical personnel is more pronounced in private hospitals which are dependent on visiting specialists to attract patients, given the doctor-centric nature of the Sri Lankan healthcare industry. An average of 900 doctors graduate from local medical faculties annually, of which around 70% are absorbed by the government sector 10, although these doctors are allowed to practise in the private sector subsequent to completing the required number of hours at public hospitals. Empirical evidence indicates that only around 12% of medical graduates are absorbed into the private sector on a full-time basis 11. Meanwhile, the migration of medical professionals remains high; the IPS 12 estimates that nearly 50% of doctors completing compulsory training in developed countries opt to permanently reside there. This is mainly attributed to the relatively lower salaries paid to public sector medical officers in Sri Lanka. The private sector is also faced with a lack of training opportunities. Nurses and medical officers have significantly fewer opportunities to specialise and pursue postgraduate education, in contrast with government sector personnel. Increasing competitive pressures Whilst demand for private healthcare is expected to be robust over the short to medium term, intensifying competitive pressures may hamper the profitability of players. This is particularly true for the capital Colombo, in which most private healthcare sector operators have consistently expanded room capacity in recent years. Our estimates indicate that the 4 listed operators increased their collective room capacity by around 55% over the last 5 years (Table 3). Meanwhile, although industry-wide statistics on hospital occupancy levels are not available, RAM Ratings Lanka estimates rates to still be good at around 80%. However, further increases in room capacity could result in oversupply over the longer term, and price competition among players as a consequence. Given increasing healthcare costs, this could put pressure on profitability margins over the medium to long term. 10 Impact of Migration on the Medical Workforce in Sri Lanka (2008) NR De Silva 11 Impact of Migration on the Medical Workforce in Sri Lanka (2008) NR De Silva 12 IPS International Migration Outlook (2008) 10

13 Table 3: Capacity expansions by private healthcare operators ( ) Hospital Branches Total Bed Capacity Nawaloka Durdans Asiri Hospital Asiri Surgical The Central Lanka Hospitals Sources: RAM Ratings Lanka, hospital annual reports and websites R ATING CONSIDERATIONS: The credit profile of a healthcare operator is evaluated under 2 main categories of risk: business and financial. The business risk of an entity is tied to several factors such as industry risk, the entity s relative competitiveness and operating efficiency. Financial risk relates to capital structure, cash flow adequacy and liquidity, among others. Business risk As discussed previously, the private healthcare industry is relatively favourable to existing players, owing to growth potential, relatively resilient demand, high entry barriers and flexibility of pricing. However, stiffer competition and the need to provide quality care to preserve brand name, coupled with the capital intensive nature of the business may increase the level of risk in the industry over the longer term. The competitiveness of a private hospital operator depends on a range of factors including size, diversification, revenue volatility, cost structures and growth strategies. In terms of portfolio size, we note that most private healthcare providers operate from a single facility, with capital intensity and funding constraints preventing smaller players from expanding capacity. On the other hand, larger more established players have in recent times sought to strengthen their geographical presence by venturing outside the capital. Operators have also attempted to diversify their revenue sources by providing additional services such as laboratory and pharmaceutical services. We note that in Colombo, where around 85% of all private sector laboratory tests are performed 13, 2 private hospitals dominate with an estimated market share of around 45%, which can act as an entry barrier to potential players. With regard to revenue trends, the 4 listed private hospitals have continued to record healthy top-line growth over the last five years (Chart 7). Given the faster expansion of its hospital portfolio, Asiri Hospitals recorded a relatively strong compound annual revenue growth of around 25% in the period from 2007 to 2012, whilst that of other players was around 13%-16%. The revenue trends are reflective of increasing patient volumes against a backdrop of rising demand for private healthcare. 13 IPS Census of Private, Co-operative and Estate Hospitals

14 Chart 7: Revenue trends of listed private hospitals Sources: Company annual reports *The dip reflected in revenue for Lanka Hospitals during FY 2010 is owing to a change in the financial year end, from March to December. In terms of the cost structure of private healthcare providers, we note that direct costs account for around 50% of hospital revenue; gross profit ( GP ) margins are generally comparative across the industry, fluctuating within a range of 45% to 50%. GP margins have remained relatively stable over the years despite rising costs, reflecting the ability of private hospitals to pass on cost increases. On the other hand, operating profit before depreciation, interest and tax ( OPBDIT ) margins varied significantly among players (Chart 8), indicative of varying levels of cost efficiency. In this regard, Asiri Hospitals records considerably wider OPBDIT margins than its peers, upheld by its cost efficiencies as well as contributions from laboratory services. Overall, the industry s profitability margins are healthy, upheld by the relatively inelastic demand which has enabled operators to consistently elevate charges. Looking ahead, industry profitability indicators are anticipated to remain healthy over the short to medium term, supported by good occupancy levels as demand continues to grow in line with lifestyle changes and increasing health awareness. Over the longer term, however, margins may narrow, given intensifying competition which may render it difficult for operators to pass on cost increases on a full and timely manner. 12

15 Chart 8: Profit margins of private healthcare providers Sources: Company annual reports Financial risk Financial risk assessment includes the evaluation of the healthcare providers capital structure, leverage, cash flow adequacy and financial flexibility. Despite the capital intensive nature of the business, the majority of players assessed have moderate gearing levels, with gearing ratios generally below 0.50 times. Healthy profitability coupled with relatively good profit retention has enabled these hospitals to generate capital internally. The debt protection metrics of industry players are also strong, reflective of healthy cash flow generation. The funds from operations debt coverage levels of players have remained healthy over the years, generally ranging from around 0.40 to 0.60 times (Chart 9). Based on indicators of hospitals assessed, the cash protection metrics of private healthcare providers are relatively stronger than that of most other industries, given their strong cash flow generation. In terms of financial flexibility, whilst debt financing through banks is a viable option for larger, more established players, the lack of funding avenues continues to be a constraining factor for smaller hospital operators. Chart 9: Debt coverage trends of listed private hospitals (FFODC) Sources: Company annual reports, RAM Ratings Lanka 13

16 StandPoint Commentary No statement in this paper is to be construed as a recommendation to buy, sell or hold securities, or as investment advice, as it does not comment on the security's market price or suitability for any particular investor. Published by RAM Ratings (Lanka) Ltd Reproduction or transmission in any form is prohibited except by permission from RAM Ratings (Lanka) Ltd. Copyright 2013 by RAM Ratings (Lanka) Ltd RAM Ratings Lanka receives compensation for its rating services, normally paid by the issuers of such securities or the rated entity, and sometimes third parties participating in marketing the securities, insurers, guarantors, other obligors, underwriters, etc. The receipt of this compensation has no influence on RAM Ratings Lanka s credit opinions or other analytical processes. In all instances, RAM Ratings Lanka is committed to preserving the objectivity, integrity and independence of its ratings. Rating fees are communicated to clients prior to the issuance of rating opinions. While RAM Ratings Lanka reserves the right to disseminate the ratings, it receives no payment for doing so, except for subscriptions to its publications. 14