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Outlook 2022: Business recovering but Omicron lurking

We remain positive on the healthcare space amid secular growth and expect a healthy recovery in non-COVID business, leading to potential margin improvement from cost-control initiatives and change in mix. Sector companies under our coverage have seen steep appreciation in stock price over the last year (~50%) driven by both hospital and diagnostic companies. Key notable points for CY22: 1) occupancy level is expected to remain strong and recovery in international patients to improve mix for hospitals, 2) likely improvement in volume growth for diagnostic companies with shift from unorganised to organised players, 3) reducing contribution from COVID-19 business; however, Omicron variant may change assumptions and 4) EBITDA margin to sustain with improving business mix and continuation of cost-control initiatives.

* Outlook for CY22 Hospitals: We expect occupancy levels to improve, while change in case mix and reduction in ALOS would improve ARPOB. Revenues from international patients are still below pre-COVID level which we believe should normalise in CY22. We expect revenue growth to be strong ~14% in FY23E despite a higher base. Companies would continue focusing on cost-control measures which should support profitability. Diagnostics: We believe diagnostic companies will observe strong mid-teens growth in base (ex-COVID) business in CY22. Low base of non-COVID portfolio of H1CY21 would likely help in registering very strong growth in H1CY22, while COVID-19 related revenues would contract sharply. We also expect a faster shift from unorganised to organised players in the current environment as larger brands are associated with safety & hygiene and have efficient home collection process, which has seen increased traction as well as likely consolidation in the industry. COVID-19: Omicron variant is highly contagious and could force restrictive measures once again, potentially affecting growth. However, learnings from the first and second wave of COVID-19 should cushion some of the negative impact, in our view.

* Key sector trends in CY21: Key trends across hospital and diagnostic sectors:

1) sharp improvement in occupancy led by pent-up demand in hospitals; however, international patients are still below pre-COVID level,

2) improving profitability by most of the hospitals with reducing COVID-19 contribution and high demand for elective surgeries and

3) fast recovery in base business volumes for diagnostic companies with normalisation. We believe cost-control measures announced during the lockdown by companies would be partially sustainable over the longer term. The impact on profitability was much higher than expectation due to quick recovery in the business resulting in earnings upgrades.

* Our view: We are positive on secular growth of the healthcare sector given high visibility, improving reach and likely margin expansion. We also introduce FY24 estimates for all the covered companies. Considering the meaningful re-rating in valuation for Apollo we downgrade to HOLD from Add while we upgrade Aster DM, HCG and Thyrocare to BUY with the recent price correction. Top picks: Thyrocare, HCG and Aster DM.

* Key risks: Regulatory hurdles such as price ceiling on hospital treatments and diagnostic tests, and increase in competitive pressures.

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