Melstacorp agreed on 20 February 2020 to buy Browns Health Care (Pvt) Ltd, which operates a 70-bed multi-speciality hospital in Ragama, in the suburbs of Colombo, for LKR1.6 billion. The mostly debt-funded acquisition will not have an immediate impact on Melstacorp’s rating due to its small size.
The planned acquisition follows a number of investments by Melstacorp into the healthcare sector over the last few years. The company manages Joseph Fraser Memorial Hospital, a small Colombo-based specialty hospital, and owns a network of diagnostic laboratories. We believe Melstacorp’s management has the necessary experience to run a healthcare business as the group managed Lanka Hospitals PLC, one of the largest private-sector hospitals in the country with 350 beds, until its divestment in 2009. However, we estimate that the contribution from the healthcare sector to Melstacorp’s EBIT, pro forma for the recent Browns acquisition, is currently small at around 1%-2%.
The proposed transaction will slightly weaken our forecast for Melstacorp’s leverage, defined as net lease-adjusted debt/EBITDAR, from 1.6x to 1.7x for the year ending 31 March 2020 (FY20), although it will remain below 2.0x, in line with its ‘AAA(lka)’ rating. Our rating-case forecast includes an assumption that Melstacorp will invest around LKR5 billion per annum in inorganic expansion, including investments in the healthcare sector, in the next few years.
A meaningful increase in cash flows from the healthcare sector over the longer term could help offset the challenges the group faces in its telecom and plantation sectors, which accounted for operating losses of around LKR1.8 billion in 9MFY20. Cash flow diversity will also help to mitigate regulatory risks in its spirits business in the form of frequent excise tax increases. However, a large debt-funded acquisition that provides limited medium-term upside to operating cash flows could pressure Melstacorp’s rating.
We expect demand for private healthcare, especially hospitals, to increase over the medium term, supported by Sri Lanka’s ageing population and the rising incidence of non-communicable diseases (NCDs). We believe public-sector hospitals do not have the capacity to handle the increase in demand, following years of underinvestment by successive governments whereby an average 1.5% of GDP was invested in healthcare in the last five years.
Geriatric care tends to be long term, while treatment of NCDs requires long hospital stays, long-term medication and, in some cases, palliative care. There has also been a wider acceptance of medical insurance over the last few years, helped by government-led insurance schemes and increasing personal income, which should also boost demand for private healthcare. However, a shortage of qualified physicians and nursing staff and regulated pricing of drugs, laboratory tests and in-patient rooms continue to crimp the full growth potential of the sector.