iKang Growth Steady, A Long-Term Play

Aug.26.14 | About: iKang Healthcare (KANG)

Let's take a break from the usual tech and trade war chatter today to look at the healthcare sector, focusing on the newly released maiden results from private clinic operator iKang (NASDAQ:KANG). The results look relatively solid but unspectacular, though that didn't stop investors from dumping iKang's shares in after-hours trade after the report came out. Even if that 17 percent sell-off holds in regular trading on Tuesday, iKang's shares are still up about 40 percent from their IPO price back in April.

These latest results show that healthcare has huge potential in China, but also that it's a tricky business due to heavy regulation as the sector opens to private participation. Until recently, government-run hospitals and clinics were the main service point for nearly all healthcare in China, and fully-owned private clinics were almost non-existent. That's slowly changing, and companies like iKang and Chindex (NASDAQ:CHDX) are hoping to capitalize by entering the space early.

All that said, let's take a closer look at iKang's new earnings report, and also a quick look at the latest quarterly report released earlier this month from Chindex, which is in the process of privatizing. To summarize, iKang's revenue and profit growth both look promising, though not spectacular, reflecting the fact that it's still relatively difficult and time-consuming to open and operate new clinics in the current climate.

The company's revenues grew 43 percent to a relatively modest $60 million (company announcement). Net income excluding share-based compensation expenses rose by a slower 37 percent to $8.9 million, a relatively strong figure when compared with the company's overall revenue. The gap between revenue and operating income growth was due to accelerating expenses, which rose nearly 60 percent during the quarter.

The company is certainly expanding quickly, with its stable of clinics rising to 50 from 37 a year earlier, including the addition of 3 facilities through an acquisition. The company reaffirmed its full-year forecast for 40-43 percent revenue growth for all 2014, which again looks solid, though unspectacular. Investors most likely dumped their shares after the report came out due to disappointment that the company didn't raise its forecasts, and also quite possibly due to profit-taking.

Next let's look quickly at Chindex, whose looming privatization after years as a publicly traded company reflect the difficulty that firms in the Chinese healthcare space have at winning investor attention. Chindex's numbers look a little less impressive, with revenue from healthcare services rising 21 percent to $55.5 million (company announcement). Income from operations fell slightly to $1.8 million from $1.9 million a year earlier, and the company reported a net loss due to expenses related to its pending privatization.

I'm including Chindex in this post not because it's a real investment option, but rather to show the difficulties of operating in the healthcare space. Chindex may also be at a slight disadvantage to iKang due to its foreign ownership, as China clearly prefers to promote companies owned by local Chinese in emerging markets like healthcare.

All of that said, the bottom line looks decidedly mixed for Chinese healthcare stocks focused on clinic operations. Over the short term, these companies will face big expenses due to the newness of the market and a high degree of bureaucracy. But their early arrival to this space should position companies like iKang to become industry leaders over the longer term as they gain experience at operating in the market and achieve economies of scale.

Thus, iKang is probably a stock to avoid for shorter-term investors with a time horizon of less than 2 years. But for buyers who are willing to wait longer for China’s healthcare market to further open to private participation, the stock looks like a more promising longer-term bet.

Bottom line: iKang and similar medical services providers will face high costs and uncertainty as China opens the market to private participation, but look like good bets over the longer term.

Disclosure: None