team Luciano Campos* Analyst HSBC Bank Brasil SA +55 11 3371 8194 luciano.t.campos@hsbc.com.br Caio Moscardini* Analyst HSBC Bank Brasil SA +55 11 3847 5635 caio.s.moscardini@hsbc.com.br *Employed by a non-us affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations 1
2 Sector structure Manufacturers Natura Hypermarcas 540 non-listed companies Distributors Profarma Cremer 3,821 non-listed companies Retailers RaiaDrogasil Brazil Pharma 82,204 non-listed companies Providers DASA Fleury 15,723 non-listed companies Operator Payers Administrator Latin America Equity Research Amil OdontoPrev SulAmérica Porto Seguro Tempo 1,386 non-listed companies Qualicorp Many other non-listed companies Source: HSBC
Share price performance 800 700 600 500 400 300 200 100 0 18-Nov-04 18-Feb-05 18-May-05 18-Aug-05 18-Nov-05 18-Feb-06 18-May-06 18-Aug-06 18-Nov-06 18-Feb-07 18-May-07 18-Aug-07 18-Nov-07 18-Feb-08 18-May-08 18-Aug-08 18-Nov-08 18-Feb-09 18-May-09 18-Aug-09 18-Nov-09 18-Feb-10 18-May-10 18-May-12 18-Feb-12 18-Nov-11 18-Aug-11 18-May-11 18-Aug-10 18-Nov-10 18-Feb-11 Source: Economática, HSBC AMIL ODPV DASA FLRY 3
4 EBIT margin asset turnover chart (2011) 3.0 Profarma 2.5 2.0 Tempo Amil 1.5 Natura Latin America Equity Research 1.0 Brazil Pharma RaiaDrogasil Porto Seguro SulAmérica OdontoPrev 0.5 Cremer Fleury DASA Qualicorp Hypermarcas 0.0 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% Source: Bloomberg, Company data, HSBC
Sector description spending in Brazil is increasing faster than GDP growth and this trend is expected to continue for many years. According to the World Health Organization (WHO), total healthcare spending in Brazil was 7.5% of GDP in 2006 and 8.4% in 2008. By comparison, healthcare spending in the US, UK, Spain, and Portugal represented 15.2%, 8.7%, 9.0%, and 10.6% of GDP, respectively, in 2008, the most recent year for which data are available. Luciano Campos * Analyst HSBC Bank Brasil S.A. +55 11 3847 5635 luciano.t.campos@hsbc.com.br *Employed by a non-us affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations Brazilians tend to choose to pay for private sector healthcare despite having public universal healthcare guaranteed by the Brazilian constitution. According to the Ministry of Health (MOH) and the National Agency of Supplemental (ANS), since 2006, the annual total spending by families and businesses with private healthcare and dental insurance has exceeded spending by the MOH, and the difference is widening over time. Taking the broadest definition of healthcare companies (chart 1), there are 14 listed companies with a combined market capitalization of BRL76.6bn as of 30 May 2012, which represents only 3.15% of Bovespa s total market cap. There are thousands of private companies in this industry, however. Players in the industry can be classified as: Drug manufacturers and others: These companies produce packaged goods for healthcare use, including pharmaceutical prescription drugs, generic drugs and non-prescription products sold overthe-counter (OTC). Hypermarcas is an example of a listed company in this category. Natura can be included if the definition of healthcare is expanded to include wellness. According to the Brazilian government, there are c540 drug manufacturers in Brazil. Drug distributors and others: These are wholesalers that purchase large volumes from manufacturers and re-sell to drug retailers or hospitals. Some are specialized in the distribution of pharmaceutical drugs, including generics, and others are specialized in the distribution of disposables (eg, gloves, syringes, etc.) for hospitals. Profarma and Cremer are the only listed companies in the segment but, according to the Federal Council of Pharmaceuticals, there are 3,821 players in this fragmented market. Drug retailers: These are drugstores and pharmacies that sell pharmaceutical prescription drugs, generic drugs, OTC and cosmetics directly to end-consumers, usually individuals. RaiaDrogasil and Brazil Pharma are the only listed companies in the segment but, according to the Federal Council of Pharmaceuticals, there are 82,204 players in this fragmented market. providers: This can include any provider of healthcare services. However, since only diagnostic service providers are listed at Bovespa so far, the healthcare providers category is synonymous with diagnostic service providers. These companies offer outpatient facilities where patients can have samples (for clinical tests) or images (for imaging exams) collected, process the samples and images to produce a technical interpretation of the results, and report the results of the tests to patients and their physicians. DASA and Fleury are the only listed companies in the segment. According to CNES (National Database of Providers), there are 15,723 players in this fragmented market. 5
payers: These are companies involved in the commercialization of private healthcare and/or dental insurance. A key sub-group of payers is the insurance operators, which assume the underwriting risk of the insurance. Some of them, like Amil, provide healthcare and dental insurance products. Others, like OdontoPrev, are dedicated to dental insurance, while others like SulAmerica and Porto Seguro offer other types of insurance in addition to healthcare and/or dental. The other subgroup of payers is the insurance administrators, like Qualicorp, which help develop and distribute the insurance products provided by the operators and manage the relationship with the final clients (individuals or corporations) but do not take the underwriting risk of the insurance. According to ANS, there are 1,386 players in this fragmented market. Key themes for healthcare payers Increasing penetration of private insurance Both insurance payers and providers benefit from the increasing penetration of private healthcare and dental insurance in Brazil. The penetration of healthcare insurance increased from 18.1% in 2000 to 25% in 2011, a CAGR of c4.0% for the number of Brazilians with healthcare insurance in the period. We estimate the penetration of health insurance will reach 33.1% by the end of 2022, which represents 72.8m total and 25.2m new consumers of private healthcare in Brazil over this period, benefiting payers and providers with a tailwind organic volume growth potential of 4.0% CAGR over the next decade. The dental insurance segment is less penetrated and can offer much stronger growth. From 2000 to 2011, the number of Brazilians with private dental insurance increase at CAGR of 17.7% and the penetration of the market increased from 1.6% to 8.8%. By the end of 2022, we conservatively forecast a total penetration of 14.7%, which implies a market CAGR of 6.2% over the next 10 years. Industry consolidation and concentration The healthcare industry is fragmented in Brazil and offers opportunities for growth through M&A. However, the industry is also highly dispersed geographically and there are not many sizable acquisition targets for listed companies. Therefore, we would expect the well-capitalized listed companies to stay active in M&A to acquire small- to mid-sized regional players. Some large transformational transactions, like the Amil-Medial, DASA-MD1 and Fleury-Labs D Or deals, are still possible but are likely to face increasing anti-trust scrutiny. In the case of healthcare insurance operators, the regulator (ANS) is enforcing the build-up of technical reserves to ensure companies solvency and protect the rights of the insured individuals. These reserves must consist mostly of cash deposits and some qualified real estate assets. Small companies, with weak balance sheets, are being driven out of the market because they cannot create enough reserves to continue operating. Therefore, in addition to M&A-driven market consolidation, stronger payers are also taking advantage of regulation-driven market share concentration. Pricing power We have noticed a shift in pricing power in favor of payers and against providers. Payers are insurance companies that pay for a significant part of the services delivered to customers by providers. The payers industry is consolidating quickly and new clients are increasingly in the form of smaller corporations and individuals purchasing insurance for the first time. Therefore, the size of insurance companies is 6
increasing, while the average size of their clients is decreasing, which is likely to increase the pricing power of insurance companies. Providers, on the other hand, are not consolidating as quickly and are likely to find it hard to resist the increasing bargaining power of large payers. Cost inflation and profitability Both payers and providers are labor- and rent-intensive industries and these inputs have been important contributors to inflationary pressures in Brazil. In the case of providers, they are also directly exposed to FX risks since they import a large part of reagents, imaging equipment, and other production inputs. Payers are indirectly, and on a much smaller scale, exposed to FX through medical inflation, especially because of hospital costs. Payers have more sources of volume growth and are gaining pricing power, thus have been able to expand margin despite the cost pressures. Providers, however, are experiencing margin pressures, mostly because of a reduced ability to pass price increases to their clients to compensate for the cost pressures. Sector drivers Employment and wage trends The current low penetration stage of the private healthcare and dental insurance markets is the main driver of the industry growth, including the potential to keep growing faster than the general economy for many years. The main forces driving the increasing penetration are (1) the increasing formalization of the economy, with an increasing population gaining access to private insurance through their employers and (2) increasing income of families, with a smaller but important part of the population paying for their own private insurance. Cost inflation and currencies Other important but secondary drivers include the unemployment rate and real wages, both as growth driver and as a driver for labor cost inflation. Real estate inflation and the exchange rate are other drivers to monitor in the sector. Regulation Regulatory forces remain an important and unpredictable driver for the sector. In general terms, healthcare insurance companies are regulated by ANS, while healthcare providers are regulated by ANVISA (safety regulator), the Brazilian equivalent of the US Food and Drug Administration. We could argue that the ANS has more influence over listed companies than ANVISA. ANS regulates technical reserves, which require capital, price increases for individual (as opposed to corporate) insurance products and minimum levels of service, which impacts profitability. On the other hand, ANVISA focuses on minimum safety conditions for products and facilities used to provide healthcare services, but it does not interfere in the pricing process of the services provided by the listed companies. Valuation Given the short tenure of the Brazilian healthcare sector in the Bovespa since IPOs were launched between 2004-2007 and the several organic and inorganic forces driving important transformations of growth, margins, and returns in the sector, we believe that DCF is the most appropriate valuation method. 7
We believe that the next most used metric should be forward-looking EV/EBITDA ratios, followed by price/earnings (PE) ratios, even though the latter can be significantly affected by tax differences. More specifically, the goodwill generated by acquisition is usually tax deductible in Brazil. Since virtually all listed companies in the sector have engaged in intensive M&A activity over the last five years, their effective income tax rates vary significantly over time and generate significant distortions that limit the applicability of PE ratios. With that caveat, payers have traded at an average one-year forward EV/EBITDA of 12.4x (8.1-16.7x), and forward PE of 18.3x (15.1-21.5x) over the last two years, while providers have traded at 8.1x (6.6-9.5x) EV/EBITDA and 15.3x (10.9-19.7x) PE in the same period. Overall, payers have experienced stronger and more sustainable sales growth with a CAGR of 28.6% in the 2008-2011 period and an expected 12.5% organic growth for 2012e. Payers ROE are also on the rise, from 12.7% in 2009 to reach 19.9% in 2012e as companies extract more value from previous acquisitions and their increasing pricing power. Providers, on the other hand, have experienced lower and more-capexintensive growth. As a result, provider s ROEs are declining from the peak of 26.6% in 2009, to 8.1% in 2012e, as the companies have to intensify capex spending to generate future growth. Brazil healthcare 2008 2009 2010 2011 2012e Payers growth Sales 28.8% 13.7% 58.3% 18.1% 12.5% EBITDA 12.5% -40.2% 178.9% 32.1% 19.3% EBIT 22.1% -46.1% 184.5% 34.1% 38.8% Net profits 56.6% -33.0% 31.3% 35.4% 39.5% Payers margins EBITDA 7.5% 4.0% 7.0% 7.8% 8.3% EBIT 5.5% 2.6% 4.7% 5.3% 6.6% Net profit 5.9% 3.5% 2.9% 3.3% 4.1% Payers productivity Capex/sales 5.3% 16.4% 11.0% 5.4% 4.3% Asset turnover (x) 1.65 1.13 1.52 1.54 1.70 Net debt/eq -0.74-0.31 0.16 0.23 0.23 ROE 20.2% 12.7% 11.7% 15.5% 19.9% Providers growth Sales 28.6% 19.1% 10.0% 39.3% 20.1% EBITDA 60.0% 1.9% 37.4% 20.7% 22.9% EBIT 54.8% 61.9% 56.2% 11.5% 26.6% Net profits -64.6% 477.9% 36.3% 29.1% 15.0% Providers margins EBITDA 23.4% 20.0% 25.0% 21.7% 22.2% EBIT 10.1% 13.7% 19.5% 15.6% 16.5% Net profit 1.6% 7.8% 9.6% 8.9% 8.5% Providers productivity Capex/sales 13.1% 6.7% 131.4% 70.6% 16.7% Asset turnover (x) 0.73 0.75 0.72 0.46 0.56 Net debt/eq 1.20 0.06 0.06 0.25 0.29 ROE 4.8% 26.6% 16.5% 18.0% 8.1% Note: based on all HSBC coverage of Brazil Source: HSBC estimates 8
Sector snapshot Key sector stats 0.57% of MSCI EM Latam Trading data ADTV (5 Year) (USD mn) 16.92 Aggregated market cap (USD bn) 4.32 Performance since inception* Absolute 157.59% Relative to MSCI EM LatAm -63.06% 3 largest stocks DASA.ON, ODONTOPREV.ON, AMIL.ON Correlations (5-year) with MSCI EM LatAM 0.22 Source: HSBC, Thomson Reuters Datastream, MSCI, I/B/E/S, At June 30, 2012 *IPO 2004-2007, performance includes dividends Top 4 stocks Stock rank Stocks Index weight 1 DASA ON 0.21% 2 ODONTOPREV ON 0.18% 3 AMIL ON 0.17% Source: HSBC, Thomson Reuters Datastream, MSCI, I/B/E/S, At June 30, 2012 Core industry driver: and dental market penetration 30% 25% 20% 15% 10% 5% 0% 24.6% 17.6% 17.9% 18.2% 18.9% 19.6% 20.7% 22.5% 21.4% 8.1% 6.9% 2.2% 2.6% 3.1% 3.3% 4.0% 4.8% 5.6% Source: ANS, HSBC PE band chart 45 35 2003 2004 2005 2006 2007 2008 2009 2010 2011 Percentage of Brazilians w ith priv ate HC insurance Percentage of Brazilians w ith priv ate Dental insurance Country breakdown Country Weights (%) Brazil 0.94% Chile 0.00% Colombia 0.00% Mexico 0.00% Peru 0.00% Source: HSBC, Thomson Reuters Datastream, MSCI, I/B/E/S, At June 30, 2012 25 15 5 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 AMIL ODPV DASA3 FLRY3 Source: Economática, HSBC PB vs. ROE 10 8 6 4 2 0 40% 30% 20% 10% 0% -10% 1Q07 3Q07 1Q08 3Q08 1Q09 3Q09 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12 Pay ers - PB Prov iders - PB Pay ers - ROE Prov iders - ROE Payers = AMIL3 and ODPV3 Providers = DASA3 and FLRY3 Source: Economatica, HSBC 9