Apollo Hospitals Enterprise - Initiating Coverage, CMP Rs.848, BUY, Target of Rs.976 - Sushil Finance

STRENGTH: Largest network of hospitals& Pharmacy chain across India, Strong Brand recall, Presence in almost every spectrum of the healthcare value chain, Healthy balance sheet with consistent cash generation WEAKNESS: Low Return ratios being a Capital-intensive industry OPPORTUNITIES: Growing medical tourism THREAT: Reduced Government Reimbursement & Sluggish regulatory framework, Increased Competition.

Aggressive bed addition, better occupancy of existing beds & reducing ALOS to drive growth: Apollo has embarked on a major expansion plan to add ~2,685 beds over the next 3-4 years which we believe, is proactively building a well geographically diversified capacity citing strong growth going ahead. The new hospitals include a blend of super and multi-specialty hospitals in metros/tier I cites and the introduction of new format (reach hospitals) in tier II cities where healthcare delivery penetration is relatively lower. We, however, expect bed additions would result in a dip in occupancy rates in the near term but with a better mix of services (cardiology, neurosciences & oncology) and a reduction in average length of stay (ALOS) (led by the introduction of faster recovery based but expensive robotic surgery) would provide the required impetus for volume & ARPOB growth going forward. We thereby expect the hospitals business to log a CAGR (FY13-15E) of 17.6% to Rs. 41.6 bn in FY15E led by a CAGR of 20.1% in the Hyderabad cluster, 11.4% in the Chennai cluster, 39.1% in other owned hospitals &9.7% in significant JVs and subsidiaries.

Pharmacy business – increased focus on improvement in EBITDA margins: Apollo with 1560 stores (as of Sept 13) is the largest branded pharmacy chain in India. Apollo's strategy of shifting focus from aggressively adding more stores to increasing the profitability of the existing stores is showing positive results (H1FY14 Pharmacy EBITDA margin at 3.1%). This in addition to maturing of stores, shutting down of non-profitable stores and increased contribution from private labels (management has guided a 1% increase in contribution every year with it currently at 6% up from 3% in the past two years) should help expand EBITDA margins going forward. We have assumed an annual addition of ~120 stores for the next 2 years thereby expecting pharmacy revenues to grow at a CAGR (FY13-15E) of 22.8% to Rs. 16610 mn in FY15E, while EBITDA margins are expected to improve from 2.7% in FY13 to 3.5% in FY15E.

Under penetrated market presents an attractive opportunity: Rising discretionary spending, changing disease patterns, greater health awareness, rising insurance coverage and medical tourism are expected to drive the healthcare sector going forward. Given Apollo's leadership position, strong brand recall & underpenetrated nature of the sector, we believe, Apollo is well poised to benefit from the strong boom in the Indian healthcare industry.

FY13-15E Revenue CAGR of 18.7% &Balance sheet strength provides comfort: We estimate consolidated revenue of the company to record 18.7% CAGR in FY13-15E whereas on the EBITDA front we believe the improvement in the pharmacy business & already existing hospitals margin will be offset by lower margins from new hospitals. Even though Apollo has embarked on a major expansion plan with it being in a capital-intensive industry; we believe, it would expanded without stressing its balance sheet (D:E ratio at 0.46x). We expect Apollo's return ratios profile to see an improvement (ROCE & ROE to increase from 8.1% & 10.2% in FY10 to 10.8% & 13.0% in FY15E) with operating leverage setting up and investment in fixed asset generating cash flows.

OUTLOOK & VALUATION

Apollo is the largest private healthcare service provider in Asia with around 38 owned hospitals & 13 managed hospitals. It has also consistently maintained its growth trajectory with its key operating metrics improving every fiscal. With the company already having an early mover advantage, a healthy BS & strong cash flows from existing hospitals, we think, Apollo will steadily enter a high-growth phase aided by major expansion projects, profitability improvement in its pharmacy business along with highly favorable industry dynamics. We believe, Apollo is investing for longer term growth & thereby asserting it position as a leading player in the Indian healthcare service space. We thereby initiate coverage with a BUY rating and target price of Rs. 976 based on 17x 1year forward EV/EBITDA.

Source : Equity Bulls

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