Edelweiss: Apollo Hospitals - spreading wings; initiating coverage; Buy

Apollo Hospitals (APHS IN, INR 519, Buy)

n  Strong play on burgeoning domestic healthcare demand

Apollo Hospitals Enterprise (APHS), India’s leading healthcare player, is present in multiple segments of the healthcare industry. The company’s unique integrated business model renders high growth to overall business. India’s healthcare demand is expected to double to USD 77 bn by FY12E and APHS is well positioned to capitalise on this demand.

n  Aggressive capacity expansion to drive future growth

Apollo’s aggressive expansion encompassing investment in tier–II/III cities and emerging models like Reach will be key driver for growth. The company is planning to add ~2,500 beds (~46% of total bed capacity) at a total investment of INR 13 bn, which will contribute 25-30% of incremental revenue growth (22% CAGR to INR 37 bn over FY10-13E). Apollo with lower level of leverage and positive operating cash flows, is fully funded for this capacity expansion.

n  Hospitals revenues to de-risk from mature clusters

Mature hospitals (including Chennai and Hyderabad) will continue to remain critical for medium term growth and are expected to post 17% CAGR over FY11-13E, providing steady cash flows for future expansion. However, post current expansion, APHS revenues from mature clusters are likely to reduce to 70%, considerably de-risking the current revenue model.

n  Improving pharmacy returns to drive stable margins

APHS pharmacy operations will stabilise as more pharmacies mature and will be accretive to operating profits by FY12, offsetting fixed costs ramp up from capacity additions. Potential upsides from divestment (including stake dilution) is currently not factored in estimates, but will unlock value in the hospitals business and will be potentially accretive to overall valuations.

n  Outlook and valuations: Positive; initiating coverage with ’BUY’

Our SOTP based target price of INR 600/share is based on DCF value of hospitals (INR 520/share) and retail pharmacies (INR 60/share). We value investment in associates at INR 16 per share. APHS is trading at premium valuation to Asian peers, which is justified given its competitive positioning and superior earrings growth. We believe ROCEs should expand on current initiatives into Reach and leased model for expansion, leading to valuation re-rating. Hence, we initiate coverage on stock with ’BUY’ recommendation.