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APOLLO HOSPITALS ENTERPRISE
Earnings impacted by higher fixed costs
�� Higher fixed costs from greenfield expansion impact earnings growth
Apollo Hospitals’ (APHS) consolidated Q3FY11 revenues of INR 6.46 bn (23% Yo-
Y) were 4% below estimate, led by slow growth in inpatient (IP) volumes from
mature clusters and lower sales from JVs (dilution of stake in Apollo Munich to
13.2% versus 16.7% in Q3FY10, not built in our estimates). EBITDA margin, of
16.1%, 30bps Y-o-Y, declined 100bps Q-o-Q (from ~17% in Q2 FY11), as onetime
selling costs (INR 100 mn for ‘Billion Hearts’ campaign) and other expenses
incurred for greenfield projects offset higher profitability in subsidiaries and JVs.
Net profit growth, of 3% Y-o-Y, was impacted from negative operating and
financial leverage from commissioning of 900 beds (Y-o-Y).
�� New facilities driving growth in hospitals
Hospitals revenue grew 23% Y-o-Y, to INR 4.3 bn, driven by strong growth in
Tier II facilities (outpatient revenues growth of 33% Y-o-Y, while IP revenues
grew 43% Y-o-Y). Strong macro demand and incremental bed additions in new
facilities (Bhubaneswar, Karur and Madhurai) has aided this growth. Moreover,
these facilities also depicted operational improvement, with reduction in ALOS
(5.6 days from 6.0 days in FY10) and higher occupancy (76%), while price
realisation increased 21% Y-o-Y.
�� Potential delay in proposed fund raising plan
APHS has proposed to raise INR 6 bn (QIP and NCDs) to fund capex of INR 11 bn
for ~2,300 planned beds additions over FY12-14. Although the company has
positive OCF (INR 2.5 bn in FY11E), likely delays in raising funds due to adverse
market conditions could defer new projects (not built in our estimates). We are
revising down our earnings by 5% in FY11, to factor in slower growth in mature
clusters and higher selling costs during the quarter. We highlight that new
facilities will remain the key driver for growth, as mature hospitals are
approaching critical scale with limited scope of expansion.
�� Outlook and valuations: Sustainable earnings growth; maintain ’BUY’
We reduce our SOTP based TP to INR 590 per share (INR 600 earlier), valuing
pharmacies at INR 60 per share (INR 70 earlier) factoring in relatively higher
volatility in margins. We value hospitals and other associates at INR 530 per
share. We believe that APHS is a relatively stable play in healthcare due to
organic growth model and higher visibility in earnings growth. Moreover,
potential divestment of pharmacies/other businesses will maintain a positive bias
and incremental visibility on timelines could act as a potential trigger for the
stock. We maintain our ‘BUY’ recommendation on the stock.
�� Higher fixed costs impact operating performance
APHS’ consolidated Q3FY11 results reported earnings growth of 3% Y-o-Y, reflecting
negative leverage from increase in capacity additions over FY10-11. APHS has
commissioned ~900 beds in owned hospitals (over FY09), leading to higher fixed
operating costs, while increase in interest costs and reduction in other income from
potential utilisation of cash have impacted net earnings growth.
APHS is a variable business model with relatively stable margins, despite significant
investments in new capacities. EBITDA margins, at 16.1%, improved 30bps Y-o-Y, led by
ramp-up in subsidiaries and JVs hospitals (Ahmadabad, Kolkata and Bangalore)
reflecting strong demand from respective Tier-I cities, offsetting cost pressures from new
hospitals. However, increase in selling costs resulted in margin pressure, leading to
100bps Q-o-Q decline in margins (17% in Q2FY11).
Revenue, at INR 6.46 bn, grew 23% Y-o-Y, 4% below estimate, led by lower-thanexpected
growth in IP volumes in mature hospitals (primarily Hyderabad; 4% Y-o-Y),
while retail pharmacy business depicted strong growth of 30% Y-o-Y (in-line). Share of
JVs grew 25% Y-o-Y, to INR 326 mn; it was, however, below our estimate due to
relatively lower share of revenues from Apollo Munich (dilution of stake to 13.2% from
16.7% not factored in our estimates). Overall, net profit, at INR 415 mn, was lower than
our estimate of INR 480 mn.
�� Standalone operational performance
The company’s standalone numbers continue to report strong growth. Revenue, at INR 6
bn, grew 25% Y-o-Y, in line with our estimate, led by strong growth in Tier-II hospitals
(42% Y-o-Y) and retail pharmacy business (30% Y-o-Y). Overall healthcare services
(including hospitals and hospital-based pharmacies) reported steady growth of 23% Y-o-
Y, driven by 11% increase in operational beds, higher occupancy (75%) and price
realisation (11% Y-o-Y). IP revenues grew 23% Y-o-Y, while OP revenue growth was
35% Y-o-Y.
EBITDA margin declined 50bps, to 15.7%, versus 16.2% in Q3FY10 due to relatively
higher selling expenses (96% Y-o-Y), as the company promoted Billion Hearts campaign
during the quarter (~INR 100 mn costs incurred till date). APHS has also been
aggressively promoting its new technologies and greenfield hospitals, leading to higher
fixed costs. Retail pharmacy EBITDA margins, at 0.31%, declined Q-o-Q from 1.8% in
Q2 FY11. APHS added ~900 beds YTD (including Secunderabad, international block and
Karaikudi launched in FY11).
Net profit, at INR 456 mn, grew 4% Y-o-Y, lower than our estimate of INR 523 mn, due
to higher operating and financial fixed costs and lower–than-estimated other income.
APHS has gross debt of INR 8.9 bn and cash of INR 1.5 bn by end YTD FY11. Tax rate, at
33%, was below our estimate of 34%.
�� Growth of mature facilities normalising to steady run-rate of 14-15%
Chart 1-4, below, depict growth in IP volumes, price realisation (IP), ALOS and
occupancy in key facilities of Chennai and Hyderabad. The trend depicts that growth in
large facilities have reached a critical scale with limited scope for expansion and hence
would depict steady-state normalised growth, while new facilities (Tier-II) are at an
inflexion point and would drive incrementally higher growth.
Chennai is stabilising with 14-15% growth in IP volumes, while RPBD (IP) remains flat
(2% Y-o-Y in Q3 FY11). Hyderabad IP volume growth of 4% Y-o-Y had negative impact
from regional/political issues during the quarter. Hyderabad has added 120 operational
beds in two facilities (Secunderabad and international block in Jubilee hills facility), which
could drive higher revenue growth over FY12.
�� Revising earnings to factor in higher fixed costs
We are revising down our earnings estimates for FY11 by 5% to factor in higher fixed
costs (selling expenses) during the quarter. We expect EBITDA margins to improve 60-
120bps to 15.5% and 16% in FY11E and FY12E, respectively, factoring in breakeven
margins from higher revenue growth in pharmacies and strong ramp-up in revenues
from subsidiaries and JVs. We are revising down our revenue estimates by 2-1% for
FY11-12, factoring in relatively slower growth in mature clusters (14% CAGR versus 17%
earlier).
�� Proposed fund raising plan
APHS has proposed to raise INR 6 bn funds via QIP. This development is in line with our
expectation to fund INR 11 bn of capex over FY12-14. Following are proposals of the
board, which were approved on December 09, 2010.
• Proposed INR 6 bn funds to be raised by issue of equity and non-convertible
debentures (including warrants), through QIP, to fund future capital expansion
(~2,300 beds additions over FY12-14). The company proposes to raise INR 3 bn by
issue of equity and INR 3 bn by issue of NCDs (redemption post 3-5 years and would
have attached warrants of INR 3 bn). The detachable warrants issued, along with
NCDs, would be utilised to raise funds for redemption of NCDs.
• Issue of warrants to promoter (Mr. PC Reddy) for 3.3 mn shares at conversion price
of INR 472 per share. This is in addition to warrants issued earlier (FY10) for 3.1 mn
shares (INR 1.2 bn) to fund capital expansion plan. These warrants have been
issued in February 2011 and have conversion period of 18 months. We have
factored in 2.5% dilution per annum factoring in full conversion of warrants (issued
in 2010 and 2011) in our FY12 and FY13 EPS estimate of INR 16.5 and INR 19.6,
respectively. We have not factored in dilution from proposed equity issue and NCD
issue (with warrants), pending clarity on timeline of issue.
We note that, although company has positive OCF (INR 2.5 bn in FY11), any likely delay
in raising funds due to adverse market conditions, could defer new projects (not built in
our estimates). APHS has planned 2,600 bed capacity additions over FY11-14, with
projected cost of INR 13.87 bn. Overall, APHS share of investment in the proposed
expansion is INR 11.7 bn, which is to be funded by a mix of debt, internal accruals and
equity. As shown in Table 6 below, the proposed funding is likely to maintain the debtto-
equity ratio of 0.4-0.5x and would not stretch the balance sheet.
�� Outlook and valuations: Positive; maintain ‘BUY’
We have reduced our SOTP-based TP to INR 590 per share (INR 600 earlier), valuing
pharmacies at INR 60 per share (INR 70 earlier) factoring in relatively higher volatility in
margins. We value hospitals and other associates at INR 530 per share. We believe that
APHS is a relatively stable play in healthcare due to organic growth model and higher
visibility in earnings growth. Moreover, potential divestment of pharmacies/other
businesses will maintain a positive bias and incremental visibility on timelines could act
as a potential trigger for the stock. We maintain ‘BUY’ on the stock.
�� Company Description
APHS, founded by Dr. P. C. Reddy, is India’s largest private healthcare service provider,
with an integrated business model providing an umbrella of healthcare services spanning
from primary healthcare like doctor consultation, pathology, preventive health checks to
specialty care treatments like cardiology. The company operates through a network of 33
hospitals and 27 clinics (~75% of total FY10 revenues) and has 5,400 beds spread
across metros and tier–I towns through owned hospitals (60% of total beds) and
subsidiaries, JVs and associates. Apart from hospitals, APHS has the largest organized
pharmacy retail chain with ~1,100 stores, accounting for ~24% of total FY10 revenues.
Moreover, the company provides consulting services from conception to commissioning
of specialized hospitals in various Afro-Asian countries. These consulting services account
for ~1% of total revenues.
�� Investment Theme
We expect APHS to sustain strong growth on back of significant expansion in Tier-I/II
cities (2,600 beds to be added over FY11-14) and rising demand for complex diseases
driving base business growth. 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. We expect ROCEs to expand from 13% in FY10
to 16% by FY12E.
�� Key Risks
Execution risk in tier II and III cities
The company’s strategy to penetrate untapped tier II/III cities could lead to execution
risk. Although the macro drivers are intact, rendering these markets as valuable
investing propositions, the dynamics of each location could be different, leading to
upside or downside risks. For instance, Apollo operations in Ahmadabad and Bangalore
took a long time to scale up and have been less profitable. Any delays in ramp up from
new facilities will adversely impact the company’s margins and ROCE.
Shortage of doctors and nurses
While demand for complex medical treatments remains high, availability of senior
consultants or doctors is becoming a key constraint. The company’s fully integrated
model provides a potential pool of talent each year through its own educational
institutions. However, potential higher attrition of doctors, especially senior doctors,
could materially impact market share. Moreover, ability to hire and retain doctors
enables the company to charge a premium for its services and leads to lower ALOS.
Rising infrastructure costs could restrict investments
The hospitals business is extremely capital intensive and hence infrastructure costs could
significantly impact its returns. Land and building comprise ~40-45% of total project
cost of a hospital. A tertiary care hospital typically needs ~750-1,000 sf area per bed
and costs ~INR 3,000-4,000 psf. Increase in costs from higher realty prices could defer
investments despite potential demand. We highlight that APHS invests in projects with
minimum IRR of ~17-18% for a specialty care set up. Due to volatility in prices and
inflation, the company is increasingly adopting the leased model for metros.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
APOLLO HOSPITALS ENTERPRISE
Earnings impacted by higher fixed costs
�� Higher fixed costs from greenfield expansion impact earnings growth
Apollo Hospitals’ (APHS) consolidated Q3FY11 revenues of INR 6.46 bn (23% Yo-
Y) were 4% below estimate, led by slow growth in inpatient (IP) volumes from
mature clusters and lower sales from JVs (dilution of stake in Apollo Munich to
13.2% versus 16.7% in Q3FY10, not built in our estimates). EBITDA margin, of
16.1%, 30bps Y-o-Y, declined 100bps Q-o-Q (from ~17% in Q2 FY11), as onetime
selling costs (INR 100 mn for ‘Billion Hearts’ campaign) and other expenses
incurred for greenfield projects offset higher profitability in subsidiaries and JVs.
Net profit growth, of 3% Y-o-Y, was impacted from negative operating and
financial leverage from commissioning of 900 beds (Y-o-Y).
�� New facilities driving growth in hospitals
Hospitals revenue grew 23% Y-o-Y, to INR 4.3 bn, driven by strong growth in
Tier II facilities (outpatient revenues growth of 33% Y-o-Y, while IP revenues
grew 43% Y-o-Y). Strong macro demand and incremental bed additions in new
facilities (Bhubaneswar, Karur and Madhurai) has aided this growth. Moreover,
these facilities also depicted operational improvement, with reduction in ALOS
(5.6 days from 6.0 days in FY10) and higher occupancy (76%), while price
realisation increased 21% Y-o-Y.
�� Potential delay in proposed fund raising plan
APHS has proposed to raise INR 6 bn (QIP and NCDs) to fund capex of INR 11 bn
for ~2,300 planned beds additions over FY12-14. Although the company has
positive OCF (INR 2.5 bn in FY11E), likely delays in raising funds due to adverse
market conditions could defer new projects (not built in our estimates). We are
revising down our earnings by 5% in FY11, to factor in slower growth in mature
clusters and higher selling costs during the quarter. We highlight that new
facilities will remain the key driver for growth, as mature hospitals are
approaching critical scale with limited scope of expansion.
�� Outlook and valuations: Sustainable earnings growth; maintain ’BUY’
We reduce our SOTP based TP to INR 590 per share (INR 600 earlier), valuing
pharmacies at INR 60 per share (INR 70 earlier) factoring in relatively higher
volatility in margins. We value hospitals and other associates at INR 530 per
share. We believe that APHS is a relatively stable play in healthcare due to
organic growth model and higher visibility in earnings growth. Moreover,
potential divestment of pharmacies/other businesses will maintain a positive bias
and incremental visibility on timelines could act as a potential trigger for the
stock. We maintain our ‘BUY’ recommendation on the stock.
�� Higher fixed costs impact operating performance
APHS’ consolidated Q3FY11 results reported earnings growth of 3% Y-o-Y, reflecting
negative leverage from increase in capacity additions over FY10-11. APHS has
commissioned ~900 beds in owned hospitals (over FY09), leading to higher fixed
operating costs, while increase in interest costs and reduction in other income from
potential utilisation of cash have impacted net earnings growth.
APHS is a variable business model with relatively stable margins, despite significant
investments in new capacities. EBITDA margins, at 16.1%, improved 30bps Y-o-Y, led by
ramp-up in subsidiaries and JVs hospitals (Ahmadabad, Kolkata and Bangalore)
reflecting strong demand from respective Tier-I cities, offsetting cost pressures from new
hospitals. However, increase in selling costs resulted in margin pressure, leading to
100bps Q-o-Q decline in margins (17% in Q2FY11).
Revenue, at INR 6.46 bn, grew 23% Y-o-Y, 4% below estimate, led by lower-thanexpected
growth in IP volumes in mature hospitals (primarily Hyderabad; 4% Y-o-Y),
while retail pharmacy business depicted strong growth of 30% Y-o-Y (in-line). Share of
JVs grew 25% Y-o-Y, to INR 326 mn; it was, however, below our estimate due to
relatively lower share of revenues from Apollo Munich (dilution of stake to 13.2% from
16.7% not factored in our estimates). Overall, net profit, at INR 415 mn, was lower than
our estimate of INR 480 mn.
�� Standalone operational performance
The company’s standalone numbers continue to report strong growth. Revenue, at INR 6
bn, grew 25% Y-o-Y, in line with our estimate, led by strong growth in Tier-II hospitals
(42% Y-o-Y) and retail pharmacy business (30% Y-o-Y). Overall healthcare services
(including hospitals and hospital-based pharmacies) reported steady growth of 23% Y-o-
Y, driven by 11% increase in operational beds, higher occupancy (75%) and price
realisation (11% Y-o-Y). IP revenues grew 23% Y-o-Y, while OP revenue growth was
35% Y-o-Y.
EBITDA margin declined 50bps, to 15.7%, versus 16.2% in Q3FY10 due to relatively
higher selling expenses (96% Y-o-Y), as the company promoted Billion Hearts campaign
during the quarter (~INR 100 mn costs incurred till date). APHS has also been
aggressively promoting its new technologies and greenfield hospitals, leading to higher
fixed costs. Retail pharmacy EBITDA margins, at 0.31%, declined Q-o-Q from 1.8% in
Q2 FY11. APHS added ~900 beds YTD (including Secunderabad, international block and
Karaikudi launched in FY11).
Net profit, at INR 456 mn, grew 4% Y-o-Y, lower than our estimate of INR 523 mn, due
to higher operating and financial fixed costs and lower–than-estimated other income.
APHS has gross debt of INR 8.9 bn and cash of INR 1.5 bn by end YTD FY11. Tax rate, at
33%, was below our estimate of 34%.
�� Growth of mature facilities normalising to steady run-rate of 14-15%
Chart 1-4, below, depict growth in IP volumes, price realisation (IP), ALOS and
occupancy in key facilities of Chennai and Hyderabad. The trend depicts that growth in
large facilities have reached a critical scale with limited scope for expansion and hence
would depict steady-state normalised growth, while new facilities (Tier-II) are at an
inflexion point and would drive incrementally higher growth.
Chennai is stabilising with 14-15% growth in IP volumes, while RPBD (IP) remains flat
(2% Y-o-Y in Q3 FY11). Hyderabad IP volume growth of 4% Y-o-Y had negative impact
from regional/political issues during the quarter. Hyderabad has added 120 operational
beds in two facilities (Secunderabad and international block in Jubilee hills facility), which
could drive higher revenue growth over FY12.
�� Revising earnings to factor in higher fixed costs
We are revising down our earnings estimates for FY11 by 5% to factor in higher fixed
costs (selling expenses) during the quarter. We expect EBITDA margins to improve 60-
120bps to 15.5% and 16% in FY11E and FY12E, respectively, factoring in breakeven
margins from higher revenue growth in pharmacies and strong ramp-up in revenues
from subsidiaries and JVs. We are revising down our revenue estimates by 2-1% for
FY11-12, factoring in relatively slower growth in mature clusters (14% CAGR versus 17%
earlier).
�� Proposed fund raising plan
APHS has proposed to raise INR 6 bn funds via QIP. This development is in line with our
expectation to fund INR 11 bn of capex over FY12-14. Following are proposals of the
board, which were approved on December 09, 2010.
• Proposed INR 6 bn funds to be raised by issue of equity and non-convertible
debentures (including warrants), through QIP, to fund future capital expansion
(~2,300 beds additions over FY12-14). The company proposes to raise INR 3 bn by
issue of equity and INR 3 bn by issue of NCDs (redemption post 3-5 years and would
have attached warrants of INR 3 bn). The detachable warrants issued, along with
NCDs, would be utilised to raise funds for redemption of NCDs.
• Issue of warrants to promoter (Mr. PC Reddy) for 3.3 mn shares at conversion price
of INR 472 per share. This is in addition to warrants issued earlier (FY10) for 3.1 mn
shares (INR 1.2 bn) to fund capital expansion plan. These warrants have been
issued in February 2011 and have conversion period of 18 months. We have
factored in 2.5% dilution per annum factoring in full conversion of warrants (issued
in 2010 and 2011) in our FY12 and FY13 EPS estimate of INR 16.5 and INR 19.6,
respectively. We have not factored in dilution from proposed equity issue and NCD
issue (with warrants), pending clarity on timeline of issue.
We note that, although company has positive OCF (INR 2.5 bn in FY11), any likely delay
in raising funds due to adverse market conditions, could defer new projects (not built in
our estimates). APHS has planned 2,600 bed capacity additions over FY11-14, with
projected cost of INR 13.87 bn. Overall, APHS share of investment in the proposed
expansion is INR 11.7 bn, which is to be funded by a mix of debt, internal accruals and
equity. As shown in Table 6 below, the proposed funding is likely to maintain the debtto-
equity ratio of 0.4-0.5x and would not stretch the balance sheet.
�� Outlook and valuations: Positive; maintain ‘BUY’
We have reduced our SOTP-based TP to INR 590 per share (INR 600 earlier), valuing
pharmacies at INR 60 per share (INR 70 earlier) factoring in relatively higher volatility in
margins. We value hospitals and other associates at INR 530 per share. We believe that
APHS is a relatively stable play in healthcare due to organic growth model and higher
visibility in earnings growth. Moreover, potential divestment of pharmacies/other
businesses will maintain a positive bias and incremental visibility on timelines could act
as a potential trigger for the stock. We maintain ‘BUY’ on the stock.
�� Company Description
APHS, founded by Dr. P. C. Reddy, is India’s largest private healthcare service provider,
with an integrated business model providing an umbrella of healthcare services spanning
from primary healthcare like doctor consultation, pathology, preventive health checks to
specialty care treatments like cardiology. The company operates through a network of 33
hospitals and 27 clinics (~75% of total FY10 revenues) and has 5,400 beds spread
across metros and tier–I towns through owned hospitals (60% of total beds) and
subsidiaries, JVs and associates. Apart from hospitals, APHS has the largest organized
pharmacy retail chain with ~1,100 stores, accounting for ~24% of total FY10 revenues.
Moreover, the company provides consulting services from conception to commissioning
of specialized hospitals in various Afro-Asian countries. These consulting services account
for ~1% of total revenues.
�� Investment Theme
We expect APHS to sustain strong growth on back of significant expansion in Tier-I/II
cities (2,600 beds to be added over FY11-14) and rising demand for complex diseases
driving base business growth. 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. We expect ROCEs to expand from 13% in FY10
to 16% by FY12E.
�� Key Risks
Execution risk in tier II and III cities
The company’s strategy to penetrate untapped tier II/III cities could lead to execution
risk. Although the macro drivers are intact, rendering these markets as valuable
investing propositions, the dynamics of each location could be different, leading to
upside or downside risks. For instance, Apollo operations in Ahmadabad and Bangalore
took a long time to scale up and have been less profitable. Any delays in ramp up from
new facilities will adversely impact the company’s margins and ROCE.
Shortage of doctors and nurses
While demand for complex medical treatments remains high, availability of senior
consultants or doctors is becoming a key constraint. The company’s fully integrated
model provides a potential pool of talent each year through its own educational
institutions. However, potential higher attrition of doctors, especially senior doctors,
could materially impact market share. Moreover, ability to hire and retain doctors
enables the company to charge a premium for its services and leads to lower ALOS.
Rising infrastructure costs could restrict investments
The hospitals business is extremely capital intensive and hence infrastructure costs could
significantly impact its returns. Land and building comprise ~40-45% of total project
cost of a hospital. A tertiary care hospital typically needs ~750-1,000 sf area per bed
and costs ~INR 3,000-4,000 psf. Increase in costs from higher realty prices could defer
investments despite potential demand. We highlight that APHS invests in projects with
minimum IRR of ~17-18% for a specialty care set up. Due to volatility in prices and
inflation, the company is increasingly adopting the leased model for metros.
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