Apollo Hospitals: Expanding scale, improving profits

Higher share of maturing hospitals, completion of capex, should lead to sharp gain in earnings from FY17

The Apollo Hospitals Enterprise stock gained seven per cent in the past five trading sessions, after the company announced it would set up its second hospital at Chittagong in Bangladesh. The stock has been on the investors' radar, after CLSA put out a buy call early last week.

Investors' interest in the hospital space has gone up after Malaysia-based IHH Healthcare Berhad bought a 74 per cent stake in Global Hospitals. The stake was purchased for Rs 1,284 crore. IHH Healthcare also has a 10.85 per cent stake in Apollo Hospitals.

A key growth trigger for Apollo Hospitals is the capacity expansion over the next three years, as well as the proportion of older beds from the capacity additions during FY12-15. New beds take a couple of years to break even, whereas the older beds are profitable, earning margins upwards of 16 per cent. Of its 7,217 beds at the end of FY15, only 10 per cent are less than one year old and 61 per cent are five years or older. Including managed hospitals, the total bed capacity is 9,215. The company intends to add 1,600 beds over the next three years (till FY18).

Despite the expansion, CRISIL Ratings says the company will sustain its healthy operating margins of 13 to 14 per cent, aided by strong operating profitability of its older hospitals, along with improving operating performance of its joint ventures, subsidiaries, and retail pharmacy business. While the retail pharmacy division has been a drag on the company's overall profitability, Apollo Hospitals' focus on improving in-store profitability has helped it increase the business' operating margins from 2.7 per cent in FY12 to 3.3 per cent in FY15.

CLSA expects FY17 to be the changing point for accelerated earnings per share (EPS) growth. The research firm believes the company will see a strong 36 to 45 per cent EPS growth in FY17 and FY18, as new hospitals scale up and capital expenditure is completed. Earnings growth between FY14 and FY16 (including estimates for this financial year) is in the range of 4.1 per cent to 7.8 per cent.

About half the analysts who track the stock have a buy with a consensus target price of Rs 1,439, which translates into a marginal 5 per cent gain from the current levels. Given the recent run up and valuations at 38 times its FY17 earnings, investors with a horizon of at least two years could look at corrections to add it to their portfolio.