Why big investors, brokerages like Fortis Healthcare

Higher proportion of mature hospitals and listing of diagnostics business bode well

The Fortis Healthcare stock was up 8 per cent after buy ratings from brokerages and on news that Rakesh Jhunjhunwala picked up a stake in the company on Tuesday. For a company whose stock has taken a beating - down almost a third per cent in about three months, due to issues at the promoter group that have little direct impact for Fortis, these latest developments are a welcome. So, why this positive stance on Fortis?

Goldman Sachs, which has a buy rating on the company, believes the mature hospitals and better occupancies will lead to margin expansion to the tune of 280 basis points during the FY18-20 period. Flagship hospitals will drive revenues, which is pegged to grow at 11 per cent annually over the same period.

Other analysts expect its revenues to grow by about 10 per cent annually led by higher volumes as well as better product (specialty) mix. About 80 per cent of the company's owned beds are five years old, which coupled with occupancies in excess of 60 per cent translates into leverage benefits and higher margins. The company's four mature facilities in Mohali, Mulund, Shalimar Bag and Kalyan clocked (prior to business trust cost) an operating profit margin of 20 per cent. The management, too, is targeting a 20 per cent operating profit margin (before trust costs) for the business over the long term, with an annual improvement of 150-200 basis points.

The second trigger is the demerger of its diagnostics chain, SRL. Fortis Healthcare has a 56 per cent stake in SRL and analysts at Axis Capital peg the stake's worth at just under Rs 3,000 crore. SRL is valued at 25 times its FY19 operating profit estimates. The diagnostics business accounts for 18 per cent of Fortis' revenue, but over half of its operating profit. To unlock value for shareholders and enable the two segments to operate independently and have a greater focus, the company's board had approved the demerger of SRL last year.

While there are legal hurdles given that Daiichi Sankyo of Japan has filed a case pertaining to its Ranbaxy acquisition in 2008 against the current promoters of Fortis, analysts at Goldman Sachs believe that if the demerger goes through there could be a multiple rerating for SRL entity. That's because, SRL currently operates at a higher operating profit margin (18 per cent in June quarter) than Fortis' Hospitals segment (5 per cent), and a listing would eliminate the conglomerate discount. Prior to Wednesday run-up, the stock was trading at a 30 per cent discount to Apollo Hospitals.

Analysts believe that the stock could see some interest given that it is a merger and acquisition candidate and the promoters are planning to sell their stake. TPG-General Atlantic and IHH have been reported to have interest in taking a majority control of Fortis, which is expected to clock healthy growth in its businesses.

Investors, however, should await clarity both on the demerger of the diagnostics entity as well as sale of promoter stake to new owners before considering the scrip.