Better times ahead for Apollo Hospitals

With better revenue growth and margin improvement, its second half performance will be better

Continued pressure on the margins of Apollo Hospitals disappointed the Street as September 2013 quarter performance also came a shade below expectations. The EBIDTA margins at 16.42% came almost similar to June 2013 quarter’s 16.3%, but 800 basis points lower than the year ago period. Among reasons for the margin pressure is the lower utilisation of beds that were added in early part of the year.

A Krishnan, CFO, Apollo Hospitals explained that the margins from existing hospital business have actually improved from 24.3% to 24.6%. But, EBIDTA losses of Rs 5.1 crore on account of the new start-up hospitals is what has taken toll on the overall margins. The new start-up beds have lower profitability initially and take about 18-24 months to ramp-up, the CFO added. The company had commissioned 340 beds in March 2013 quarter (200-beds at multi-specialty hospital at Aynambakam in Chennai and 140-bed Ortho & Spine specialty hospital in Bangalore) and also entered into a long term lease with Lifeline Hospital in South Chennai (170 beds ), which has led to rise in fixed costs.

Revenues in the September quarter at Rs 975 crore up 16.5% year-on-year and 7.7% sequentially, were also slightly lower than Bloomberg consensus estimates of Rs 987 crore. EBIDTA at Rs 160.11 crore also came marginally lower than expectation of Rs 163 crore. With depreciation costs increasing 17.5% to Rs 31.72 crore and finance costs rising 20% to Rs 22.55 crore, net profits at Rs 87 crore were up just 4.52%, compared to year ago quarter. As a result, the stock lost 2.5% to close at Rs 874 versus Sensex’s 1.02% fall.

Moving forward, Apollo, which is on an expansion spree, plans to add 2,800 beds across India in three years at a cost of incurring Rs 2,000 crore. The company that currently has over 8,500 beds in 51 hospitals across India plans to set up a mix of hospitals for smaller cities as well as big super specialty hospitals for larger cities. Out of the planned Rs 2,000 crore expenditure Rs 500 crore has been already invested and remaining Rs 1,500 crore will be a mix of internal accruals and debt. Given Apollo’s current debt-equity of 0.38 times and cash flows, funding the expansion should not be a concern.

Amongst its business segments, while Healthcare services (two-third of revenues) grew at 13.9% year-on year to Rs 636.52 crore, Pharmacy business (a third of revenues) grew at a faster pace of 22% year-on-year (11.3% sequentially) to Rs 338.64 crore. The profitability from Pharmacy segment is also improving with profit before interest and tax (PBIT) up 55% year-on-year to Rs 8.5 crore. PBIT margins at 2.51% were better than 2.14% in June’13 quarter and 2.11% in September’12 quarter. The increasing same store sales and new pharmacies achieving maturity are providing the traction. Krishnan added that the stand alone pharmacies (SAP) margins also improved from 2.9 to 3.3%. However, since margins are relatively lower than hospitals business and revenue growth was faster, it pulled down overall margins for Apollo.

Going ahead, the company plans to 200 pharmacies a year. The total pharmacies stood at 1,526 at the end of June’13. Analysts at HSBC in their earlier note had observed that driven by an increase in same-store sales, buying efficiencies, and the benefit of operating leverage they forecast a 400 basis points improvement in margins over two years with number of stores reaching 1,800 by FY15.

While the first half of FY14 lagged, second half will be better believe analysts as well as the management, with better revenue growth and margin improvement. It is therefore not surprising that consensus target price as per Bloomberg data (since October 2013) stands at Rs 977 indicating a upside of close to 12%.