Healthy dose of growth for Apollo Hospitals

The company is likely to see strong revenue growth as well as improving profitability on the back of significant expansion in its hospitals business and pharmacies

Apollo Hospitals corrected sharply (down 10 per cent in a month) after CLSA offloaded six per cent stake in the company recently. The outlook for the stock, however, continues to be strong given its expansion plans, a strong balance sheet and improving profitability. The divestment of its stake in non-core business will boost its profitability but also bring in funds for expansion. While foreign direct investment (FDI) approval in retail had raised investor hopes as it would mean value unlocking in the pharmacy business, implementation is some time away. Nevertheless, the segment is likely to see growing profitability which will add to the company’s growth.

Balaji Prasad and Rohit Goel of Barclays Capital are bullish on the stock due to consistent execution and strong growth through capacity expansion. They forecast a two-year annual earnings per share growth of 30 per cent. Almost 70 per cent (17 out of 24 analysts) according to Bloomberg have a buy call on the stock with a consensus target price of Rs 887, implying an upside of 11 per cent. While analysts are bullish, given that the stock has been an outperformer with a 52 per cent return over the last year, valuations are running at a premium to its five-year averages. Medium- to long-term investors can park their money on dips.

Robust expansion plans
Apollo Hospitals is expanding its network of hospitals and has recently announced setting up 10 specialty hospitals for treatment of heart diseases and cancer at different locations in the country. These 50-75 bedded hospitals will be set at an investment of Rs 400 crore. The expansions are in addition to 2,000 new beds announced by the company earlier. The company has, over a period of time, grown organically without putting undue stress on its balance sheet. The divestment of the BPO business will also infuse funds for expansion.

HIGHER REVENUE GROWTH, MARGINS
In Rs crore	FY12	FY13E	FY14E
Net sales	3,147	3,841	4,807
Y-o-Y change (%)	20.8	22.0	25.2
Ebitda	513	633	818
Y-o-Y change (%)	22.7	23.4	29.2
Ebitda (%)	16.3	16.5	17.0
Net profit	219	318	419
Y-o-Y change (%)	19.3	45.2	31.5
P/E (x)	49.3	35.0	26.6
E: Estimates Source: Barclays

Apollo enjoys leadership position in the private hospitals space in India managing 50 hospitals under a single brand, with a capacity of 8,276 beds. The planned expansions are likely to take this to more than 11,000. After a dominant presence in South India, Apollo is geared to have pan-India presence through its REACH initiative, which is targeted at Tier II and Tier III cities.

Divestment: Positive move
The company has recently divested stake in its healthcare BPO business, Apollo Health Street. This divestment for Rs 220 crore is positive as it helps move away from a non-core business. The cash flows from the same could be utilised for the hospitals business. The company already had lined up a capex of around Rs 1,800 crore for FY13-15 and now plans Rs 400 crore more. Analysts at Edelweiss observe that the divestment is positive for the business as it would improve the profitability/return on capital employed on the one hand and cash flows on the other that could be utilised for the more profitable hospital business. Analysts at Citi add that the sale proceeds will reduce net debt/equity (already comfortable at 0.4 times) further to 0.3 times. Moreover, return on capital should improve, given that Apollo Health Street contributed around one per cent to Apollo Hospital’s profits and five per cent to capital employed.

Retail business
Apollo has the largest retail pharmacy chain (first of its kind) with 1,364 stores in operation. The business, which grew at 30 per cent in FY12 contributed to 30 per cent of the overall revenues. On the positive side, the segment turned profitable with earnings before interest, taxes, depreciation and amortisation (Ebitda) margins of 1.7 per cent. While analysts at Edelweiss estimate the margins to grow further to 2.5 per cent by end of FY13, those at IIFL see the Ebitda margins touching three per cent by FY15. This is to be led by maturing stores and increase in sale of private label goods.

Attention has shifted to the pharmacy business after the clearance of FDI in retail. While the company can unlock value in this business too, the management may not divest its stake immediately and would prefer to expand operations and attain more scalability. Also, the fact that the company’s pharmacies are spread across multiple states and the need for state government approval would be a limiting factor for divestment. Analysts at Citi do not see value unlocking from the business in the near term.