Valuations, drug pricing policy limit upsides for Apollo Hospitals

The Apollo Hospitals stock has corrected 11 per cent from its 52-week high of Rs 1,096 on May 17 to Rs 950 currently, after the company reported its fourth quarter and FY13 results, which were slightly below expectations and weak on a sequential basis. Some concerns on the profitability of the company's pharmacy business have also emerged after the new drug pricing policy announcement last week.

Apollo saw its revenues grow 13.9 per cent year-on-year during the March quarter; much lower than the 19-21 per cent growth seen consistently during the first three quarters of FY13. On a sequential basis, the revenue was Rs 848 crore, compared with Rs 856 crore in the December 2012 quarter. Bottom line growth at 22 per cent in the March quarter, too, was the lowest in FY13, compared with 24.7 per cent in the December quarter and 36-49 per cent seen in first two quarters. Sequentially, profits fell 10.3 per cent.

The management attributed the decline in revenue to the extended holidays in the March quarter. There were three or four incidents when holidays fell close to the weekends and led to extended holiday spells. Also, looking at certain conferences which doctors were attending in January, the hospital utilised the same for keeping operation theatres closed for maintenance purposes, impacting revenues.

Apollo Hospitals commissioned the 200-bed multi-speciality hospital at Aynambakam in Chennai and the 140-bed ortho and spine speciality hospital in Bangalore in the March 2013 quarter and entered into a long-term lease for Lifeline Hospital facility in OMR, South Chennai (170 beds). Total capacity, including joint ventures, thereby, increased to 51 hospitals with total bed capacity of 8,420 beds as on March 31. Though this is positive, the additions have led to the increase in fixed costs while the capacity utilisation of newly-added beds too, remained low in the March quarter. Thus, Ebitda margins at 15.7 per cent slipped 96 basis points compared to the year-ago period. Along with an increase in interest costs and depreciation, profit growth slowed.

As capacity utilisation levels increase, the company's margins and profit growth should improve. Of the 6,382 owned beds, 5,549 were operational and had occupancy of 72 per cent in the March quarter. The management observed that capacity utilisation should increase to 76-77 per cent in a few quarters.

In the pharmacy segment, the total number of retail pharmacies as on March 31 stood at 1,503. On net basis, around 139 stores were added in FY13. Contribution from the pharmaceutical retail segment has increased to around 33 per cent of total revenues in FY13. The pharmaceutical retail segment that had become profitable in FY12 saw margins increase from 1.9 per cent in FY12 to 2.7 per cent in FY13.

However, the recent drug price control policy has led to some caution among investors. Management believes that though the pricing of drugs will get cleared during the first quarter, there should not be any major impact on sales as a whole. The retail segment contributes 22 per cent to the hospital revenues, and major sales in the hospitals are of life saving drugs, so the impact of pricing policy should be limited. Any drastic cut in prices could hurt revenues and margins of this business.

The company plans to add retail stores at a run rate of around 170 per annum. The hospital bed capacity is also expected to increase by 1,000 beds in FY14. The debt-equity ratio is just at 0.2, which is much better than its peers, and provides leeway for expansion/acquisitions. While the hospital business should drive growth in the current financial year, led by higher utilisations and number of beds, it would be prudent to wait for clarity in the pharmacy business regarding drug pricing policy. Nevertheless, valuations are close to fair levels.

Perin Ali and Manoj Garg, analysts at Edelweiss Securities, note, "We expect medium-term operating margins to trend higher (estimate 45 basis points expansion over FY13-15) as more pharmacies mature and new facilities start scaling-up. We rollover target price to Rs 1,060 on 16 times FY15 estimated EV/Ebitda and maintain 'HOLD' as valuations fully price in earnings growth potential."

Though 16 out of 24 analysts polled by Bloomberg have a Buy rating, given the consensus target price of Rs 944, an immediate upside is limited.