Fortis Healthcare stock awaiting a breakout

Beyond the near-term impact of demonetisation, margin expansion in both hospitals and diagnostic businesses will drive earnings

Recent news of TPG Capital planning to buy stake in Fortis Health care has helped the latter’s stock regain a large part of the lost ground after demonetisation. While some market pundits say interest by TPG is an indication Fortis is poised to deliver better performance going ahead, it will have to be seen what valuati­o­ns the company can garner. Thus, further development in this regard will be tracked cl­o­s­ely. The company, however, has said it is evaluating the best possible ways to raise fu­n­ds and no firm decision has been approved by its board.

Nevertheless, Fortis’ pros­p­­e­cts seem to be improving. One, the company is expected to deliver higher growth on the back of better capacity ut­i­lisation, brownfield expans­i­o­ns and improving margins. Also, the listing of its diagnostics arm SRL is likely to lead to value-unlocking. 

The company has reported improvement in its marg­ins in recent quarters, unlike its larger peer Apollo Hosp­itals. For the first half of FY17, operating profit margin is up 100 basis points year-on-year for the hospitals segment, wh­i­le in the September quarter, this division’s better performance boosted Fortis’ consolidated margins by 100 basis p­o­ints. Apollo Hospitals, on the other hand, has seen margins decline 20 basis points du­ring the September quarter.

Margin expansion in the hospitals segment has been driven by the company’s eff­o­r­ts to improve occupancy levels and revenues per bed. The introduction of high-end me­d­ical programmes should further fuel growth of this busin­e­ss. Importantly, Fortis has not undertaken major greenf­i­eld expansions and can more than double its operating bed capacity with brownfield exp­a­nsion, which provides visib­i­lity for profitable growth go­i­ng ahead, says an analyst at a foreign brokerage. Apollo, on the other hand, has seen many greenfield ex­p­a­nsions, which are imp­a­c­t­ing margins.

Analysts at Motilal Oswal Securities expect 10-fold gro­w­­th in Ebitda before business trust costs for the hospitals business (CAGR of 19 per cent over FY16-19) of Fortis, and see another 200-basis point margin expansion for diagnostics business during FY16-19.

In the near term however, the Street is trying to assess the impact of demonetisation. The December quarter, which is seasonally weak, can thus see some more pressure. Ana­l­ysts at JP Morgan say their channel checks suggest a mid single-digit revenue impact. Analysts also believe the trend has started normalising and more clarity will emerge by January-February; it would be business as usual in FY18. 

Hence, any weakness in the stock should be looked at as an opportunity to accumulate. The stock, which has be­en range-bound between Rs 155 and Rs 200 since early 2015, can break out of this range on the upside, going ahead. Their target prices range from Rs 230-275 on sum-of-the-parts valuat­i­on, indicating an upside pot­e­n­tial of 23-54 per cent.