Apollo Hospitals Enterprise Rating Buy: Prospects for company’s growth strong

Given strong growth visibility, we raise our Ebitda estimates by 7%/4%, but reduce EPS by 9%/8% for FY20/21 given higher tax rates.

Apollo Hospitals (APHS) has emerged as the largest Indian private hospital player (~10,200 total bed capacity with ~7,500 operational beds) across healthcare value chain — hospitals, clinics, pharmacy and diagnostics. Its key differentiator has been superior clinical outcomes led by its Center of Excellence (COE) and visionary management. This has led to improved operating metrics (ARPOB, ALOS & Occupancy).

While matured hospitals (41% of sales) and pharmacy business (40%) are expected to see steady growth with gradual margin expansion, we expect higher growth and Ebitda margin expansion from new hospitals (~33% of bed capacity contributing only ~9% to Ebitda) as maturity profile improves.

With capex phase behind and capacities in place, management said at its meet that the focus is on sweating the capacities: (i) targets mid-teen Ebitda margin from new hospitals (currently @ ~8%) over 2 years; (ii) aims to double pharmacy segment revenue to Rs 100 bn on ~50% increase in store count; (iii) scale up clinics’ (AHLL’s) profitability led by 15-20% revenue growth. With strong operating performance (13%/19% revenue/Ebitda CAGR over FY19-22e) and moderating capex (from FY20), we expect FCFs and RoCEs to improve.

Given strong growth visibility, we raise our Ebitda estimates by 7%/4%, but reduce EPS by 9%/8% for FY20/21 given higher tax rates. Maintain Buy with revised TP of Rs 1,760 (16x H1FY22e EV/Ebitda) vs. Rs 1,680. Near term catalysts: value unlocking in health insurance business (Apollo Munich) and front-end pharmacy business to reduce promoter pledge and net debt.

Strong visibility of sales/Ebitda growth
> APHS to sustain long-term growth led by (i) filling clinical gaps across hospitals; (ii) development of COE for better value growth; (iii) better operating metrics; (iv) better case/patient mix; and (v) creating a good work environment for doctors.
> APHS’ growth guidance for next 2-3 years: (i) Matured hospital revenue growth of 10-12% p.a. with gradual increase in margin; (ii) New hospitals revenue growth of ~15% pa with improvement in margin; and (iii) Revenue growth of ~20% pa for Pharmacy and ~20% for AHLL with margin expansion.
> Superior clinical outcome led by its Center of Excellence – key differentiator
> APHS has forte in clinical excellence through (i) strong doctor pool; (ii) wider clinical offerings; (iii) continuous improvement in quality of services;
(iv) implementation of advance technology (Proton therapy, robotics).

Moderating capex coupled with better financials to improve RoCE, FCF
> APHS invested ~Rs 43 bn (over FY14-19) which added ~60% bed capacity (~3,880 beds) from FY13. This resulted in subdued RoCE (~10%), as large part of capital employed (over FY14-19) was not optimally utilised. However, with maturity of new hospitals leading to better in-patient volume and improved occupancy, we expect Ebitda margin & ROCE to improve over next few years.
> Moderation in capex (from Rs 6.7 bn in FY19 to ~Rs 3-4 bn pa in FY20/21) coupled with improving financials would lead to higher FCF; adds visibility of debt reduction in near future.
> APHS is not looking for any large M&A but will remain open for any mid-small sized opportunistic acquisition.