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Himani Singh [email protected]

OUTPERFORMER

Current price Rs 480

Target price Rs 593

Potential upside 24%

Time Frame 18 months

Apollo Hospitals (APOHOS)

Initiating Coverage

March 18, 2008| Healthcare

Heal the world …

Sales & EPS trend

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Net Sales Diluted EPS (Rs) Stock metrics Promoters holding 27.46 Market Cap 2820 52-week H/L 627 / 365 Sensex 14833 Average volume 15599 Comparative return metrics (%) Stock return 3 M 6M 12M Apollo Hospital -1.0 0.31 -2.7 Indraprasth M -30.1 -4.0 17.3 Fortis -8.6 -9.6 NA

Apollo Hospitals is a leading player in the high-growth healthcare sector. It currently has a network of 18 owned hospitals and 8 hospitals through subsidiaries/JV/associates totalling to more than 4,000 beds. The company also has 12 hospitals under management contracts which increases its spread and raises its total bed count to more than 6,800. Apollo has presence across the healthcare delivery value chain with 420 pharmacy outlets. Its integrated business model, scale, national footprint and presence across multiple disease and delivery segments make it one of the best plays on the sector.

Demand for healthcare to exceed supply Currently, India has a capacity of ~ 1.05 million beds. To meet projected demand and maintain bed-to-population ratio at 1.9:1000, India will need to expand its bed capacity by 632,000 to 1.68 million by 2016, translating to Rs 165,300 crore worth of investment. Privately-operated healthcare services account for over half of all in-patient hospital visits and 82% of all out-patient visits.

Apollo well placed with national footprint, presence across value chain Over the years, Apollo has created a healthcare powerhouse that has significant presence in every sphere of healthcare across the nation. Its integrated business model, scale, national footprint and presence across multiple disease and delivery segments will help it capitalise on the growing need for healthcare services.

Aggressive expansion plans across spectrum Apollo plans to expand organically as well as inorganically in their hospital business to take their bed base to more than 8500 by FY11. Apollo has formed JV to establish hospitals in Thane and Nashik. It plans to expand its owned portfolio by embarking on new hospital projects in Vishakhapatnam and Bhubaneswar. Apollo also plans to expand its pharmacy outlets to 1,200 by FY11.

Valuations

We expect Apollo to consolidate its leadership position through its ongoing expansions. At the current price of Rs 480, the stock is trading at 24x its FY09E EPS of 20 and at 19x its FY10E EPS of 25. We believe that the current levels are very attractive and arrive at our target price of Rs 593 through a DCF valuation. We rate the stock an OUTPERFORMER.

Exhibit 1: Key Financials

Year to March 31 FY07 FY08E FY09E FY10E Revenue 949.45 1186.92 1278.68 1655.54 Net Profit 95.36 114.66 121.20 154.66 Shares in issue (crore) 5.16 5.87 6.02 6.18 EPS (Rs) 18.47 19.54 20.12 25.04 P/E (x) 26.89 24.60 23.89 19.20 Price/Book (x) 3.40 2.22 2.04 1.84 EV/EBIDTA 18.21 14.89 14.36 11.72 RoNW (%) 12.6% 9.0% 8.6% 9.6% RoCE (%) 10.0% 10.1% 9.5% 10.9% Source: ICICIdirect Research

Analyst’s Name

ICICIdirect | Equity Research

Price Trend

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Table of Contents

Company Background 3

Investment Rationale 4 Demand for quality healthcare expected to overshoot announced supply 4 Apollo poised to benefit the most with presence across value chain pan India 5 Aggressive expansion plans across spectrum 7 Apollo has more headroom to play with revenue variables 10 Added advantage from announced five year tax holiday 10 Medical tourism to provide further fillip 10 Rising penetration of health insurance ; An opportunity 11

Risks & Concerns 12

Financials 13 Consistent top line growth across the business lines 13 Bottom line to surge backed by margin expansion and low finance cost 13 Efficient working capital management 14 Returns remain capped in medium term, improvement post FY09E 15

Hospital Bed-base 16

Valuations 17

Financial Summary 18

Exhibits Exhibit 1: Key Financials 1 Exhibit 2: Apollo Hospitals’ presence across the healthcare delivery value chain 3 Exhibit 3: Infrastructure needs a major fillip 4 Exhibit 4: Major capex plans announced by private players 4 Exhibit 5: Clear focus on Super-speciality and Multi-speciality 5 Exhibit 6: Apollo Hospitals utilises organic as well as inorganic route to expand 6 Exhibit 7: Plans to extend pharmacy chain to 1200 outlets by FY10 7 Exhibit 8: Expansion engine running overtime in 2000’s 8 Exhibit 9: More than 300 beds to be added in owned hospitals through ramp-up 9 Exhibit 10: Thousand beds to come by FY09 through projects underway 9 Exhibit 11: India’s comparative cost advantage in medical tourism (in US$) 11 Exhibit 12: Apollo revenue to grow across Hospitals, Pharmacy & Others 13 Exhibit 13: Increase in EBIDTA contributed by control over employee cost & increase in revenue 14 Exhibit 14: Trends of current ratio and creditor to debtor ratio indicate efficient working capital 14 Exhibit 15: Returns to jump post FY09E once asset turnover improves 15 Exhibit 16: EV/EBIDTA band 17 Exhibit 17: EV/Sales band 18 Exhibit 18: Discounted Cash Flow 18 Exhibit 19: Apollo trading at attractive P/E levels 19

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Exhibit 15: Subsidiary structure

Exhibit 2: Apollo Hospitals’ presence across the healthcare delivery value chain

Source: Company, ICICIdirect Research

Promoter & Institutional holding trend

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Company Background Apollo Hospitals Enterprises Ltd (AHEL) was incorporated as a public limited company in 1979. Promoted by Dr Prathap C Reddy, it is the first group of hospitals that pioneered the concept of corporate healthcare delivery in India. AHEL today is the leading private sector healthcare provider in Asia and owns and manages a network of speciality hospitals and clinics, a chain of pharmacy retail outlets across the country, and provides consultancy services for commissioning and managing hospitals. With nursing and hospital management colleges, pharmacies, diagnostic clinics, medical transcription services, third-party administration and telemedicine, Apollo's leadership extends to all aspects of the healthcare spectrum. AHEL has over 26 hospitals of which 14 are client hospitals, managed by professionals deputed from Apollo. The consultancy division of AHEL offers project and operations management consultancy services to clients varying from to commissioning of a wide range of healthcare models. Over the years, Apollo Hospitals has founded various group companies to empower its flagship company, Apollo Hospitals Enterprise Ltd, to create a healthcare powerhouse that has a leadership position in every sphere of healthcare.

Share holding pattern Shareholder % holding Promoters 27.46 Institutional investors 30.10 Other investors 34.68 General public 7.74

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INVESTMENT RATIONALE

Demand for quality healthcare expected to overshoot announced supply Currently, India has a capacity of around 1.05 million beds. To meet projected demand and maintain bed-to-population ratio at 1.9:1000, India will need to expand its bed capacity by 632,000 to 1.68 million by 2016, translating to Rs 165,300 crore worth of investment.

Exhibit 3: Healthcare infrastructure needs a major fillip

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India (2002)Mexico (2004)

Malaysia (2001)China (2003)

Thailand (2000)Brazil (2002)USA (2003)

UK (2004)Korea (2002)

Russia (2005)Japan (2001)

Hospital beds per 10000 people

Source: WHO

In India, privately-operated healthcare services accounts for over half of all in-patient hospital visits and 82% of all out-patient visits. Going forward, we expect more investment to come in from the public against private for provisioning the demand growth in the same proportion.

Exhibit 4: Capex plans announced by major players

Source: CRIS-INFAC, ICICIdirect Research

* P: Primary Care; S: Secondary Care; T: Tertiary Care

Healthcare providers with a capacity for a fast ramp-up of bed base and having a geographical spread in metros, tier-I and tier-II cities, where incidence of lifestyle-related diseases is high, would benefit the most from the increased demand for healthcare services. Apollo, with its well diversified services focus on tertiary care in cardiac ailments along with multi-speciality, would stand to benefit from the demand supply mismatch scenario.

Number of hospitals

Number of beds

Location Planned beds

Beds by 2011

Type of Facility*

Apollo Hosp 26 6885 Pan India ~1500 ~8400 PST Manipal HC 20 7629 Southern India 3025 10654 PST

Wockhardt 8 1390 Southern, Western & Eastern 1850 3240 T

Fortis HC 12 1800 Northern India & Chennai 1337 3137 ST

Max HC 7 765 NCR 585 1350 PST

Care 7 1020 Southern India & Nagpur 315 1335 PST

Even to maintain the current ratio on an increased base of population, Indian healthcare sector would experience huge supply shortfall

Announced capex plans inadequate to quench the expected demand

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Apollo well-placed with national footprint, presence across value chain Apollo Hospitals, the largest healthcare provider in the private sector in India, has come a long way from their first Chennai hospital in 1983 to a group with ~ 6,800 beds in 26 hospitals. Over the years, Apollo Hospitals has created a healthcare powerhouse that has significant presence in every sphere of healthcare across the nation. Apart from hospital services, pharmacies, diagnostic clinics, medical transcription services, nursing and hospital management colleges, third party administration and telemedicine, Apollo’s leadership and focus extends to all aspects of the healthcare spectrum.

Apollo Hospitals Apollo offers primary and secondary care facilities through point-of-contact medical services and healthcare prevention services in an in patient and outpatient setting in their diagnostic clinics. CII-McKinsey estimates that the total spending in primary market in India was approximately Rs 37,000 crore in 2001 while spending in secondary market is estimated at Rs 25,000 crore in 2001. And a huge growth potential remains untapped.

Exhibit 5: Clear focus on super-speciality and multi-speciality

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Super-Speciality Multi-Speciality Diagnostic Clinics


Apollo has established centres of excellence in a variety of medical disciplines – cardiology, oncology, orthopaedics, cosmetic and plastic surgery, critical care medicine and emergency and trauma care through their multi-speciality and super-speciality tertiary care hospitals which offer highly specialised and sophisticated medical care and surgical procedures in a primarily inpatient setting. CRIS-INFAC estimates that expenditure on tertiary care hospitals comprised approximately 15-20% of the total Rs 125,300 crore spending for healthcare delivery in India in 2006. According to CRIS-INFAC, this segment is expected to grow faster than the primary or secondary care segments because of an expected rise in complex lifestyles. Apollo hospitals have around 3800 super-speciality and multi-speciality beds owned by self or subsidiary/associate/ JV, which

Consistent growth in quality bed base

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are spread in metros, tier-I and tier-II cities, stand to gain the most with the expected increased demand in healthcare delivery market in India.

Ownership and operating models Apollo has 14 owned multi-speciality and super-speciality hospitals primarily in Chennai and Hyderabad and 4 owned diagnostic centres. Seven multi-speciality and super-speciality hospitals are owned through subsidiaries / associates / JV along with two diagnostic centres. Around 36% of Apollo Hospitals bed base is owned and operated by them while 25% of beds are owned through subsidiaries / JV / associate. Apart from the organic portfolio, Apollo has focussed to increase their presence across geographies, to cater to larger number of patients, through management contracts and franchise contracts they have entered over the years. By now Apollo hospitals has an impressive 1800 multi-speciality bed under management contract. Apollo hospitals have around 480 beds under franchise hospitals in Bangalore, Margoa and Indore.

Exhibit 6: Apollo Hospitals utilises organic as well as inorganic route to expand

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Equal weight of owned beds and beds through other arrangements under portfolio

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Pharmacy Apollo’s pharmacy business is the largest pharmacy chain in India, which adds to Apollo Hospitals’ brand value and recall rate. By FY07, Apollo had a network of 420 pharmacies with 44 out of the located in their hospitals and the balance as standalone outlets. Apollo runs pharmacies on a 24 hour basis on various locations in locations with high visibility and revenue potential. They offer a wide range of medicines, surgical, hospital consumables, health products and general ‘over-the-counter’ products. Going forward, Apollo plans to take the pharmacy count to 1,200 by 2010-11 through investment of around Rs 120 crore. Exhibit 7: Plans to extend pharmacy chain to 1200 outlets by FY10

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Hospital Pharmacy Standalone Pharmacy

Source: Company, ICICIdirect Research Consultancy

Apollo Hospitals also offers consultancy services which comprises of pre-commissioning consultancy services which includes feasibility study, strategic planning, infrastructure consultation, human resource recruitment and training and medical equipment consulting. Apollo also provides post-commissioning consultancy services which include management contracts, franchising and technical consultation. Fee for consultancy services are based on the scope of the services provided and the expected length of service. These services allow Apollo to capitalise on the learning and experience they have in the healthcare delivery and also tap the opportunities to spread inorganically while remaining asset light.

Aggressive expansion plans across spectrum

Apollo Hospital plans to expand organically as well as inorganically in their hospital business to take their bed base to more than 8500 by FY11. They already have significant presence in major circles except in the west where they have only one hospital in Ahmedabad. Apollo has formed JV to establish hospitals in Thane and Nashik. Also Apollo plans to deepen its reach in the south, which is fast emerging as a medical tourism hub, by embarking on new hospital projects in Vishakhapatnam. For an increased presence in eastern India, a new hospital in Bhubaneswar is being developed. Apollo has earmarked Rs 200 crore for hospital expansion and Rs 120 crore for expansion in pharmacy to 1200 outlets.

Pharmacy to increase from 420 in FY07 to 1200 by FY11

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Growth so far … Apollo Hospitals was incorporated by Dr Prathap Reddy in 1979 and began operations in 1983 with Apollo Chennai, the first corporate hospital to be set up in India. Since then, it has spread its presence across the healthcare value chain by venturing beyond into pharmacy, consulting, telemedicine and third party insurance. Apollo Hospitals also expanded inorganically through the hospital management & franchise model. The group is now a conglomerate with 26 owned, 9 managed and 3 franchise hospitals along with 2 technical consultancy agreements and 420 pharmacy outlets.

Exhibit 8: Expansion engine running overtime in 2000’s


1980’s 1983: Commenced operations with

Greams Lane, Chennai 1985: TCA with RMH Tiruvannamalai 1988: Jubilee Hills, Hyderabad

1990’s 1994: Nandanam, Chennai 1996: Hyderguda, Hyderabad 1996: Vikramapuri, Hyderabad 1996: Indraprastha, Delhi (Associate) 1996: Management of ARAM, Ranchi 1997: Apollo, Madurai 1998: Jehangir, Pune (Mgmt) 1998: NMDC, Bacheli (Mgmt) 1999: Apollo Heart & Kidney, Vizag

2000’s 2000: Thondiarpet, Chennai 2000: Kukatpally, Hyderabad 2000: Malakpet, Hyderabad 2000: Mehdipatnam, Hyderabad 2000: Apollo, Aragonda 2001: DRDO, Hyderabad 2001: Apollo, Bilaspur 2001: Apollo BGS, Mysore 2001: Apollo Heart & Kidney, Vizag 2001: Apollo, Indore (Franchise) 2002: PH Road, Chennai 2002: Apollo Gleneagles, Kolkotta (JV) 2002: Apollo Gariahat, Kolkotta (JV) 2002: Rajiv Gandhi, Raichur 2002: Sagar, Bangalore (Franchise) 2002: Apollo, Colombo (Franchise) 2003: Sowcarpet, Chennai 2003: Apollo, Ahmedabad (JV) 2003: Apollo KH, Ranipet (Mgmt) 2003: Apollo, Margoa (Franchise) 2004: City Centre, Ahmedabad (JV) 2004: TCA with Lagoon, Nigeria 2005: Apollo, Kakinada (Subsidiary) 2005: Apollo, Noida (Associate) 2005: Apollo SPS, Ludhiana (Mgmt) 2005: Apollo, Dhaka (Mgmt) 2005: St Johns, Chennai (Mgmt) 2006: Infosys, Mysore 2006: Apollo Pankaj, Agra 2007: Apollo, Bangalore (Subsidiary) 2007: Lalitha, Bangalore (Mgmt) 2007: Apollo BSR, Bhilai (Mgmt)

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Growth to come … Apollo Hospitals understands the huge demand opportunity that lies ahead in the healthcare sector and has proactively built capacity which is well diversified geographically.

Brownfield expansion To strengthen its position even further, Apollo has undertaken bed ramp-up activity where they are increasing the bed count in their existing hospitals. Such expansions are very economical as majority, around 70%, of the expenditure incurred in setting up a green-field hospital goes in for the land and medical equipments, which in such case are already present. Brownfield expansion gives the hospital additional capacity within a short time span too. Currently Apollo Hospitals has plans to increase the bed capacity in Chennai, Hyderabad, Aragonda, Bilaspur and Mysore hospitals.

Exhibit 9: More than 300 beds to be added in owned hospitals through ramp-up Location FY07 FY08E FY09E FY10E Chennai 984 1046 1076 1076 Hyderabad 569 669 669 765 Aragonda 42 54 54 54 Bilaspur 225 250 250 250 Mysore 167 176 176 176


Green-field expansion Apollo Hospitals also plans to increase their spread to reach more and more patients and thereby firm up their market position as leader in healthcare services in India. Apollo Hospitals has undertaken a Rs 200 crore capex to add a 220 bed multi-speciality hospital in Bhubaneswar and a 325 bed multi-speciality hospital in Vishakhapatnam. Both these hospitals are expected to commence operations by January 2009. Apollo has also entered into separate joint venture agreements to start a 200 bed hospital at Mauritius, a 100 bed hospital at Nashik and a 200 bed hospital at Thane. The Nashik hospital is expected to be operational in FY09 while Mauritius and Thane hospitals are expected to be operational in FY10.

Exhibit 10: Thousand beds to come by FY09 through projects underway Location Bed Base Expected Commencement Bhubaneswar 220 Q3FY09 Vishakhapatnam 325 Q4FY09 Mauritius (JV) 200 Q4FY09 Nashik (JV) 100 Q1FY09 Thane 200 Q4FY09


Brownfield expansion would help capture the increase in demand without heavy investment

New projects to increase the reach of Apollo Hospitals and drive revenues in future

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Inorganic expansion The hospital business is very capital-intensive with major investments required in infrastructure and medical appliances. Management contract of hospitals is one way of expanding brand reach without blocking funds in assets. In 1996, Apollo Hospitals ventured into the inorganic route of expansion through a management contract for 130 bed super-speciality ARAM Hospital, Ranchi. Since then almost every year they have been adding a hospital with 100 - 300 bed capacity to their managed/ franchise hospital portfolio. Currently, Apollo Hospitals has nine management contracts and three franchise hospitals with a total bed count of 1,665 and 480 respectively which contributed 13.8% to the gross revenues in FY07. Apollo Hospitals commenced operations of two managed hospitals in 2007 viz. 80 bed hospital in Bangalore and 150 bed hospital in Bhilai. Such addition in the managed bed category is expected every year and would be revenue accretive going forward.

Apollo has more headroom to play with revenue variables Apollo Hospitals is the single largest private player in the healthcare delivery segment currently and it would take quite some time for its competitors to catch up with Apollo in terms of capacity and geographical spread achieve by Apollo by being the first mover in the field. Although Apollo Hospital leads in term of hospital portfolio, bed base and revenues, they have not marked their revenue per bed aggressively. The strategy followed by Apollo works on volume base to increase occupancy rates with a lesser revenue per bed as against its competitors which work on a higher revenue per bed on a smaller bed base. This strategy, we believe, would benefit Apollo hospitals in times of increased demand when they would have a higher headroom to increase their per bed revenues and still remain competitive.

Added advantage from the announced five year tax holiday The Union Budget for 2008-09 had a pleasant news of a five year tax holiday for hospitals opened anywhere in India except urban agglomerations which commence operations between April 2008 and March 2013. Apollo Hospital’s ongoing projects in Bhubaneswar, Vishakhapatnam, Nashik and Bhilai are expected to benefit from this announcement. We expect Apollo Hospital to take maximum advantage of this rebate and announce their tier-I and tier-II plans with a target of commencement within the specified period. Generally, a green-field hospital takes two years to breakeven at EBIDTA level while cash break even takes another six months and book break even by four and a half years on an average. Thus the tax holiday would help green-field projects in a faster recovery thus would attract the much needed investment in the sector.

Medical tourism to provide further fillip Medical tourism has gained momentum over recent years and India is fast becoming a major medical tourism hub in the world. As governments worldwide grapple with soaring healthcare cost, the relative low cost of surgery and critical care in India is drawing the attention of global healthcare providers. Medical value travel contributes only 0.9% of the total hospital revenues. However, it is expected to become a US$1.4 billion industry and contribute more than 2.5% of the total hospital revenues by 2012. In 2006, around 180,000 to 200,000 international patients received medical treatment in India, up from approximately 10,000 in 2000.

India emerging as a medical tourism hub

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Exhibit 11: India's comparative cost advantage in medical tourism (in US$)

Procedure US insurer's cost US retail price India Thailand Singapore

Angioplasty 25,704 to 37,128 57,262 to 82,711 11,000 13,000 13,000

Gastric bypass 27,717 to 40,035 47,988 to 69,316 11,000 15,000 15,000

Heart bypass 54,741 to 79,071 122,424 to 176,835 10,000 12,000 20,000

Heart-valve replacement (single) 71,401 to 103,136 159,326 to 230,138 9,500 10,500 13,000

Hip replacement 18,281 to 26,407 43,780 to 63,238 9,000 12,000 12,000

Hysterectomy 9,591 to 13,854 20,416 to 29,489 2,900 4,500 4,500

Knee replacement 17,627 to 25,462 40,640 to 58,702 8,500 10,000 13,000

Mastectomy 9,774 to 14,118 23,709 to 34,246 7,500 9,000 12,400

Spinal fusion 25,302 to 36,547 62,778 to 90,679 5,500 7,000 9,000 Sources: Subimo (US rates, including at least one day of hospitalisation); PlanetHospital (international rates)

International patients choose India primarily because of the substantial difference in the cost of high-end surgery and critical care and quicker access to medical care vis-à-vis some highly developed countries. The cost of such medical care also compares favourably against costs of other more established medical tourism destinations like Thailand. Apollo Hospital stands to gain the most from the expected increase in medical tourism with around 1050 super-speciality beds in Chennai, 650 beds in Hyderabad and a substantial base in southern India, which is fast emerging as the medical tourism hub in India.

Rising penetration of health insurance ; An opportunity According to a 2002 Planning Commission report, less than 10% of India’s population is covered under some form of health insurance. Mediclaim penetration was only 1.6%, although the number of people with health insurance is increasing. The number of people covered under health insurance plans has increased from 4 to 5 million in 2001 to over 12 million in 2006. According to CRIS-INFAC, approximately 30% of the in-patients in private hospitals had insurance cover in 2006. Apollo Hospital seeing opportunity has signed a joint venture with DKV, a market leader in health insurance business in Europe, to invest upto 20% in Apollo DKV Insurance Company, to carry health insurance operations in India. Apollo DKV is in the process of obtaining certificate of registration before it commences business.

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RISKS & CONCERNS

Execution risk While Apollo Hospitals’ plans seem robust, timely execution would be a key variable. Any delay in the development of the upcoming hospitals would shift the revenue estimates downwards thereby affect the profitability. We believe growth will be propelled mainly through owned-hospitals and pharmacy chain. Any deviation in the company’s strategy of future developments and expansion would shift the profitability estimates forward.

Availability and retention of medical professionals With the surge in global demand for medical professionals, the attrition rate in the sector is expected to increase. This trend has posed crucial challenge to identify fresh talent, developing mechanics to train and retain them. Apollo hospitals has taken steps to mitigate this risk through putting medVarsity online backed by Apollo and NIIT which as a catalyst to students and is complimentary to existing study system.

Rapid technological advances The hospital sector is highly capital-intensive in nature, with 40-45% of the expenditure being incurred on equipment. The industry is characterised by frequent innovations and changing technology. Normally equipment is upgraded every 7-10 years, which requires cash inputs. Any frequent shift in technology and impairment of equipment would put a dent on the profitability.

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FINANCIALS Consistent top line growth across the business lines

Apollo Hospitals has shown a consistent growth in top line across the hospital, pharmacy and other businesses. During FY05-07, when the private healthcare sector gained substantial weight in the overall healthcare industry, Apollo Hospitals’ top line increased at a phenomenal 23% CAGR to Rs 949 crore in FY07 from Rs 632 crore in FY05. This growth was achieved through expansion of the pharmacy business which contributed Rs 131 crore in FY07 and commencement of Apollo Hospitals, Kakinada with 150 beds. Going forward, the increased demand in the tertiary care segment is expected to remain in the favour of Apollo. We believe Apollo will be booking a CAGR of 16% in top line between FY07-09 on the back of expansions in hospital bed base from 3.750 to 4,500 and increase in pharmacy outlets from 420 in FY07 to 850 by FY09. During FY07-10, Apollo is expected to witness a 20% CAGR growth in net sales (Rs 1187 crore in FY08, Rs 1278 crore in FY09, and Rs 1655 crore in FY10).

Exhibit 12: Apollo revenue to grow across Hospitals, Pharmacy & Others

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Bottom line to surge backed by margins expansion & low finance cost Apollo Hospitals has been steady improving its operating margins during FY05-07. Going forward, we expect the company to optimise on its resources by increasing capacity in existing hospitals, sharing of doctors amongst hospitals in the same city. We believe with increased demand for better medical services in the tertiary segment, where Apollo has major presence, would help it garner better average revenue per occupied bed (ARPOB) from Rs 27 lakh in FY07 to Rs 33 lakh in FY10 at an increased bed base. We believe with increased focus on super-speciality hospitals and tertiary care segment, Apollo has a huge margin for hiking its revenue per bed, which is significantly lower than its competition. We expect net profits to surge at a 37% CAGR during FY07-09 to Rs 121 crore in FY09E from Rs 64 crore in FY07 (excluding extraordinary income from sale of Colombo hospital) and at a 34% CAGR during FY07-10E to Rs 155 crore in FY10E on the back of launch of Apollo hospitals in Bhubaneswar and Vishakhapatnam and room expansions in Apollo Hyderabad.

20% CAGR in top line

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Exhibit 13: Increase in EBIDTA contributed by control over employee cost & increase in revenue

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Efficient working capital management Apollo Hospitals has managed its working capital requirements efficiently which is indicated by its current ratio which is expected to be in the range of 1.69-1.71 in FY08. Also Apollo Hospitals manages its creditor and debtor efficiently with their respective periods for FY08E and FY09E at 40-45 and 40-42 and a creditor to debtor ratio of 0.5 helps Apollo in maintaining its working capital requirements. This enables Apollo Hospitals to work on comfortable level of liquidity required for short term requirements. The liquidity leeway enjoyed by Apollo Hospitals would act as a buffer for the company in tough times of aggressive expansions.

Exhibit 14: Trends of current ratio & creditor to debtor ratio indicate efficient working capital

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Returns remain capped in medium term, improvement post FY09E Healthcare is a capital-intensive industry and does not experience high return ratios. Share of investment into medical equipments and land is as large as 70% for Apollo. Due to competitive forces, Indian demography and the fact that 82% of the healthcare spending comes from private out-of-pocket funding, a substantial increase in revenue per bed per day is not feasible in the short term thereby limiting the increase of asset turnover ratio. In FY09 we expect bed expansions in the existing facilities and the launch of new projects would result in a slight dip in occupancy leading to an asset turnover ratio of 1.07 which we expect to improve in FY10 to 1.24 on the back of better asset utilisation. Consequently till FY09 returns would remain capped with ROE in the range of 8.6%-9% and ROCE in the range of 9.5%-10%. Post the improvement in asset turnover in FY10 we foresee an improvement in ROE to 9.6% in FY10 and ROCE to improve to 11% in FY10E.

Exhibit 15: Returns to jump post FY09E once asset turnover improves

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Hospital Bed-base

Owned Hospitals FY07 FY08E FY09E FY10E Chennai Apollo Hospitals Greams Lane 610 619 619 619 Apollo Speciality Hospital, Nandanam 224 262 262 262 Apollo hospitals Thondiarpet 48 60 60 60 First Med Hospital PH Road 85 88 118 118 Apollo Hospitals Sowcarpet 17 17 17 17 Hyderabad Apollo Hospitals Jubilee Hills 309 384 384 480 Apollo Emergency Hyderguda 41 46 46 46 Apollo Emergency Medical Centre Kukatpally 10 20 20 20 Apollo DRDO 125 125 125 125 Apollo Centre Vikramapuri 76 86 86 86 Apollo Emergency Medical Centre Malakpet 4 4 4 4 Apollo Emergency Medical Centre Mehdipatnam 4 4 4 4 Madurai Apollo Hospitals 165 165 165 165 Vizag Apollo Heart & Kidney Hospital 65 65 65 65 Aragonda Apollo Hospitals 42 54 54 54 Bilaspur Apollo Hospitals 225 250 250 250 Mysore Apollo BGS Hospitals 161 170 170 170 Apollo BGS Medical Centre at Infosys campus 6 6 6 6 Bhubhaneswar 220 Vishakhapatnam 325 Total Owned Hospital Beds 2217 2425 2455 3096 Hospitals under Subsidiaries Apollo Hospitals Kakinada 150 150 150 150 Apollo Hospitals Bangalore 250 250 250 Apollo Reach 150 300 Hospitals under JV Apollo Gleneagles Hospitals Kolkotta (AGHL) 325 325 325 325 Apollo Clinic, Gariahat Kolkotta (AGHL) 8 8 8 8 Apollo Hospitals Ahmedabad(AHIL) 300 300 300 300 Apollo Hospitals - City Centre Ahmedabad (AHIL) 20 20 20 20 Mauritius 200 Nashik 100 100 Thane 200 Hospitals under Associates Apollo Hospitals Delhi (IMCL) 632 632 632 632 Apollo Hospitals Noida (IMCL) 100 100 100 100 Managed Beds 2445 2675 2675 2675 Total Hospital Beds 6197 6885 7165 8356

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VALUATIONS India is under-serviced as far as healthcare services. With the huge expected demand in the tertiary care segment, along with the changes in demography, we expect Apollo Hospitals would benefit the most in the long-term from its pan India presence with multi-speciality and super-speciality facilities. We expect the company to maintain its average occupancy rates in excess of 70% on an extended room base and increase its revenue per bed steadily.

On an EV/EBIDTA valuation, Apollo Hospitals is valued at 14.8x in FY08E. Going forward, an EV/EBIDTA of 14.3x in FY09E is the cheapest amongst competitors while 11.7x in FY10E looks very compelling at current levels. By discounting FY10 earnings by 14x, its lowest ever EV/EBIDTA, we arrive at Rs 594 per share valuation.

Exhibit 16: EV/EBIDTA band

10x

14x

18x

22x

0

1000

2000

3000

4000

5000

6000

Apr-05

Jun-05

Sep-05

Dec-05

Mar-06

Jun-06

Sep-06

Dec-06

Mar-07

Jun-07

Sep-07

Dec-07

Mar-08

Source: ICICIdirect Research

On EV/Sales basis, Apollo Hospital looks undervalued at current levels trading at 2.2x and 2x FY08 and FY09 net sales. While a multiple of 1.8 of FY10 sales it looks attractive. By discounting FY10E sales by an EV/Sales multiple of 2.4, we arrive at per share value of Rs 611.

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Exhibit 17: EV/Sales band

2.2x

2.6x

3.0x

3.4x

1000

2000

3000

4000

Apr-0

5

Jun-

05

Aug-

05

Oct-0

5

Dec-

05

Feb-

06

Apr-0

6

Jun-

06

Aug-

06

Oct-0

6

Dec-

06

Feb-

07

Apr-0

7

Jun-

07

Aug-

07

Oct-0

7

Dec-

07

Feb-

08


Our Discounted Cash Flow (DCF) valuation gives a value of Rs 593 to the stock. We have assumed terminal growth rate at 2.5%. Risk free rate of return is 7.7% while market rate of return is taken as 15%. WACC works out to be 10.57%.

Exhibit 18: Discounted Cash Flow

Year Ending 31 March 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Number of Owned Beds 2425 2455 3096 3116 3266 3516 3666 3916 4066 4316 Number of Pharmacy 596 800 1000 1200 1200 1300 1400 1450 1550 1600 Total Revenue 1186.92 1287.70 1665.48 1922.54 2023.45 2271.16 2509.80 2804.25 3254.74 3686.61 EBIDTA 206.36 231.14 286.35 398.73 412.78 463.32 537.10 600.11 696.51 825.80 Interest 32.10 33.05 32.10 27.52 25.05 21.53 19.70 18.02 15.52 14.28 Depreciation 44.22 51.72 61.22 52.16 54.55 54.82 57.08 57.23 59.37 58.90 PBT 151.54 169.28 216.68 343.42 359.56 415.34 490.69 557.23 656.00 789.00 Tax 45.46 48.08 62.02 106.46 111.46 128.76 152.12 172.74 203.36 244.59 PAT 114.66 130.23 164.59 247.89 260.12 299.81 353.13 400.49 470.24 563.77 FCF -33.83 86.24 82.52 201.49 199.53 257.48 274.41 353.55 362.04 507.89 NPV 3789.71 Equity Share Value 593.43


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Exhibit 19: Apollo trading at attractive PE levels

28x

20x

22x

24x

26x

300

350

400

450

500

550

600

Apr-0

6

Jun-

06

Aug-

06

Oct-0

6

Dec-

06

Feb-

07

Apr-0

7

Jun-

07

Aug-

07

Oct-0

7

Dec-

07

Feb-

08


We expect Apollo to firm up its market leader position by ongoing expansions and would simultaneously be able to expand returns with improving revenue per bed along with strong occupancy levels. Our outlook on the healthcare delivery sector remains positive. At the current price of Rs 480, the stock is trading at 24x its FY09E EPS of 20 and at 19x its FY10E EPS of 25. We believe that the current levels are very attractive and arrive at our target price of Rs 593 through a DCF valuation. We rate the stock an OUTPERFORMER.

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FINANCIAL SUMMARY

Profit & Loss Rs Crore Y/e March FY07 FY08E FY09E FY10E Net Sales 949.45 1186.92 1278.68 1655.54 YoY Growth(%) 25.0% 25.0% 7.7% 29.5% Other Income 7.15 21.50 22.91 23.65 Expenses Employee Cost 142.19 171.08 187.06 250.05 % of NS 15.0% 14.4% 14.6% 15.1% Material Consumed 487.04 593.46 639.34 827.77 % of NS 51.3% 50.0% 50.0% 50.0% Power & Fuel 22.78 23.74 25.57 33.11 % of NS 2.4% 2.0% 2.0% 2.0% Other Operating 2.70 14.24 12.79 19.87 % of NS 0.3% 1.2% 1.0% 1.2% Admin & Others 142.69 178.04 191.80 248.33 % of NS 15.0% 15.0% 15.0% 15.0% Total Expenses 797.39 980.56 1056.56 1379.13 EBIDTA 152.06 206.36 222.12 276.41 YoY Growth(%) 24.7% 23.0% 7.8% 30.5% % of NS 16.0% 17.4% 17.4% 16.7% Depriciation 40.75 44.22 51.72 61.22 Interest 27.01 32.10 33.05 32.10 PBT 122.43 151.54 160.26 206.75 Tax 32.56 45.46 48.08 62.02 Share in profit/( loss) of associates 5.49 8.59 9.02 9.94 PAT 95.36 114.66 121.20 154.66 % of NS 10.0% 9.7% 9.5% 9.3%


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Balance Sheet Rs Crore Y/e March FY07 FY08E FY09E FY10E Sources of Funds Equity Capital 51.64 58.69 60.24 61.78 Pref. Share Capital 0.00 0.00 0.00 0.00 Reserves & Surplus 702.44 1209.35 1356.19 1550.36 Networth 754.08 1268.03 1416.42 1612.13 Total Debt 357.91 337.91 378.70 368.70 Minority Interest 34.18 34.18 34.18 34.18 Deferred Tax 59.40 63.95 68.76 74.96 Total Liabilities 1205.57 1704.07 1898.05 2089.96 Application of Funds Gross Block 834.30 884.30 1034.30 1224.30 Less: Acc. Depreciation 237.22 281.44 333.15 394.37 Net Block 597.08 602.86 701.15 829.93 Capital WIP 184.48 334.48 284.48 214.48 Investments 255.12 555.12 705.12 755.12 Current Assets 415.88 515.87 548.10 696.57 Less: Current Liabilities & Provisions 247.76 305.04 341.56 406.91 Net Working Capital 168.12 210.84 206.54 289.66 Misc. Exp not w/o 0.78 0.78 0.78 0.78 Total Assets 1205.57 1704.07 1898.06 2089.97 Source: Company, ICICIdirect Research

Cash Flow Rs Crore Y/e March FY07 FY08E FY09E FY10E Opening Cash 53.12 70.60 86.21 85.22 Profit After Tax 95.36 114.66 121.20 154.66 Depreciation 40.75 44.22 51.72 61.22 Provisions & Others 19.50 -29.26 -29.90 -29.39 Cash Profit 155.62 129.61 143.02 186.48 Changes in WC Net Increase in CL 10.57 57.28 36.53 65.34 Net increase in CA 74.83 84.38 33.22 136.42 Cash Flow after change in working capital 91.35 102.51 146.33 115.40 Capex & Other Investing Activities -126.44 -500.00 -250.00 -170.00 Cash Flow after investing activity -35.09 -397.49 -103.67 -54.60 Proceeds from financing actvity 52.57 413.10 102.68 66.64 Cash Flow after financing activity 17.48 15.61 -0.99 12.05 Net Cash inflow 17.48 15.61 -0.99 12.05 Closing Cash 70.60 86.21 85.22 97.26 Source: Company, ICICIdirect Research

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Ratio Analysis Y/e March FY07 FY08E FY09E FY10E Margins (%) EBIDTA 16.0% 17.4% 17.4% 16.7% PAT 10.0% 9.7% 9.5% 9.3% Asset based ratios (%) RONW / ROE 12.6% 9.0% 8.6% 9.6% ROCE / ROI 10.0% 10.1% 9.5% 10.9% Gearing Debt / Equity 0.47 0.27 0.27 0.23 Per Share (Rs) Earnings 18.47 19.54 20.12 25.04 Book Value 146.03 216.07 235.15 260.97 Cash EPS 24.22 29.69 31.39 39.55 Turnover (Days) Asset 1.00 1.03 1.07 1.24 Inventory 13.48 13.32 13.33 13.44 Debtor 8.72 8.70 8.70 8.70 Creditor 6.10 8.00 9.09 11.11 Valuations (x) P / E 26.89 24.60 23.89 19.20 P / BV 3.40 2.22 2.04 1.84 M.Cap / Sales 2.61 2.38 2.26 1.79 EV / EBIDTA 18.21 14.89 14.36 11.72 EV / Sales 2.92 2.59 2.49 1.96 Market Cap. (Rs Crore) 2482.01 2820.72 2895.22 2969.24 EV (Rs Crore) 2769.32 3072.43 3188.71 3240.68 Du Pont Analysis PAT/PBT 0.78 0.76 0.76 0.75 PBT/EBIT 0.82 0.83 0.83 0.87 EBIT/Sales 0.16 0.15 0.15 0.14 Sales/Assets 1.00 1.03 1.07 1.24 Assets/Equity 1.26 0.91 0.84 0.83 Source: Company, ICICIdirect Research

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RATING RATIONALE

ICICIdirect endeavours to provide objective opinions and recommendations. ICICIdirect assigns ratings to its stocks according to their notional target price vs current market price and then categorises them as Outperformer, Performer, Hold, and Underperformer. The performance horizon is 2 years unless specified and the notional target price is defined as the analysts' valuation for a stock.

Outperformer: 20% or more; Performer: Between 10% and 20%; Hold: +10% return; Underperformer: -10% or more.

Harendra Kumar Head - Research & Advisory [email protected] ICICIdirect Research Desk, ICICI Securities Limited, Mafatlal House, Ground Floor, 163, H T Parekh Marg, Churchgate, Mumbai – 400 020 [email protected]

Disclaimer The report and information contained herein is strictly confidential and meant solely for the selected recipient and may not be altered in any way, transmitted to, copied or distributed, in part or in whole, to any other person or to the media or reproduced in any form, without prior written consent of ICICI Securities Ltd (I-Sec). The author of the report does not hold any investment in any of the companies mentioned in this report. I-Sec may be holding a small number of shares/position in the above-referred companies as on date of release of this report. This report is based on information obtained from public sources and sources believed to be reliable, but no independent verification has been made nor is its accuracy or completeness guaranteed. This report and information herein is solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments. Nothing in this report constitutes investment, legal, accounting and tax advice or a representation that any investment or strategy is suitable or appropriate to your specific circumstances. The securities discussed and opinions expressed in this report may not be suitable for all investors, who must make their own investment decisions, based on their own investment objectives, financial positions and needs of specific recipient. This report may not be taken in substitution for the exercise of independent judgement by any recipient. The recipient should independently evaluate the investment risks. I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of the use of this report. Past performance is not necessarily a guide to future performance. Actual results may differ materially from those set forth in projections. I-Sec may have issued other reports that are inconsistent with and reach different conclusion from the information presented in this report. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject I-Sec and affiliates to any registration or licensing requirement within such jurisdiction. The securities described herein may or may not be eligible for sale in all jurisdictions or to certain category of investors. Persons in whose possession this document may come are required to inform themselves of and to observe such restriction.

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