Apollo Hospitals: Correction a good entry point

With concerns overdone on rupee depreciation, growth will be boosted by robust expansion plans, indicating strong prospects

The Apollo Hospitals Enterprise stock has underperformed the Sensex since mid-May, due to concerns over margins and the rupee's depreciation. From a 52-week high of Rs 1,096.15 on May 17, it is down to Rs 896. However, analysts believe the concerns are overdone and given its vigorous expansion plans, the correction is a good entry opportunity for medium-term investors. At current levels, the valuations are also reasonable, as the stock is quoting at the lower end of the price/earnings band seen in the past four years. The company added 436 beds in FY10-13. Expansion is to be at a much larger pace, of 2,685 beds in FY13-16, a compounded annual growth rate of almost 10 per cent. In the pharmacy business, too, with a thrust on profitability and the aim of adding around 200 stores a year from the 1,526 as on June 30, the outlook is positive.

The aggressive expansion had taken some toll on margins (increase in fixed costs due to new capacity) in the past two quarters. Notably, these are estimated to improve in the second half of FY14, once occupancy improves at the commissioned beds. Also, as the cost of foreign currency debt is under control (and hedged), and costs of imported consumables sold at pharmacies are a pass-through, currency-related worries will ease, say analysts. The consensus one-year target price for the stock by Bloomberg data is Rs 1,009 (16 analysts polled since August), indicating potential upside of 13 per cent. Recently, reports suggested Apollo plans to set up a business trust to hold some of its property assets, to eventually be listed on the Singapore exchange. The unconfirmed news is that the plan would help raise $400 million (Rs 2,500 crore). Since the business is capital-intensive, this will help the company fund its aggressive expansion plan.

Even without such plans, it is poised to meet the capex requirement. While the debt to equity ratio was 1.3 at the end of FY13, analysts estimate it will generate net cash from operating activities of around Rs 440 crore. They believe the company can comfortably meet its capex of  Rs 400-500 crore in FY14 without further stretching its balance sheet. And, as the new capacities go on stream, the cash flows should only increase. The company commissioned 340 beds in the March quarter, 200 at its multi-speciality hospital at Aynambakam in Chennai and another 140 at its ortho & spine speciality hospital in Bangalore. And, entered into a long-term lease with the Lifeline Hospital facility in south Chennai (170 beds). So, fixed costs increased. With occupancy low, the margins slipped, albeit marginally, from an average of 16.1 per cent in FY13 to 15.7 per cent in the past two quarters. However, these are estimated to improve slowly from the second half of FY14.

Margins will also get a boost from the fast-growing pharmacy business. Revenue here had grown 23 per cent year-on-year in the June  quarter, to Rs 304 crore. Its Ebitda margins were three per cent in the quarter, up 49 basis points (bps) year-on-year, driven by an increase in same-store sales, buying efficiencies and the benefit of operating leverage. Analysts at HSBC forecast a 400 bps improvement in margins over two years (for the pharmacy business), with the number of stores reaching 1,800 by FY15. Also, over the medium term, the management might decide on divesting part of its stake or bringing a strategic partner in the pharmacy business, which should help raise funds to fuel growth and boost the stock valuations.

On the rupee's depreciation, while many consumables are imported in the pharmacy business, a large part is a "direct pass-through" to customers. Analysts at Citi observe Apollo raised prices around five per cent from September and add that if the recent reversal in the rupee's weakness holds, Apollo will gain on a net basis. On foreign currency debt of $90 million, the cost of debt (loaded for hedges) is comfortable at 9-9.5 per cent, they add.

Riding on its stronghold in healthcare and as a natural extension, the company is slowly venturing into related areas. This month, it launched its first advanced fever clinic in Chennai and plans to open 10 more by end-FY14. With about four 'Cradle' (baby delivery) centres, Apollo Health & Lifestyle,  a subsidiary, is aiming to add 36 centres in the next four to five years. All this should add to the growth rates in the long run.