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Healthcare

Hospitals

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Global Research

India Hospitals

India's health gap

HSBC India Hospitals coverage

Ticker

Company

Rating

TP

Price

EV/EBITDA

PE

Potential

 

(INR)

(x)*

(x)*

return (%)*

APHS IN

Apollo Hospitals

OW

796

650

13.9

32.6

22.9

FORH IN

Fortis Healthcare

N

115 107.5

12.9

50.1

6.5

Note: * EV/EBITDA and PE for FY13, PE and Potential return based on 5 Jul 2012 closing price. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield. Source: HSBC estimates, DataStream

9 July 2012

Girish Bakhru*, CFA

Analyst HSBC Securities & Capital Markets (India) Private Limited

+91 22 2268 1638

girishbakhru@hsbc.co.in

Damayanti Kerai*

Associate

Bangalore

View HSBC Global Research at: http://www.research.hsbc.com

*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations

Issuer of report:

HSBC Securities and Capital Markets (India) Private Limited

Disclaimer & Disclosures

This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it

India is substantially underinvested in healthcare with 17% of the world’s population but only 6% of the beds

Meagre public healthcare spending in India presents a big investment opportunity for private players

Initiate coverage on Apollo (OW) and Fortis (N)

Huge demand-supply mismatch: At 0.9 beds per 1,000 people, India ranks low among emerging nations in healthcare provision, even though it carries 20% of the global disease burden. Increasing affluence, changing demographics and shifting lifestyle-driven disease patterns support growth. The investment opportunity for private players is huge in our view, given public participation is low and out-of-pocket spend is as high at 80%.

Significant capacity in pipeline: Leading players Apollo and Fortis plan to cumulatively add 5,000 beds by FY15 (51% of their current combined capacity). We expect industry margins to remain flat despite significant new capacity addition, thanks to improving returns from mature beds and a continued focus on improving occupancy, case mix and turnover.

Existing challenges thriving new delivery models:

Shortage of skilled medical personnel, increasing real estate costs and emergence of new entrants despite significant entry barriers have compelled Apollo and Fortis to diversify. Apollo’s low-cost REACH hospitals and Fortis’s foray into overseas markets and new service segments are new, developing business models.

Initiate OW on Apollo Hospitals, N on Fortis Healthcare.

We initiate coverage on Apollo with an OW rating on the back of the strong growth in its hospital business, increasing contribution from pharmacy and adequate funding for expansion. Any potential strategic tie-up in pharmacy could act as a near-term share price catalyst. On the other hand, we expect near-term earnings for Fortis to remain under pressure given its high interest burden after its overseas expansion. While its growth in India is strong, its international prospects are uncertain.

www.asiamoney.com/survey/takesurvey/en/BP12/

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Apollo and Fortis at a glance

Parameters

Apollo Hospitals

Fortis Healthcare

Bloomberg ticker

APHS IN

FORH IN

Shareholding pattern

Promoter (33.10%), FII (40.04%), DII (2.40%), Others (24.46%)

Promoter (81.48%), FII (4.96%), DII (0.83%), Others (12.73%)

Market cap (USD m)

1,623

801

52 week high/low (INR)

716.9/452.2

171.5/81

Rating

OW

N

Target price (INR)

796

115

Price (INR)

650

107.5

Potential return (%)

22.9

6.5

ROE (FY13e)

10.4%

2.6%

Net Debt/Equity (FY13e)

0.2

1.5

3-year sales CAGR (FY12-FY15e)

21.8%

33.0%

3-year PAT CAGR

29.6%

47.2%

Sales mix

Standalone hospitals: 62%, Retail pharmacy: 27%, JV/subsidiaries: 11%

India: 50%, Australia & NZ: 31%, Hong Kong :15%, Vietnam: 3%, Dubai: 1%

Operational parameters

Number of hospitals

51

75 (68 in India)

Employees

>16,000

>23,000

Doctors network

>4,000

>3,900

Beds operational

5,153

3,985 (doesn’t include international beds)

Owned beds

5,888

2,985 (doesn’t include international beds)

Beds in pipeline

2,955

3,165

Total bed network

10,731

12,325 (including 1,500 beds in international locations)

CoE (%)

65%

65-70%

Average Revenue per Operating Bed (ARPOB) (INR/day)

20,455 (net of doctor fees)

25,479

Average Length of Stay (ALOS) (days)

4.78

4.00

Occupancy (%)

71

73

In-patient admissions

281,020

276,983*

Out-patient visits

2.31mn

NA

Revenue per adjusted patient admissions (INR)

77,745

NA

Key positives

Leadership position in private healthcare in India, strong brand equity

Second largest private healthcare player in India after Apollo; strengthened its domestic position

Strong established presence in Chennai and Hyderabad with improving mix resulting in growth in ARPOBs Largest player in organized retail pharmacy in India, key beneficiary of FDI in retail

through aggressive acquisitions – Escorts, Wockhardt, Malar, SRL Entry to diagnostic business and international markets provide good diversification

Key negatives

Concentration of revenue in Chennai and Hyderabad cluster (c55% of total healthcare service revenues), increasing competition and

Leverage is high especially after acquisition of international assets and return ratios are lowest among peers in Asia

other operational issues can impact the overall company performance Pharmacy is a drag on overall margins

Lack of experience in greenfield operations given large part of growth is driven by acquisitions Risk of execution given entry into international markets where Fortis has less experience

Key catalysts

Margin expansion in pharmacy business, Increasing occupancy at Hyderabad cluster, quick ramp up in new beds – esp. under Mumbai cluster

Listing of clinical establishments REIT, commencement of operations at Fortis colorectal hospital Singapore, recovery of margins in SRL diagnostic business

Note: Potential return based on 5 Jul 2012 closing price. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield. Source: Company data, HSBC estimates

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Hospitals 9 July 2012

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Contents

Investment summary

Structural deficiencies Healthcare: An emerging private affair What we look for in hospitals Initiating coverage

Valuation and performance India healthcare overview

Healthcare infrastructure inadequate in India Key drivers Key hurdles

Company profiles Apollo Hospitals (APHS)

Leader in private healthcare Financials & valuation:

Hospital business brings in 75% of revenue Apollo Hospitals: Operating metrics Retail pharmacy at inflection point Other ventures Earnings CAGR over 20% Balance sheet is healthy Key downside risks Initiate as OW, TP of INR796

4

4

5

7

9

10

13

13

15

19

23

24

24

25

27

32

34

36

37

37

38

39

Fortis Healthcare (FORH)

44

Pan-Asia branding

44

Financials & valuation:

45

Pan-Asia focus

47

India hospital business

50

Diagnostic business

53

International businesses

56

Sales growth on consolidation

59

Balance sheet is stretched

60

Key downside risks

60

Key upside risks

61

Initiate as N, TP INR115

61

Key metrics overview

65

Basic operating metrics

65

Appendix

68

Healthcare snapshot in India

68

Differentiation among hospitals

69

Budget 2012-13 highlights

70

Healthcare in 12th Five-year Plan

70

History of private equity deals in India’s healthcare sector 72

India physician and nursing density well below world average

73

Healthcare infrastructure in India

74

Disclosure appendix

77

Disclaimer

79

technicians

workers

Health

Lab

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Hospitals 9 July 2012

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Investment summary

Structural healthcare deficiencies and rising healthcare spend suggest growth among private players is sustainable Significant capacity expansion over the next decade and new business models also contribute to growth among private players While there are number of challenges and risks, high entry barriers favour incumbents such as Apollo and Fortis

Structural deficiencies

Low on supply

While the healthcare delivery market is huge (USD60bn in 2010) and has been growing at a c12% CAGR (over2007-2010), investment in the industry has lagged significantly behind. Public participation has been poor, with more than 75% of overall investment in healthcare coming from the private sector (one of the highest rates in the world).

Despite a large share (c50%) of hospitals overall healthcare market, the infrastructure in terms of number of hospitals, beds and medical personnel is far below the world average. India only has 9 beds per 10,000 people, versus the US (31 beds) and the world average (29 beds). This is despite India carrying a higher share of the world’s total disease burden (at 20%).

We estimate c60% of India’s c30,000 hospitals are private and c45% of hospital beds are private. We believe this ratio would be even higher if we look at beds only in tertiary care, given public healthcare infrastructure is currently oriented to primary and secondary needs.

India accounts for 20% of global disease burden while its share of health infrastructure is inadequate
India accounts for 20% of global disease burden while its
share of health infrastructure is inadequate
25%
20%
20%
15%
8%
8%
10%
6%
5%
0%
Source: Fortis Healthcare
Disease
burden
Beds
Doctors
Nurses

9%

1%

Numbers of hospitals and hospital beds in India

Attribute/Year

1981

1991

2001

2010*

No. of Hospitals No. of private hospitals % in private sector No. of beds No. of private beds % in private sector

6,805

2,926

43

504,538

141,271

28

11,571

6,595

57

806,409

258,051

32

15,622

11,404

73

29,760

17,000

57

903,952 1,048,715

343,501

38

471,922

45

Note: * 2010 numbers are extrapolated numbers Source: Directorate General of State Health Services, India

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In-patient and out-patient revenues in India are expected to grow significantly

In-patient INR bn 1,000 2,000 3,000 4,000 5,000 6,000 2018e Out-patient 0 2013e 2008 1,802 903
In-patient
INR bn
1,000
2,000
3,000
4,000
5,000
6,000
2018e
Out-patient
0
2013e
2008
1,802
903
1,175
787 3,205
1,745
Out-patient:8%
In-patient: 14%
2008-18 CAGR

Source: CRISIL

High in demand

Some of the key factors driving growth in demand for healthcare services include:

Rising income levels: increasing affordability and awareness for quality treatments

Changing demographics: increasing proportion of elderly who have more healthcare needs

Changing disease profile: higher incidence of cardiac ailments, diabetes and other lifestyle-related medical disorders that require more hospitalization

Medical tourism: low cost quality treatment makes India a favoured destination

Increase in health insurance: increasing insurance penetration increases affordability

It is estimated that the overall healthcare market will reach cUSD80bn by 2015 (source: CRISIL), the majority of which will be in-patient revenues. Currently cINR250bn worth of spending is on in- patient services and the majority (c60%) of healthcare spending is out-patient; this which indicates healthcare affordability remains low and disease patterns are still dominated by acute infections. We believe with an increased share of lifestyle disorders and improving affordability

among middle class, the in-patient revenues will be a key growth driver within healthcare services.

Importantly, we believe the rise in demand will

largely benefit private players given their stronger

brands and focus on higher successful outcomes

(which are benchmarked against developed world

healthcare).

Healthcare: An emerging private affair

India’s national healthcare spending is 4.1% of

GDP (source: World Bank 2010), which is among the lowest rates in the world. As a result, quality healthcare has increasingly fallen into the hands of private players. Over the last two decades, a large number of tertiary care hospitals within the public sector have faced a resource crunch resulting in an inability to maintain quality service.

This along with increasing affordability, growing demand for complex diagnostic and therapeutic treatments and increasing awareness has increased the preference for private hospitals.

USD160bn investment opportunity and largely private

Given India’s current low global ranking in terms of the ratio of hospital beds to population, we believe there is a huge investment opportunity.

Assuming the population continues to grow at the current rate, India needs to add c930,000 beds by 2020 to improve its bed to population ratio to just 15 beds per 10,000 people. This would require an additional investment of cUSD52bn assuming a bed costs USD50,000. We believe 30% of additions will be required for complex medical treatments in cardiac, oncology and transplant therapies. To reach the global average of 30 beds per 10,000 people, we calculate India would need to invest to cUSD160bn in hospital healthcare.

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Crucially, we believe the investment opportunity will continue to fall largely in the hands of private players given the low government participation.

Huge investment opportunity towards goal of meeting global average beds per population

Advantage to Apollo and Fortis

Given the high initial set-up costs, long gestation periods and continuing challenges in terms of the

shortage of skilled medical personnel and

continual change in medical technology, the

Current population

1,200m

barriers for entry to healthcare provision in India

Growth rate assumption

1.25-1.3%

are high.

2020e population

1,325m

Per bed development cost

INR2.5mn or cUSD50,000

Existing players including Apollo and Fortis have

Target no. of beds per 10,000 people

already achieved the following:
15

20

25

30

Additional no. of beds

932

1,594

2,256

2,918

Established a presence in “hot-spots”

required (‘000) Additional investment

  • 52 89

125

162

including metros across the country.

required (USDbn)

Utilized their early-mover advantage to create

Source: HSBC estimates

Both Apollo and Fortis have been aggressive in

sizeable capacity and reach and establish brand equity that defines quality healthcare

expanding bed capacity. Apollo aims to add c40% of current bed capacity in the next three years which would take its owned beds to over 8,500. The Fortis model has been more acquisition

Established an ability to attract and retain strong medical talent which we believe is critical to success of a hospital

driven and share of greenfield projects may

Reached a stage of reaping significant cash flows from mature beds

slowly increase. The group has widened its network to 75 hospitals and over 12,000 beds including acquisition of assets under FHIL (Fortis Healthcare International).

We believe it will be difficult for new players to establish a significant presence in tertiary care in major Indian markets, like the large cities, in light of the above.

Apollo and Fortis - Stock performance against HSBC Drug Index and Sensex

0 50 300 250 200 150 100 Oct-07 Apr-12 Apr-10 Apr-08 Apr-09 Apr-11 Oct -10 Oct-08
0
50
300
250
200
150
100
Oct-07
Apr-12
Apr-10
Apr-08
Apr-09
Apr-11
Oct -10
Oct-08
Oct-09
Jan-10
Jan-08
Jan-09
Jan-12
Jan-11
Oct-11
Jul-07
Jul-10
Jul-09
Jul-12
Jul-08
Jul-11
HSBC Drug Index
Apollo
Sensex
Fortis

Source: DataStream

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What we look for in hospitals

Balanced capacity expansion and higher proportion of younger beds

The growth in the hospital industry hinges on new beds. We prefer operators with a planned gradual build-up of capacity and a portfolio of hospitals with a larger proportion of younger beds (under three years since development and acquisition), which provide margin enhancement opportunities.

Improving or stable returns on capital

While most of the hospital industry suffers from low returns due to its capital intensive nature, we prefer organizations that have a history of generating higher returns on incremental investments and/or are exhibiting meaningful improvement in their ratios as most facilities mature in the portfolio. Typically a tertiary bed can generate over 25% operating margin from the fifth year of operation with the peak at c30%.

Lower gearing and exposure to bad debt

Given the capital intensive nature of the hospital business, companies with easier access to new capital have an advantage. We believe exposure to bad debt is an issue to consider when evaluating hospitals. Given the relatively high share of out- of-pocket expenses in the country, the exposure to bad debt has so far been low.

Portfolio end-market characteristics

We prefer high exposure to local markets that operate with significantly higher ARPOBs (lesser competition), higher affordability (higher per capita disposable income) and have reasonably strong in-patient and out-patient volume. We believe characteristics of markets that hospitals operate in can greatly affect financial and operational performance of the overall business.

Net debt/EBITDA comparison

Company

FY12

FY13e

FY14e

FY15e

Apollo

1.0

0.7

0.8

0.6

Fortis

11.4

6.6

5.9

5.2

Bumrungrad

1.3

0.8

0.7

Tenet

4.0

3.6

3.3

3.0

Lifepoint

2.7

2.6

2.3

2.3

Health South

2.6

2.5

2.1

2.1

Universal health

4.0

2.6

2.1

1.9

Source: Datastream, Company data

 

ROE comparison for key hospitals

 

35

30

 

Bumrungrad

25

25

20

Univ ersal Health

 

Tenet

15

Raffles

Raffles

10

Apollo Lifepoint
Apollo
Lifepoint

5

Fortis
Fortis

0

FY12

FY13e

FY14e

FY15e

Source: Datastream, Company data

 

Geographical distribution of facilities for Apollo and Fortis

Fortis

_________________________

_________________________

 

Apollo _________________________

Region

Operating beds

No. of Hospitals

Region

Operating beds

No. of Hospitals

North India

2,067

31

Chennai

1,159

9

South India

712

15

Hyderabad

930

8

West India

688

9

Kolkata

425

2

East India

388

10

Delhi

681

2

International

130

3

Bangalore

236

1

 

Ahmedabad

228

2

Other India

1,294

11

International

200

1

Total

3,985

68

5,153

36

Source: Company data

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Hospitals peer comparison

 

Market

Rating

Price Target

Pot'l

EPS CAGR

cap

price

return

FY13-15e

EPS (LC) _________

 

PE (x) __________

Company

(USDm)

(LC)

(LC)

(%)

FY12

FY13e

FY14e

FY15e

FY12

FY13e

FY14e

FY15e

Apollo

1,622.8

OW

650

796

22.9%

31.0

16.2

20.0

27.2

34.3

40.4

32.6

23.9

19.0

Fortis

800.5

N

107.5

115

6.5%

63.1

1.8

2.1

3.9

5.7

60.3

50.1

27.2

18.8

Raffles

1,003.0

NR

2.3

NA

NA

12.8

0.1

0.1

0.1

0.1

24.8

21.2

19.4

16.6

Bumrungrad

1,744.7

NR

75.3

NA

NA

16.0

1.8

2.7

3.2

3.7

41.1

27.7

23.7

20.6

Tenet

2,106.3

NR

5.1

NA

NA

12.8

0.4

0.6

0.6

0.7

13.8

9.3

8.1

7.3

Lifepoint

1,943.9

NR

39.9

NA

NA

11.4

3.2

3.3

3.7

4.1

12.4

12.0

10.7

9.7

Health South

2,265.3

NR

23.7

NA

NA

8.4

1.4

1.5

1.6

1.8

16.7

15.9

14.7

13.5

Universal health

4,145.7

NR

42.8

NA

NA

10.1

4.0

4.4

4.9

5.3

10.6

9.8

8.8

8.1

Note: LC=Local Currency, INR is LC for Apollo and Fortis, SGD for Raffles, Thai Baht for Bumrungrad and USD for Tenet, Lifepoint, Health South, Universal health; Price and potential return as of

  • 5 Jul 2012 closing price. Potential return equals the percentage difference between the current share price and the target price, including the forecast dividend yield. Source: HSBC estimates, DataStream, Company data

Hospitals peer comparison (continued)

Company

________

EV/EBITDA

(x) ________

 

EBITDA margin (%) ______

 

ROE (%) __________

FY12

FY13e

FY14e

FY15e

FY12

FY13e

FY14e

FY15e

FY12

FY13e

FY14e

FY15e

Apollo

16.7

13.9

11

9.1

16.3

16.3

16.9

16.8

10.0

10.4

12.7

14.5

Fortis

23.6

12.9

11.3

9.9

13.4

14.2

14.7

14.7

2.2

2.6

4.7

6.4

Raffles

18.5

16.5

14.1

11.9

24.5

24.5

25.0

25.2

16.2

16.2

16.7

16.9

Bumrungrad

20.2

18.1

16.0

13.3

26.3

24.9

25.0

24.8

24.8

28.0

28.6

28.5

Tenet

6.0

5.4

4.9

4.5

11.1

13.2

13.6

13.8

14.4

17.8

15.9

16.9

Lifepoint

6.4

6.1

5.6

5.4

15.1

16.8

17.1

17.4

8.5

8.1

8.6

8.3

Health South

7.5

7.1

6.6

6.3

23.0

23.0

23.0

23.5

135.7

61.5

56.7

46.9

Universal health

8.6

5.9

5.3

4.9

12.0

16.4

16.6

16.8

18.6

16.5

15.9

14.9

Note: LC=Local Currency, INR is LC for Apollo and Fortis, SGD for Raffles, Thai Baht for Bumrungrad and USD for Tenet, Lifepoint, Health South, Universal health Source HSBC estimates, DataStream, Company data

Jul-08 Mean: 10.4x 20 10 15 0 5 Jul-07 Apollo Hospitals: EV/EBITDA (x) range Jul-10 Jul-09
Jul-08
Mean: 10.4x
20
10
15
0
5
Jul-07
Apollo Hospitals: EV/EBITDA (x) range
Jul-10
Jul-09
Jul-12
Jul-11
EV/EBITDA
Mean
Max
Min

Source: DataStream, HSBC estimates

Jul-10 Min Max Mean EV/EBITDA Jul-11 Jul-12 Jul-09 Jul-08 Fortis Healthcare: EV/EBITDA (x) range Jul-07 0
Jul-10
Min
Max
Mean
EV/EBITDA
Jul-11
Jul-12
Jul-09
Jul-08
Fortis Healthcare: EV/EBITDA (x) range
Jul-07
0
50
100
150
200
Mean: 11.7

Source: DataStream, HSBC estimates

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Initiating coverage

We initiate coverage on the two leading private hospital chains in the country — Apollo Hospitals and Fortis Healthcare. We value both using sum- of-the-parts primarily using EV/EBITDA methodology for the hospitals business. We also use DCF as an alternative valuation approach.

Apollo Hospitals (APHS IN, OW, TP INR796)

We initiate on Apollo Hospitals with an Overweight rating. Apollo is the largest hospital chain in the country with 8,300 beds (5,888 owned and 2,388 managed) of which 5,153 beds were operational as of FY12. The company has an aggressive expansion plan with over 500 operational beds planned in FY13 alone.

Over the next three years it has an expansion plan of c2,900 beds, funding for a large part of which is tied up. The retail pharmacy business is at an inflection point with margin expansion expected on the back of incremental contributions from new pharmacy stores as they reach maturity.

We value the hospital business at 14x FY14e EBITDA and pharmacy at 0.5x sales. These two segments form over 95% of our target price. We value Apollo’s 22% stake in Indraprastha Medical (listed associate) at 1x market cap and Apollo’s 39.4% stake in Apollo Health Street at book value to arrive at a target price of INR796.

Fortis Healthcare (FORH IN, N, TP INR115)

We initiate on Fortis Healthcare with a Neutral rating. Fortis is the second largest hospital chain in India in terms of operational beds but has been most aggressive in terms of growth which in large part has been the result of acquisitions including Escorts, Malar and Wockhardt hospitals. The India hospital business now forms only 50% of total revenues after the consolidation of its international assets, which were previously held by its promoter company. These recent acquisitions have significantly increased leverage and worsened its return ratios.

While a pan-Asia presence is a positive, the higher costs and debt will put pressure on near-term margins. Nonetheless the expansion plan is robust with close to a doubling of its bed capacity in India over the next three years. Additionally, as per company recent plans for splitting the company’s assets and listing a REIT structure in Singapore may bring additional funds and lower debt. The diagnostic business under SRL recently made its third private equity investment and may see a turnaround in margins in the longer term. We value the India business at 14x FY14e EBITDA (similar to Apollo) and the international business at 12x FY14e EBITDA. Our 12-month target price is INR115.

HSBC vs. Consensus estimates

(INRm)

Net sales __________

 

EBITDA ___________

 

Net profit __________

 

FY13e

FY14e

FY15e

FY13e

FY14e

FY15e

FY13e

FY14e

FY15e

HSBC

Apollo

37,060

44,669

56,846

6,124

7,869

9,555

2,782

3,778

4,769

Fortis

53,730

61,824

70,222

7,646

9,085

10,324

865

1,598

2,304

Consensus

Apollo

37,881

45,514

54,837

6,345

7,710

9,371

3,050

3,788

4,457

Fortis

47,219

59,820

73,112

6,717

8,399

10,405

977

1,733

2,212

HSBC vs. consensus

Apollo

-0.7%

-1.9%

3.7%

-3.5%

2.1%

2.0%

-8.8%

-0.3%

7.0%

Fortis

13.8%

3.4%

-4.0%

13.8%

8.2%

-0.8%

-11.5%

-7.8%

4.2%

Source: HSBC estimates, Bloomberg

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Hospitals 9 July 2012

Valuation and performance

abc

Indian hospitals trade at a premium to global peers High valuations are justified by significant market potential and growth dynamics favouring incumbents, in our view We use a sum-of-the-parts valuation methodology, with the hospital business valued using relative EV/EBITDA

Indian hospitals trading at a premium

Both Apollo and Fortis are trading at premium valuations compared to hospitals in developed markets. However, we think this is justified by strong expansion plans and the sector’s structural growth story, which favours private players.

We note that the group is currently trading at 14.5x one-year forward EV/EBITDA, compared to a historical trading range of 10-25x and a five- year average of 16x. While Apollo has seen a stable EV/EBITDA of 14x in the past year, the EV/EBITDA multiple for Fortis has come off from high levels after its foray into overseas markets through Fortis International.

On a PE basis, Apollo currently trades at 31.6x FY13e and 23.2x FY14e EPS. The stock has historically traded at an average one-year forward PE of 29.3x and three-year average of 26.1x. Fortis, on the other hand, is trading at a 49.6x one- year forward PE with a one-year average of 54.1x owing to its low earnings.

EV/EBITDA over PE

EV/EBITDA is widely used to value hospitals largely because of substantial changes to financial structures over time. Each hospital has its unique capital structure and allocation strategy; the impact on depreciation, interest expenses and ultimately net profit varies depending upon whether the company acquires or divests facilities or utilizes cash to pay off debts. Additionally, different groups of hospitals at different ages and sizes affect expenses below operating level. Thus we prefer using EV/EBITDA over PE. A lack of a substantial history of positive earnings merits use of EBITDA multiples in certain cases (such as Fortis). Lastly the group tends to trade in a tighter band on EV/EBITDA than on PE.

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India Hospital Index: 12-month forward EV/EBITDA Operating efficiency of key hospitals 30 35% Health Bumrungrad 25
India Hospital Index: 12-month forward EV/EBITDA
Operating efficiency of key hospitals
30
35%
Health
Bumrungrad
25
1
y r av g:
15.9
30%
South
20
3-y r av g:
17.4
25%
Raffles
15
20%
10
Lifepoint
Apollo
15%
5
10%
Tenet
0
Universal
Fortis
5%
Health
0%
0
25
50
75
100
125
150
12-month forw ard EV/EBITDA
Asset turnover
Source: DataStream
Source: DataStream (Bubble size = ROIC)
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Jul-12
Op. margin
Healthcare Hospitals 9 July 2012 ab c India Hospital Index: 12-month forward EV/EBITDA Operating efficiency of
India Hospital Index: 12-month forward P/E 40 1 y r av g: 22.1 30 3 y
India Hospital Index: 12-month forward P/E
40
1
y r av g:
22.1
30
3
y r av g:
24.6
20
10
0
12-month forw ard PE
Source: DataStream
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Jul-12

EV/Bed

EV/Bed is a frequently used tool to value

hospitals. While it is easy to compute and use

within one geographical set of hospitals, the

number of beds is not a good indicator of the

profitability of the business as the economic

conditions in different geographies vary considerably. Hence it is of limited use when comparing hospitals across different markets.

P/E vs EPS CAGR comparison

P/E

30 5.0 15.0 10.0 30.0 50.0 25.0 40.0 35.0 20.0 45.0 10 15 20 25 Fortis
30
5.0
15.0
10.0
30.0
50.0
25.0
40.0
35.0
20.0
45.0
10
15
20
25
Fortis
35
40
45
50
55
5
Universal HealthServices
Tenet Healthcare
Lifepoint
HealthSouth
Raffles Medical
Bumrungrad
Apollo

EPS CAGR (%)

Note: EPS CAGR for FY12-15e Source: DataStream

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EV/Bed matrix across hospitals

Company

No. of shares

Share price

Market cap

Net debt

EV

No. of beds

EV/bed

outstanding

(LC)

(m in LC)

(m in LC)

(m in LC)

(USD '000)

Apollo

136

652

88,573

4,928

93,501

5,153

363

Fortis

405

107

43,476

45,699

89,175

3,985

448

Raffles

537

2

1,252

-28

1,224

380

2,553

Bumrungrad

728

75

54,812

3,694

58,506

554

3,728

Tenet

414

5

2,106

4,247

6,353

13,509

470

Lifepoint

49

40

1,944

1,471

3,415

6,048

565

Health South

96

24

2,265

1,225

3,490

6,500

537

Universal health

90

43

3,832

3,613

7,445

25,006

298

Note: LC=Local Currency, INR is LC for Apollo and Fortis, SGD for Raffles, Thai Baht for Bumrungrad and USD for Tenet, Lifepoint, Health South, Universal Health; calculations based on 5 Jul 2012 closing price Source: DataStream

DCF

We have used DCF as an alternative methodology for valuing Indian hospitals. We believe DCF is an apt tool to value hospitals given the capital intensive nature of the industry and large cash flows tied to the future.

Current valuations, however, also reflect heightened M&A activity and private equity interest, which we believe are not accounted for in DCF. We believe hospital valuations react to such events favourably. See a list of PE and M&A deals in the hospital space in the appendix.

Historical price performance

Hospital stocks are considered very defensive given that healthcare demand tends to be resilient even during poor economic conditions. Apollo has been a strong performer in this space beating Fortis and the broader equity index by a large margin. Apollo has outperformed the BSE Sensex by a whopping 70% in the past two years. Even during the past year with the Sensex down 8%, Apollo appreciated by 30%. Fortis, on the other hand, has seen a sharp share price decline following its acquisition of Fortis International. The stock has underperformed BSE Sensex by 30% in the last 12 months.

Apollo has seen strong absolute stock performance in the last two years Apollo has outperformed both
Apollo has seen strong absolute stock performance in the
last two years
Apollo has outperformed both Fortis and HSBC Drug Index
80%
300
60%
250
40%
200
20%
150
0%
100
-20%
50
-40%
0
-60%
2012
y td
6 mth
1-y r
2-y r
Apollo
Fortis
Sensex
BSE Healthcare
Apollo
Fortis
HSBC Drug Index
Source: DataStream
Source: DataStream
Jul-07
Jul-08
Jul-09
Jul-10
Jul-11
Jul-12
Healthcare Hospitals 9 July 2012 ab c EV/Bed matrix across hospitals Company No. of shares Share

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India healthcare overview

Sector growth prospects in India are compelling, as existing healthcare infrastructure is inadequate for demand Disposable income growth, rising healthcare awareness and changing demographic and lifestyle trends to drive the growth Players with an established base and strong record of execution to emerge as winners

Healthcare infrastructure inadequate in India

Structural deficits present significant opportunities

According to the World Health Organization (WHO) Health Statistics 2011 report, India lags several developing nations like China, Brazil, Russia and Mexico, as well as smaller countries like Thailand, Sri Lanka and Vietnam in terms of healthcare provision.

In terms of beds, India had just 9 per 10,000 population during 2000-09, well behind the global average of 29. India also lags behind in terms of its ratios of medical personnel to population, with just 6 physicians per 10,000 population versus a global median of 14, and 13 nurses and midwives per 10,000 compared to a global average of 29.

This structural shortage represents a huge growth opportunity for healthcare companies in India. Assuming the average cost to develop a bed excluding land cost is INR2-2.5m, we estimate India would need to investment INR5,000-6,100bn just to reach the global average of 29 beds per 10,000 people. We believe private sector healthcare players will benefit the most from this investment

opportunity given the private sector accounted for 68% of spending on healthcare in 2008 in India (source: WHO). Private sector players consist mainly of corporate, diagnostic laboratories, pharmacies, trusts, charitable organizations.

India had lowest bed to population ratio in 2000-09 period

97 29 41 24 29 31 16 18 22 9 100 120 0 India Brazil China
97
29
41
24
29
31
16
18
22
9
100
120
0
India
Brazil
China
Global
Russia
Mexico
Vietnam
Thailand
Malaysia
Sri Lanka
80
60
40
20
No . of beds per 10,000 poupulation

Source: World Health Organization Report

As seen from the exhibit, India’s healthcare expenditure as a percentage of GDP is one of the lowest in the world at just 4.2%. India’s government healthcare spending is particularly low because of the high proportion of private healthcare spending. As public health is a responsibility managed at the state level in India, the increased participation requires commitment from state governments.

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Density of doctors and nurses per 10,000 population in India is among lowest in the world

Vietnam No. of nurses per 10,000 population No. of doctors per 10,000 population UK US India
Vietnam
No. of nurses per 10,000 population
No. of doctors per 10,000 population
UK
US
India
Italy
Brazil
China
Global
France
Russia
Spain
M exico
Canada
120
S Korea
Thailand
Australia
Sri Lanka
Malaysia
Germany
Singapore
Indonesia
0
20
40
60
80
100

Source: World Health Organization Report

As per the 12th Five-Year Plan, the government plans to triple spending on healthcare, raising it from 0.9% to 2.5% of GDP over 2012-17. The increase in budgeted allocation is in accordance with the increasing focus on National Rural Health Mission (see appendix), introduction of district-wide pilots of Universal Health Coverage (UHC), planned establishment of new medical colleges like All India Institute of Medical Sciences, and the creation of a public health cadre (government appointed healthcare supervisors) and a central procurement agency to provide access to free medicines.

Healthcare expenditure as % of GDP in India is one of lowest across globe India healthcare
Healthcare expenditure as % of GDP in India is one of lowest
across globe
India healthcare expenditure trend
20.0
60
25
20
15.0
40
15
10
10.0
20
5
4.2
0
5.0
0
-5
0.0
Health ex penditure per capita (current USD)-LHS
y oy grow th (%)-RHS
HC as % of GDP, 2009
Health ex penditure as % of GDP-RHS
Source: World Bank
Source: World Bank
US
German
France
Canada
Australia
UK
Spain
Brazil
Russia
Mexico
Vietnam
Thailand
China
India
Malaysia
Sri
Global
USD
1996
1998
2000
2002
2004
2006
2008
2010
%
Healthcare Hospitals 9 July 2012 ab c Density of doctors and nurses per 10,000 population in

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Healthcare delivery forms the major component of overall healthcare expenditure

59.5% Pharmaceuticals Healthcare serv ices Healthcare deliv ery : 42.8% Diagnostics:3.6% Retail pharmacy :13.1% Medical dev
59.5%
Pharmaceuticals
Healthcare
serv ices
Healthcare deliv ery : 42.8%
Diagnostics:3.6%
Retail pharmacy :13.1%
Medical dev ices &
supplies, 8.2%
32.3%

Source: ICRA report

Key drivers

According to Frost & Sullivan, the Indian healthcare market was worth USD59.5bn in 2010, and is expected to grow at a CAGR of c15% over the next few years. Of the total healthcare market in India, 70-72% comprises healthcare delivery services, 20-22% pharmaceutical market and the remaining is medical technologies and other services.

This growth will mainly be driven by: 1) rising income levels and health awareness; 2) changing disease profiles with a shift from acute to chronic diseases; 3) changing demographics; 4) booming medical tourism; and 5) increasing healthcare insurance coverage.

Rising affluence

Rising income and education levels have raised the standard of health awareness, boosting demand for both standard and advanced healthcare services among the population. This can be observed in the rising trend of private healthcare expenditure as a proportion of GDP over the past decade. Growth of over 25% in private healthcare expenditure in 2010 was much higher than the average growth of 12% of the last decade.

Hospital service expense has grown consistently

25% 20% CAGR 2000-2007:12.1% 15% 10% 5% 0% 1995 2000 2002 2004 2006 2007 2011
25%
20%
CAGR 2000-2007:12.1%
15%
10%
5%
0%
1995
2000
2002
2004
2006
2007
2011
Hospital service expense has grown consistently 25% 20% CAGR 2000-2007:12.1% 15% 10% 5% 0% 1995 2000

Hospital serv ices ex pense as % of total consumer ex penditure on healthcare

Source: Euromonitor, HSBC estimates

This trend suggests a shift in demand towards private healthcare, which have gained market share from public hospitals. According to India’s Central Bureau of Health Intelligence, the majority of Indians prefer private healthcare despite a higher average cost of USD4.3 compared to USD2.7 in government-owned facilities. Only 23.5% urban residents and 30.6% rural residents prefer government facilities, which imply a widespread lack of confidence in the public healthcare system.

Rising trend of personal disposable income in India

10 % y oy change-RHS Per capita personal disposable income-LHS FY09 FY06 FY07 FY08 FY05 FY10
10
% y oy change-RHS
Per capita personal disposable income-LHS
FY09
FY06
FY07
FY08
FY05
FY10
'000 INR
20%
20
30
40
50
0
0%
5%
10%
15%

Source: Press Information Bureau, Government of India

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Medical and healthcare services increasing as % of total private consumption expenditure

FY15e (%) Source: CSO, D&B Misc. goods and serv ices Food, bev erages & tobacco Transport
FY15e
(%)
Source: CSO, D&B
Misc. goods and serv ices
Food, bev erages & tobacco
Transport & communication
Clothing & footw ear
pow er
Gross rent, fuel &
Furnitures & appliances
Medical care and health serv ices
Recreation & Education
FY20e
5
FY10
FY05
20
40
60
80
0
100
6.5
5.6
4.8

In India, 67% of spending on healthcare is private, of which 75% is out-of-pocket expenditure (which is one of the highest levels in the world). Also, with rising disposable income and increasing awareness about healthcare, a relatively large proportion of discretionary income in India is being spent on healthcare services. As seen above, despite a fall from pre-2005 levels, healthcare and medical needs as a proportion of total private consumption are expected to increase from the current 4.8% to 6.5% by FY20.

We believe rising disposable income of Indian households and increasing discretionary spending on healthcare will be the key growth drivers for healthcare service providers, mainly the private players as a majority of healthcare spend is out- of-pocket private spending.

Changing disease profile

Rising affluence of Indian households has led to an epidemiological shift towards life-style-related chronic diseases like cardiovascular disorders (CVS), mental disorders and diabetes. The extent of chronic disease burden is clear: India is now the diabetes centre of the world with more than 50m diabetic patients and this number is further expected to increase. Increasing proportion of aging people in the overall population is another factor contributing to increasing chronic disease burden as aged people are more susceptible to chronic disease such as hypertension, diabetes and heart ailments.

Considering the higher cost and longer duration involved in the near-term treatment of chronic diseases, there will be increasing demand for

Household annual disposable income trend in India

No. of households

( calculated at constant 2009 value)

_________

Compounded annual growth rate (CAGR) _____

('000)

2010

2015e

2020e

2010-2020e

2000-2007*

1995-2007*

above US$500

222,980

241,746

258,855

1.5%

2.5%

2.3%

above US$1,000

213,802

236,111

255,295

1.8%

4.5%

4.0%

above US$5,000

73,722

123,948

171,261

8.8%

20.3%

15.8%

above US$10,000

18,357

42,211

77,050

15.4%

12.9%

10.1%

above US$25,000

3,663

6,579

12,926

13.4%

11.5%

9.4%

above US$45,000

1,760

2,936

4,590

10.1%

11.6%

9.6%

above US$75,000

931

1,558

2,440

10.1%

11.7%

9.7%

above US$150,000

392

660

1,035

10.2%

Note:* 2000-2007 and 1995-2007 BAGR based on constant 2007 value Source: Euromonitor International

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Consumer expenditure on hospital services have grown more than other spend on healthcare*

(INR bn)

1995

2000

2002

2004

2006

2007

1995-2007

2000-2007

 

CAGR

CAGR

Medicines, medical devices

285.8

393.9

483.9

578.2

732.4

756.6

9.3%

9.8%

Out-patient services

211.2

338.9

436.4

519

665.6

700.3

11.5%

10.9%

Hospital services

82.9

136.4

183.3

221.8

286.6

303.2

12.5%

12.1%

Total

579.9

869.2

1103.6

1319

1684.6

1760.1

10.6%

10.6%

Note: expenses calculated at constant 2007 values Source: Euromonitor International

advanced, well-equipped diagnostics centres and hospitals. Increasing affluence help ensure that Indian households can afford the cost of chronic disease treatment. As per industry estimates, cardiovascular diseases, cancer and diabetes accounted for 13.8% of all hospitalized cases in India in 2008 (accounting for 38.6% of in-patient revenues in value terms). Chronic diseases are expected to account for approximately 17.5% and 19.9% of the hospitalized cases in 2012 and 2017 respectively.

As per a WHO report (Mahal et al. 2010), between two study periods (1995-96 and 2004) the share of chronic disease in total out-of-pocket health expenditures in India increased from 31.6% to 47.3%, which shows the growing importance of chronic diseases in terms of their financial impact on households and a financial burden on affected individuals and households. Also, it was observed that hospitalization expenses due to chronic diseases were nearly 160% higher than hospitalization expenses due to communicable

diseases. Hence, increasing chronic disease burden underpins growth for hospitals and other healthcare service providers.

962 1,000 800 835 641 598 650 596 460 380 310 405 Increasing chronic disease burden
962
1,000
800
835
641
598
650
596
460
380
310
405
Increasing chronic disease burden in India (cases per
100,000 population)
1,200
1,000
400
200
800
600
0
Cardiac
Diabetes
Mental
COPD and
disease
health
asthma
2005
2015e
2030e

Source: The National Commission of India, HSBC estimates

Changing demographics

The changing population dynamic is another factor to fuel demand for healthcare infrastructure and services in India. As per the exhibit below, the aging population (+50 years/+60 years aged) is becoming a larger share of total population. The

Chronic diseases are increasingly the main cause of deaths projected in India

12 10 8 6 4 2 0 Deaths (×1 000 000) 2030 2015 2004 2020 2008
12
10
8
6
4
2
0
Deaths (×1 000 000)
2030
2015
2004
2020
2008
2025
  • Maternal, perinatal, and nutritional disorders

  • Other non-communicable diseases

  • Other unintentional injuries

    • Intentional injuries

  • Cancers

  • HIV/AIDS, Tuberculosis and malaria

Other infectious diseases

Cardiov ascular disease

Road traffic injuries

Maternal, perinatal, and nutritional disorders Other non-communicable diseases Other unintentional injuries Intentional injuries Cancers HIV/AIDS,
Maternal, perinatal, and nutritional disorders Other non-communicable diseases Other unintentional injuries Intentional injuries Cancers HIV/AIDS,
Maternal, perinatal, and nutritional disorders Other non-communicable diseases Other unintentional injuries Intentional injuries Cancers HIV/AIDS,

Source: World Health Organization

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United Nations Population Division projects that India’s population aged 50 or more will expand to 34% by 2050 from the current 12-13% level.

As per various studies, c50% of older Indians have at least one chronic disease like diabetes, asthma, cardiac and mental disorders. The aging population will lead to an increase in these diseases which in turn increases demand for healthcare services.

India’s aging population is becoming a large share of total population

20% 15% 10% 5% 0% As % of total population 1990 2000 1970 1980 2010 1950
20%
15%
10%
5%
0%
As % of total population
1990
2000
1970
1980
2010
1950
1960
Aged 60+
Aged 50+

Source: United Nations Population Division

Medical tourism

Due to ballooning healthcare costs in developed nations (US, UK, Western Europe), more patients from these countries are viewing India as a preferred destination for affordable, quality medical care. According to a report by the Associated Chambers of Commerce and Industry of India (ASSOCHAM), India’s medical tourism sector is expected to grow to INR95m by 2015 from INR15m in 2008.

In 2010, 730,000 foreigners visited the country, of which 156,000 were medical tourists. The ASSOCHAM report estimates this number will grow at a CAGR of 40% over 2011-15. That said, while India faces stiff competition from Singapore and Malaysia which are also emerging as healthcare destinations, increasing medical tourism demand is emerging from parts of Middle East and Western Asia.

The cost of advanced surgeries like heart-valve replacement in India is about one-tenth of the price of comparable treatments in the US or the UK (see below). We believe India’s cost advantage and quality medical services leave Indian healthcare service providers well placed to benefit from the growth in medial tourism.

200 111 114 82 93 156 108 500 400 300 200 100 - Medical tourists increased
200
111
114
82
93
156
108
500
400
300
200
100
-
Medical tourists increased by c20% over 2008-10
150
100
50
-
2005
2006
2007
2008
2009
2010
Medical Tourists ('000s) - left axis
  • Medical Tourists Receipts (USD mn) - right ax is

Source: Bureau of Immigration

Apollo has the largest market share among the

private hospitals in the country and received about 50,000 medical tourists in 2010, followed by

Max, Fortis, Care and Sterling. Growing specialty services with a focus on highly skilled technology driven surgeries including robotics is expected to drive medical tourism in the future.

Medical tourists by nationality, 2010 (in %)

2% 3% 23% 3% 4% 4% 37% 24% Maldives Bangladesh Nigeria Oman Afghanistan Sri Lanka UAE
2%
3%
23%
3%
4%
4%
37%
24%
Maldives
Bangladesh
Nigeria
Oman
Afghanistan
Sri Lanka
UAE
Others

Source: HSBC, ASSOCHAM

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India has a cost advantage over other countries for performing same surgeries

(USD)

US

UK

Thailand

Singapore

India

Heart Surgery

100,000

41,726

14,250

15,312

6,000

Heart Valve Replacement

1,60,000

30,000

10,500

13,000

6,000

Bone Marrow Transplant

250,000

292,470

62,500

150,000

30,000

Liver Transplant

300,000

200,000

75,000

140,000

45,000

Knee Replacement

48,000

50,109

8,000

25,000

6,000

Hip Replacement

38,000

18,000

10,000

12,000

6,000

Source: Fortis Healthcare

JCI accredited hospitals distribution in Asia

Jordan Korea South 20.3% Saudi Arabia 5% Others China 7.3% 9.4% Thailand 7.3% Singapore 5.2% 6.3%
Jordan
Korea
South
20.3%
Saudi Arabia
5%
Others
China 7.3%
9.4%
Thailand
7.3%
Singapore
5.2%
6.3%
2.6%
Indonesia
8.3%
India
Phillipines
Qatar
3.6%
UAE 20.3%
Israel
2.6%
2.1%

Source: Joint Commission International

Increase in health insurance

Given that there is a large proportion of out-of- pocket spend on healthcare in India, healthcare insurance has yet to become material in terms of affordability and reach. As the penetration of healthcare insurance increases, quality healthcare will become more affordable to a larger percentage of the population. Currently less than 5% of the population has some form of health insurance and this is expected to increase to 20% by 2015.

Gross Written Premium (GWP) for new health insurance has consistently grown in India over the last few years

150 100 50 0 FY07 FY08 FY09 FY12 FY10 FY11
150
100
50
0
FY07
FY08
FY09
FY12
FY10
FY11
Gross Written Premium (GWP) for new health insurance has consistently grown in India over the last

Gross Written Premium (INR bn)

Source: IRDA

Key hurdles

Trained personnel shortage

Finding and retaining qualified doctors and nurses is challenging especially when the country has a low ratio of medical personnel to the population. India

suffers on these parameters essentially due to a lack

of adequate training and the high incidence of

migration of talent to developed markets.

According to data released by the government of India in 2008, India had a shortfall of 0.6m doctors,

1m nurses and 0.2m dental surgeons. This is particularly problematic for the public healthcare system, which is at risk of losing experienced and qualified staff to the private sector.

As per the Medical Council of India, around 34,700 doctors graduated from 335 medical colleges in India in 2010. Assuming a similar level of growth in the number of graduating doctors and medical colleges, we believe the number of doctors per 10,000 people can increase from the current level of 6 to 8.3. Although this level won’t completely ease

the shortage of qualified doctors in India, this will

bring the doctor to people ratio closer to the WHO recommended level of 10.

The retention of talented medical pool is a critical

issue given most patients are tied to a doctor and there have been instances in the past where the

departure senior talented personnel has resulted in lower occupancy that has impacted profitability.

High cost burden

Setting up a facility in a large town/metro is costly

with an average cost of INR8-10m per bed. About

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50-55% of this cost is attributed to the acquisition of land and construction related expenses.

Many leading companies are opting for an asset-light model by leasing their assets over a long period of time (typically 30 years) and paying lease rate with certain escalation every year to the lessor. In certain cases, the lessee shares the percentage of EBITDA. Such a model helps ease the need for upfront investments and also leads to lower depreciation and interest expenses going forward, thus reflecting better on return ratios.

Additionally the purchase and replacement of advanced medical equipment involve significant costs, and expose hospitals to currency fluctuation risk, given most equipment needs to be imported from overseas.

Access to capital and land

Given the high capital intensity, access to capital is a constant risk and could be critical to a successful business strategy.

Additionally, the acquisition of new land and expansion into existing areas can be costly and challenging and is subject to market movements. Many firms are opting for a lease on a long-term basis over owning direct land.

Most hospitals look for favourable lease arrangements when accessing new territories which are unexplored in terms of market potential. In certain cases, negotiations and re- arrangements might lead to certain disputes and may incur additional costs.

Technological advancement

Constant upgrading of facilities and incorporation of new technologies are essential to sustain patient volumes and reduce average length of stay. Additionally, the lack of modern medical equipment and operating theatres could lead to market share losses. Many large hospitals are benchmarking their medical equipment against western hospitals to attract foreign patients. In our view, this is critical factor to sustaining long-term growth in medical tourism in India.

While surgical treatment costs are low in India, equipment costs and other investments in technology incur similar pricing and can put pressure on margins.

Increasing competition in local markets

The penetration of medical services is uneven across India. In Gurgaon and Hyderabad, for example, the supply of beds outstrips demand, impacting occupancy and pricing power. This can make building a brand and market presence in some metro areas a significant challenge for nationwide players.

As per the latest data available, Chennai, Bangalore and Hyderabad rank high among metros with over 2 beds per 1,000 population vs Delhi (1.4), Mumbai (0.8) and Kolkata (0.8).

Additionally, some hospitals are establishing a competitive advantage by specializing in a particular field, such as Asian Heart Institute in cardiology and Aditya Jyot Hospital in

Private players dominate the healthcare facilities in Indian metros

Metro

No. of hospitals

No. of private hospitals

No. of beds

No. of private beds

Delhi

523

380

35,200

21,000

Mumbai

539

151

37,370

21,500

Kolkata

200

72

20,938

14,657

Bangalore

320

212

18,000

10,800

Hyderabad

523

300

14,000

8,400

Chennai

350

210

20,508

10,254

Source: Company data (Data as of 2010. Number of hospitals is estimate for Chennai, private beds are estimated for Kolkata, Hyderabad and Chennai)

Healthcare

Hospitals 9 July 2012

ophthalmology. These hospitals tend to present tough competition to hospitals that offer a wider range of services, as they have built up a strong brand within their own field, offering proven expertise in handling complicated cases. They operate on lower costs and hence have better profitability.

The potential entry of overseas healthcare chains in India is another threat.

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Company profiles

Apollo Hospitals (APHS IN): Leader in private healthcare Fortis Healthcare (FORH IN): Pan-Asia branding

Healthcare

Hospitals 9 July 2012

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Apollo Hospitals (APHS)

Strong brand and broad reach enables Apollo to maintain leadership in both hospital and pharmacy businesses Increasing occupancy in Hyderabad and other clusters, coupled with aggressive expansion plans, suggests ample room for growth Initiate with OW and TP of INR796; unlocking value in non-core businesses is a material catalyst

Leader in private healthcare

Apollo is the established leader among private healthcare providers in India, with the widest footprint in the southeast and an increasing presence

in the northwest. With coverage expansion to over

  • 50 self-owned hospitals and 8,500 self-owned beds,

we believe the company is well positioned to benefit from the potential growth in the country’s currently weak healthcare infrastructure base. We expect timely additions of beds, ramp-up in occupancy levels in Hyderabad and other clusters and further improvement in average revenue per operating bed (ARPOB) at key clusters including Chennai and Hyderabad to be material drivers of growth in the near term. The standalone pharmacy business, while still a drag on overall margins, is likely to show gradual improvement; value in this business could be unlocked through a potential divestment.

Core hospital business outlook strong –

Mumbai cluster newest entry: Apollo Group currently has 5,888 beds and aims to add about 3,000 new beds through FY15, which includes setting up a new cluster in Mumbai which should bring higher ARPOB given the industry statistics in metros. At the same time, occupancy is increasing in Hyderabad and ARPOB at flagship

hospitals is expanding through an improving case mix and focus on centres of excellence. The REACH model (targeting non-metro and non- urban) is expected to scale up patient volumes in bigger hospitals. We expect hospitals to remain

the key driver of earnings, contributing over 95% of the total in the next three years. We estimate sales to grow at a CAGR of 22% over FY12-15 in the core business and operating margins to expand 50bp during this period.

Unlocking value in retail pharmacy and other

non core businesses: The retail pharmacy business which broke even last year is at an inflection point, with profitability expected to

continue improving. A potential stake sale to a strategic partner and likely divestment of outsourcing business under Apollo Health Street (as guided by the company) could unlock significant value, in our view.

Initiate with OW: We initiate coverage of Apollo Hospitals with an OW rating, valuing it using a sum-of-the-parts methodology (14x EV/EBITDA for hospitals, 0.5x EV/sales for pharmacy business and additional INR23 per share for associates). Key risks include delay in execution of key projects and slower margin build up in pharmacy business.

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Hospitals 9 July 2012

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Financials & valuation: Apollo Hospitals

Financial statements

Year to

03/2012a

03/2013e

03/2014e

03/2015e

Profit & loss summary (INRm)

Revenue

31,475

37,602

46,669

56,846

EBITDA

5,131

6,124

7,869

9,555

Depreciation & amortisation

-1,239

-1,464

-1,678

-1,878

Operating profit/EBIT

3,892

4,660

6,192

7,677

Net interest

-891

-920

-950

-1,000

PBT

3,260

4,020

5,522

6,977

HSBC PBT

3,260

4,020

5,522

6,977

Taxation

-1,150

-1,339

-1,839

-2,323

Net profit

2,193

2,782

3,788

4,769

HSBC net profit

2,193

2,782

3,788

4,769

Cash flow summary (INRm)

Cash flow from operations

1,835

3,521

2,845

5,050

Capex

-4,539

-4,000

-3,500

-3,500

Cash flow from investment

-4,065

-3,900

-3,395

-3,385

Dividends

-648

-822

-1,119

-1,409

Change in net debt

-1,717

-424

1,669

-256

FCF equity

-2,963

-759

-935

1,250

Balance sheet summary (INRm)

 

Intangible fixed assets

1,351

1,351

1,351

1,351

Tangible fixed assets

20,855

23,391

25,213

26,836

Current assets

14,679

17,033

19,795

22,378

Cash & others

2,368

3,903

3,140

3,855

Total assets

42,771

47,661

52,245

56,450

Operating liabilities

4,733

4,927

5,936

6,323

Gross debt

8,517

9,707

10,614

11,073

Net debt

4,928

4,504

6,174

5,917

Shareholders funds

25,068

28,573

31,242

34,602

Invested capital

29,783

32,944

37,282

40,386

 

Ratio, growth and per share analysis

 

Year to

03/2012a

03/2013e

03/2014e

03/2015e

Y-o-y % change

Revenue

20.8

19.5

24.1

21.8

EBITDA

22.7

19.4

28.5

21.4

Operating profit

20.1

19.7

32.9

24.0

PBT

24.7

23.3

37.3

26.4

HSBC EPS

8.4

23.8

36.2

25.9

Ratios (%)

Revenue/IC (x)

1.1

1.2

1.3

1.5

ROIC

10.3

10.9

12.7

14.1

ROE

10.0

10.4

12.7

14.5

ROA

6.8

7.3

8.6

9.8

EBITDA margin

16.3

16.3

16.9

16.8

Operating profit margin

12.4

12.4

13.3

13.5

EBITDA/net interest (x)

5.8

6.7

8.3

9.6

Net debt/equity

19.7

15.8

19.8

17.1

Net debt/EBITDA (x)

1.0

0.7

0.8

0.6

CF from operations/net debt

37.2

78.2

46.1

85.3

Per share data (INR)

EPS Rep (fully diluted)

16.15

19.99

27.23

34.28

HSBC EPS (fully diluted)

16.15

19.99

27.23

34.28

DPS

4.00

4.95

6.74

8.48

Book value

184.53

205.39

224.57

248.72

Overweight

Valuation data

Year to

03/2012a

03/2013e

03/2014e

03/2015e

EV/sales

2.7

2.3

1.9

1.5

EV/EBITDA

16.7

13.9

11.0

9.1

EV/IC

2.9

2.6

2.3

2.1

PE*

39.7

32.1

23.5

18.7

P/Book value

3.5

3.1

2.9

2.6

FCF yield (%)

-3.7

-0.9

-1.2

1.5

Dividend yield (%)

0.6

0.8

1.1

1.3

Note: * = Based on HSBC EPS (fully diluted)

 

Issuer information

 

2

Share price

(INR)640.95

Target price

(INR)796.00

4

.

2

Reuters (Equity)

APLH.BO

Bloomberg (Equity)

APHS IN

Market cap (USDm)

1,582

Market cap

(INRm)

86,186

Free float (%)

67

Enterprise value (INRm)

85175

Country

India

Sector

HEALTH CARE PROVIDERS

Analyst

Girish Bakhru

Contact

+91 22 22681638

Price relative

470 Apollo Hospitals Rel to BOMBAY SE SENSITIVE INDEX 2011 2010 2012 2013 270 370 770
470
Apollo Hospitals
Rel to BOMBAY SE SENSITIVE INDEX
2011
2010
2012
2013
270
370
770
570
670
770
270
370
470
570
670

Source: HSBC

Note: price at close of 05 Jul 2012

Healthcare

Hospitals 9 July 2012

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Apollo’s hospital network across India

Tiruvannamalai Belandur Belandur Karaikudi Karaikudi Taranaka Taranaka Bangalore Bangalore Hyderabad Hyderabad Thirukadaiyur Thirukadaiyur Tiruvannamalai Tirupathi Ayanambakkam
Tiruvannamalai
Belandur
Belandur
Karaikudi
Karaikudi
Taranaka
Taranaka
Bangalore
Bangalore
Hyderabad
Hyderabad
Thirukadaiyur
Thirukadaiyur
Tiruvannamalai
Tirupathi
Ayanambakkam
Ayanambakkam
Pune
Pune
Lavasa
Lavasa
Karimnagar
Karimnagar
Belapur
Belapur
Bhilai
Bhilai
Agra
Chitoor
Karur
Karur
Trichy
Trichy
Bellary
Bellary
Calicut
Calicut
Nellore
Nellore
Mysore
Mysore
Chitoor
Agra
Kurnool
Kurnool
Ranipet
Ranipet
Raichur
Raichur
Madurai
Madurai
Chennai
Chennai
Argonda
Argonda
Tirupathi
Margoa
AHEL Affiliated Hospitals
AHEL Affiliated Hospitals
Clinics / Diagnostic Centres
Clinics / Diagnostic Centres
Clinics / Diagnostic Centres
Hospital owned by Subsidiary/
Hospital owned by Subsidiary/
Hospital owned by Subsidiary/
Vizag
Vizag
Ranchi
Ranchi
Margoa
AHEL Affiliated Hospitals
Bhagalpur
Bhagalpur
Mumbai, Byculla
Mumbai, Byculla
Bhubaneswar
Bhubaneswar
Ahmedabad
Kakinada
Kakinada
Kolkata
Kolkata
Thane
Thane
Noida
Agra
Agra
Nasik
Nasik
Indore
Indore
Bilaspur
Bilaspur
Bacheli
Bacheli
Delhi
Delhi
Noida
Ahmedabad
Gurgaon
Gurgaon
Ludhiana
Ludhiana
Under Construction
Under Construction
Under Construction
Associates/JVs of AHEL
Associates/JVs of AHEL
Associates/JVs of AHEL
Hospital owned by AHEL
Hospital owned by AHEL
Hospital owned by AHEL

Source: Company data, HSBC

Healthcare

Hospitals 9 July 2012

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Hospital business brings in 75% of revenue

Largest hospital network in India

Apollo obtains revenues from two main segments:

healthcare services and retail pharmacy. Healthcare services comprising hospital-based revenues, hospital-based pharmacies and consultancy generated 75% of revenues in FY12 while retail pharmacy accounted for 25%.

With over 51 hospitals and 8,000 beds, Apollo has the widest reach in the country with a significant presence in major metro areas, including Chennai, Hyderabad, Ahmedabad, Bangalore, Kolkata and New Delhi.

Founded in 1979, the group owns about 5,890 beds through its own hospitals and JV partnerships, and manages another 2,600 beds. The company started its operations in Chennai and had just 150 beds in 1983. In 1988, it expanded to Hyderabad.

It was in early 2000 that it made its entry in New Delhi and Kolkata (until then it had no presence in northern India). The company opened the 425-bed Gleneagles Hospital in Kolkata through a 50:50 JV with Parkway Group of Singapore and another in Ahmedabad in JV with Cadila Pharma. In 2008, the company launched its REACH initiative to make quality healthcare accessible to people in rural areas.

“Apollo” brand

Apollo records close to 750 admissions, 6,500 out-patients, 200 critical care cases, 120 key

cardiac procedures, 50 neuro-surgeries, and conducts 400 dialysis and 40,000 laboratory tests every day.

Apollo has many firsts to its name (see exhibit below). The well-known ACE@25 programme implemented in 32 of the group’s centres focuses on centres of excellence and aids in improving clinical outcomes at its hospitals (benchmarking against globally renowned healthcare institutions with 25 parameters).

During FY12, the Apollo Transplant Institute completed 929 transplants in a single year making it one of the busiest programs of its kind in the world. The company has adopted the latest technology – the daVinci Si Surgical robotic system – to obtain the best clinical outcomes in various procedures. The Apollo Institute of Robotic Surgery, launched six months ago, has already completed 55 robotic surgeries.

ACE@25 – cornerstone of superior clinical outcome

Few parameters

Institutes benchmarked against

Mortality Rate

Cleveland Clinic

ALOS

Mayo Clinic

Complication rates

National Healthcare Safety Network

Healthcare associated

Massachusetts General Hospital

infection rates

Patient satisfaction with

US Census Bureau

pain management

Medication errors

Singapore General Hospital

Transplant survival rates

National Kidney Foundation (NKF)

Source: Company, HSBC

Apollo expansion timeline

1983-88 1989-2000 2001-04 2005-10 2011-14
1983-88
1989-2000
2001-04
2005-10
2011-14

Apollo Hospital, Chennai

Indraprastha Apollo Hospitals,

Apollo Gleneagles, Kolkata

Imperial Hospital, Bangalore

Plans to add 2,418 beds

Apollo Hospital, Hyderabad

Delhi

Hospitals in Mysore,

2 REACH Hospitals, and

by FY14

 

Apollo Specialty Hospital,

Ahmedabad, Bilaspur

hospitals in Bhubaneshwar,

 

Chennai

Apollo Standalone pharmacy

Secunderabad, Mauritius,

 

Lavasa, Dhaka, Kakinada

Apollo Muncih Health Insurance

Apollo Health Street

Source: Company data

Healthcare

Hospitals 9 July 2012

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A few firsts at Apollo

First in critical surgeries

First transplants

First in technology

929 solid organ transplants in a single calendar

Paediatric liver transplant in India

First to install the most modern diagnostic and

year, the transplant programme of the Apollo

surgical infrastructure like the 320-Slice CT

hospitals is the first program in the world to

Scan and many others

cross the 900 barrier in transplants

First donor incompatible kidney transplant

Adult liver transplant in India

First hospital group to bring the 320 Slice CT-

performed at Apollo Hospitals Chennai using

Angio scan system and the 64 Slice CT-Angio

technique of column adsorption of blood group

scan system to India

antibodies

World's 1st iPod Navigation Hip Resurfacing

Cadaver liver transplant

in India

First hospital group in Southeast Asia to

Surgery was successfully performed at Apollo

Speciality Hospitals, Chennai

Pioneered open heart surgeries and cardiac

catheterization, in the early 1980’s

By 1992, Apollo Hospitals introduced Artery

Stenting for the first time in India

Transplant in acute liver failure in India

Liver-kidney transplant in India were all

performed by Apollo Hospitals

Conducted over 90,000 cardiac surgeries - one

of only 10 hospitals in the world to achieve

these volumes. Achieved a 99.6% success rate

in cardiac bypass surgeries, over 91% of which

were beating heart surgeries

Pioneer of the preventive health check

programmes in India and performed 3m checks

to date

Apollo Hospitals was the first Indian hospital

group to introduce Stereotactic Radiotherapy

and Radiosurgery for cancer treatment

Pioneered orthopaedic procedures like hip and

knee replacements, the Illizarov procedure and

the Birmingham hip re-surfacing technique

introduce the 16 Slice PET-CT Scan

Equipped with the largest and most

sophisticated sleep laboratory in the world

Introduced the most advanced CyberKnife®

Robotic Radio Surgery System in Asia Pacific,

the world’s first and only robotic radiosurgery

system designed to treat tumours anywhere in

the body with sub-millimetre accuracy