Fortis Healthcare - Myirisbreport.myiris.com/NFASIPL/FORHEALT_20130503.pdf · Nomura | Fortis Healthcare May 3, 2013 3 Cashflow (INRmn) Year-end 31 Mar Notes FY11 FY12 FY13F FY14F

Key company data: See page 2 for company data and detailed price/index chart.

Fortis Healthcare FOHE.NS FORH IN

HEALTH CARE & PHARMACEUTICALS

EQUITY RESEARCH

One for the patient; upgrade to Buy

Investors’ interest to be driven by business stability, gradual improvement in financials

May 3, 2013

Rating Up from Neutral

Buy

Target price Reduced from 170 INR 124

Closing price April 30, 2013 INR 101

Potential upside +22.8%

Action: Upgrade to Buy; TP lowered to INR124 Fortis’ business strategy appears to have made a complete U-turn. From being very aggressive on acquisitions, management is now focusing on consolidating businesses and pursuing an asset light model. The international acquisition strategy pursued by management in FY12 led to net debt-to-equity rising to 1.98x, which by end-FY14F is likely to reduce to 0.38x, based on our estimates. Divestment of assets and businesses through FY13F and FY14F will lead to this improvement, in our view. Near-term ROE is low at 1-3% but we expect average incremental ROE over the next five years to be ~33%. The stock has been a significant underperformer vs. peers over the past four years, with its P/B multiple contracting from 3x in FY10 to 0.82x in FY14F. We capture the longer-term improvement through DCF. Our DCF value of INR124/sh implies a potential upside of 23%. Upgrade to Buy.

Catalysts Commissioning and ramp-up of the newly commissioned Gurgaon, Ludhiana and Chennai facilities and subsequent improvement in margins; lower capex and improvement in ROEs.

DCF-based TP lowered to INR124; Buy With operating and financial leverage kicking in, we expect robust earnings growth beyond the explicit forecast period. We estimate earnings CAGR of 23% over FY15-24F. We use 13% COE and 5% terminal growth rate beyond FY24F. We factor in only the announced pipeline projects and low leverage in our DCF model. Cash flows are discounted back to FY14F.

31 Mar FY12 FY13F FY14F FY15F

Currency (INR) Actual Old New Old New Old New

Revenue (mn) 29,840 24,371 59,671 28,202 53,962 58,876

Reported net profit (mn) 722 2,264 6,561 3,131 687 1,531

Normalised net profit (mn) 722 2,264 6,561 3,131 687 1,531

FD normalised EPS 1.78 5.24 16.19 7.25 1.39 3.09

FD norm. EPS growth (%) -41.0 47.1 808.4 38.3 -91.4 122.8

FD normalised P/E (x) 56.8 N/A 6.2 N/A 72.9 N/A 32.7

EV/EBITDA (x) 28.3 N/A 14.6 N/A 15.3 N/A 12.5

Price/book (x) 1.3 N/A 0.8 N/A 0.8 N/A 0.8

Dividend yield (%) na N/A na N/A na N/A na

ROE (%) 2.2 6.4 16.1 8.2 1.3 2.7

Net debt/equity (%) 197.8 net cash 94.4 net cash 38.0 35.9

Source: Company data, Nomura estimates

Anchor themes

We believe Fortis Healthcare is a play on the growth story in Asia Pacific healthcare. In our view, Fortis has come to the end of an investment cycle and will now focus on cash flows and profitability.

Nomura vs consensus

Our FY15F EBITDA is 10% higher than consensus.

Research analysts

India Pharmaceuticals

Saion Mukherjee - NFASL [email protected] +91 22 4037 4184

Aditya Khemka - NSFSPL [email protected] +91 22 4037 4197

See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts.

Nomura | Fortis Healthcare May 3, 2013

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Key data on Fortis Healthcare Income statement (INRmn) Year-end 31 Mar FY11 FY12 FY13F FY14F FY15FRevenue 14,828 29,840 59,671 53,962 58,876Cost of goods sold -3,930 -6,673 -10,621 -9,531 -10,103Gross profit 10,898 23,167 49,049 44,431 48,773SG&A -7,121 -13,575 -25,408 -24,698 -27,232Employee share expense -2,731 -7,382 -19,691 -17,671 -18,731Operating profit 1,046 2,211 3,950 2,062 2,809

EBITDA 2,091 4,033 6,777 4,691 5,665Depreciation -1,045 -1,822 -2,827 -2,629 -2,855Amortisation

EBIT 1,046 2,211 3,950 2,062 2,809Net interest expense -696 -2,970 -6,426 -2,416 -1,978Associates & JCEs -75 13 75 75 75Other income 923 1,773 1,838 1,488 1,371Earnings before tax 1,198 1,028 -563 1,209 2,277Income tax -152 -408 153 -272 -528Net profit after tax 1,046 619 -410 937 1,748Minority interests -44 40 -820 -250 -218Other items 242 63 7,790 0 0Preferred dividends

Normalised NPAT 1,244 722 6,561 687 1,531Extraordinary items

Reported NPAT 1,244 722 6,561 687 1,531Dividends

Transfer to reserves 1,244 722 6,561 687 1,531

Valuation and ratio analysis

Reported P/E (x) 33.5 56.8 6.2 72.9 32.7Normalised P/E (x) 33.5 56.8 6.2 72.9 32.7FD normalised P/E (x) 33.5 56.8 6.2 72.9 32.7FD normalised P/E at price target (x) 41.1 69.6 7.7 89.4 40.1Dividend yield (%) na na na na naPrice/cashflow (x) na 14.1 7.4 261.4 8.1Price/book (x) 1.3 1.3 0.8 0.8 0.8EV/EBITDA (x) 29.4 28.3 14.6 15.3 12.5EV/EBIT (x) 61.1 51.5 24.8 34.0 25.0Gross margin (%) 73.5 77.6 82.2 82.3 82.8EBITDA margin (%) 14.1 13.5 11.4 8.7 9.6EBIT margin (%) 7.1 7.4 6.6 3.8 4.8Net margin (%) 8.4 2.4 11.0 1.3 2.6Effective tax rate (%) 12.7 39.7 na 22.5 23.2Dividend payout (%) 0.0 0.0 0.0 0.0 0.0Capex to sales (%) 23.8 19.1 -9.8 -43.5 6.0Capex to depreciation (x) 3.4 3.1 -2.1 -8.9 1.2ROE (%) 3.8 2.2 16.1 1.3 2.7ROA (pretax %) 2.1 2.7 3.3 1.9 3.0

Growth (%)

Revenue 101.2 100.0 -9.6 9.1EBITDA 92.9 68.0 -30.8 20.8EBIT 111.3 78.7 -47.8 36.2Normalised EPS -41.0 808.4 -91.4 122.8Normalised FDEPS -41.0 808.4 -91.4 122.8

Per share

Reported EPS (INR) 3.02 1.78 16.19 1.39 3.09Norm EPS (INR) 3.02 1.78 16.19 1.39 3.09Fully diluted norm EPS (INR) 3.02 1.78 16.19 1.39 3.09Book value per share (INR) 79.89 80.28 130.27 120.04 123.13DPS (INR) 0.00 0.00 0.00 0.00 0.00Source: Company data, Nomura estimates

Relative performance chart (one year)

Source: ThomsonReuters, Nomura research

(%) 1M 3M 12M

Absolute (INR) 0.9 -8.0 -5.3

Absolute (USD) 1.1 -9.5 -8.0

Relative to index -2.4 -5.8 -17.8

Market cap (USDmn) 925.0

Estimated free float (%)

52-week range (INR) 119.4/89.55

3-mth avg daily turnover (USDmn)

0.49

Major shareholders (%)

Promoter 81.4

Source: Thomson Reuters, Nomura research

Notes

On our estimates, Fortis trades at 0.8x FY13F price-to-book value


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Cashflow (INRmn) Year-end 31 Mar FY11 FY12 FY13F FY14F FY15FEBITDA 2,091 4,033 6,777 4,691 5,665Change in working capital -336 7,071 -3,310 -1,390 -160Other operating cashflow -2,573 -8,188 2,043 -3,109 700Cashflow from operations -818 2,916 5,510 192 6,204Capital expenditure -3,536 -5,700 5,852 23,500 -3,537Free cashflow -4,354 -2,784 11,362 23,692 2,667Reduction in investments 0 0 0 0Net acquisitions

Reduction in other LT assets -1,170 -9,847 2,350 0Addition in other LT liabilities 967 -573 -30 22Adjustments 25,272 -3,114 16,864 -2,320 -22Cashflow after investing acts 20,918 -6,101 17,806 23,692 2,667Cash dividends

Equity issue 13,421 5 3,700 5,977 0Debt issue -45,746 9,418 -14,733 -27,275 0Convertible debt issue

Others -74 -805 -6,976 -2,447 -1,956Cashflow from financial acts -32,399 8,617 -18,009 -23,744 -1,956Net cashflow -11,481 2,516 -204 -52 711Beginning cash 13,113 1,633 4,149 3,945 3,893Ending cash 1,633 4,149 3,945 3,893 4,604Ending net debt 9,201 64,362 49,833 22,610 21,899Source: Company data, Nomura estimates

Balance sheet (INRmn) As at 31 Mar FY11 FY12 FY13F FY14F FY15FCash & equivalents 1,633 4,149 3,945 3,893 4,604Marketable securities

Accounts receivable 1,940 5,467 5,970 5,552 6,288Inventories 263 799 897 809 871Other current assets 10,275 9,423 11,547 10,547 10,547Total current assets 14,111 19,838 22,360 20,802 22,310LT investments

Fixed assets 27,820 97,478 90,298 64,170 64,851Goodwill

Other intangible assets

Other LT assets 5,807 6,977 16,825 14,475 14,475Total assets 47,739 124,293 129,483 99,446 101,636Short-term debt 1,498 31,778 32,222 24,948 24,948Accounts payable 1,691 7,730 7,499 6,653 7,160Other current liabilities 1,361 5,603 5,249 3,199 3,330Total current liabilities 4,550 45,111 44,971 34,800 35,437Long-term debt 9,336 36,733 21,555 1,555 1,555Convertible debt

Other LT liabilities 635 1,602 1,029 998 1,020Total liabilities 14,521 83,446 67,555 37,354 38,013Minority interest 304 8,308 9,128 2,628 2,628Preferred stock 0 0 3,700 3,700 3,700Common stock 4,094 4,095 4,095 4,693 4,693Retained earnings 28,820 28,444 45,004 51,071 52,602Proposed dividends

Other equity and reserves

Total shareholders' equity 32,914 32,539 52,800 59,464 60,994Total equity & liabilities 47,739 124,293 129,483 99,446 101,636

Liquidity (x)

Current ratio 3.10 0.44 0.50 0.60 0.63Interest cover 1.5 0.7 0.6 0.9 1.4

Leverage

Net debt/EBITDA (x) 4.40 15.96 7.35 4.82 3.87Net debt/equity (%) 28.0 197.8 94.4 38.0 35.9

Activity (days)

Days receivable 43.0 45.4 35.0 39.0 36.7Days inventory 28.0 29.1 29.1 32.7 30.3Days payable 240.0 258.4 261.7 271.0 249.5Cash cycle -169.0 -183.8 -197.6 -199.3 -182.5Source: Company data, Nomura estimates

Notes

We are building in capex of INR3bn for FY14F, in line with management’s expectations

Notes

We expect the company to deleverage the balance sheet over FY13-14F by sales of assets and fresh issue of equity


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We lower our 12-month TP on Fortis to INR124 and upgrade the stock to Buy. Our positive stance on the stock is driven by: a) consolidation of the business with steady and gradual improvement in financials and b) stock underperformance over the last three years, resulting in a valuation discount to its peers, in our view. In our opinion, Fortis’ business strategy has made a complete U-turn. From being very aggressive on acquisitions, management now appears focused on consolidating businesses and pursuing an asset light model. As of FY13F, 84% of the consolidated sales accrue from assets which have been acquired over the last eight years. The international acquisition strategy pursued by management in FY12 led to net debt-to-equity rising to 1.98x with EBITDA-to-interest ratio of 1.36x. In FY13F, we expect Fortis to reduce its balance sheet leverage through: a) hiving off the key Indian Hospital Infrastructure into Religare Health Trust (RHT) and thus moving into a predominantly asset light model and b) selling a stake in its Diagnostic business Super Religare Laboratories (SRL) to private equity. We estimate net debt-to-equity to be reduced to 0.94x by end FY13F. In FY14F, we expect Fortis to further deleverage its balance sheet by: a) selling a stake in Dental Corp; b) fresh issue of shares to comply with the SEBI’s regulation of promoter stake being at a maximum of 75% by June 2013; and c) issuing fresh shares and convertibles to meet capital expenditure and other expenses. We estimate debt-equity ratio of 0.38x by end-FY14F.

We forecast a steady revenue CAGR at 17.6% over FY13-15F ex Dental Corp (DC). We exclude DC as Fortis would sell its stake in the entity in Q1FY14, as per management. Historically, DC was a high margin business for Fortis with EBITDA margin at 18%. Thus, we estimate that the exclusion of DC would bring down Fortis’ consolidated margins in the near term but we expect improvement over time on ARPOB (average revenue per occupied bed) improvement, higher capacity utilisation and leverage on net rental paid to RHT. Currently ROE is low at 1-3% (FY14-15F), but should improve as asset turnover increases; we expect average incremental ROE over next five years at ~33%.

We value Fortis based on discounted cash flows (DCF) to arrive at our 12-month target price of INR124. We believe Fortis’ current earnings and profitability are suppressed and consequently, multiple based valuations on near-term earnings are likely to fail to appropriately capture the long-term improvement that we anticipate. On a lower base, we expect strong growth in EBITDA from FY15F onwards as net service fee grows at a slower pace compared to operational EBITDA and Fortis starts to receive dividend income from RHT. As well, we expect contributions from the newly commissioned facilities to improve. We forecast FY14-17F EBITDA CAGR of 24%. We estimate FY17F net earnings at INR3.06bn vs. INR687m in FY14F. We are conservative in our valuation to the extent that we have assumed no leverage by the terminal year.

Fortis is currently trading at 33x FY15F P/E (FY15F EPS of INR3.09) at a significant premium to its peers. With a high asset base and associated operating leverage, we expect Fortis’ earnings growth to be higher vs. its peers beyond the explicit forecast period. In our opinion, comparison on an EV/EBITDA basis is more appropriate. On an EV/EBITDA basis, Fortis trades in line with Apollo (APHS IN, Buy) and also at a 13% discount to its regional peers.

Over the last three years the stock has corrected 37% vs. +83% for Apollo. As indicated in Fig. 3, on a P/B basis the stock has corrected from 3x in FY10 to 0.82x in FY13F. Over the same period, the P/B multiple for peers has expanded with average P/B multiple of 5.1x currently. We expect investors’ confidence in Fortis to rise with stability in the business accompanied by gradual improvement in the financials. Our 12-month target price implies a P/B of 1.1x on FY14F.


5

We set 12-month TP at INR 124, based on DCF We value Fortis based on discounted cash flows (DCF). We believe Fortis’ current earnings and profitability are suppressed and consequently, multiple-based valuations on near-term earnings are likely to fail to appropriately capture the long-term improvement that we expect. We think Fortis’ near-term earnings are suppressed owing to management’s aggressive acquisitions and commissioning of large hospitals in Gurgaon, Ludhiana and Chennai. The company managed to reduce debt by transferring some of its assets to RHT (Religare Health Trust). However, as detailed later in the report, we believe the financial impact is marginal in the near term as Fortis is committed to a high service fee payout to the Trust. On a lower base, we estimate strong growth in EBITDA from FY15F onwards as net service fee expands at a slower pace compared to operational EBITDA and Fortis starts to receive dividend income from RHT. In addition, we expect contributions from the newly commissioned facilities to improve. We estimate FY14-17F EBITDA CAGR of 24%. We forecast FY17F net earnings at INR3.06bn vs. INR687m in FY14F.

Key assumptions of our long-term DCF model include:

• We assume contribution from only five greenfield hospitals that are planned by Fortis and RHT at this stage. The hospitals that we have included in our model are Gurgaon, Ludhiana I (currently under Fortis), Ludhiana II (under RHT), Arcot Road Chennai (brownfield), and Hyderabad (under RHT). In addition, we also consider expansion in already operational hospitals. We estimate the number of operating beds will increase from 3,386 in FY13 to 6,545 in FY21.

• We assume the blended EBITDA margin for India Hospital business to rise from 14.3% in FY13F to 19.3% in FY21F.

• We assume the diagnostic business to maintain mid-high teen growth over FY13-FY20F. Being the largest and most established player in an underpenetrated market, we expect sustainable growth over the long term.

• We remain conservative on our international business forecast at 4% revenue CAGR over the long term.

• Tax rate assumed at 30% over the long term.

• Capex assumed is related to capacity expansions and maintenance capex. We expect capex intensity to be much lower vs the asset heavy model previously. Fortis will be investing primarily in equipment going forward, in our view.

• We use cost of equity of 13%. (Risk free rate of 8%, Beta of 1 and risk premium of 5.0).

• Terminal growth rate of 5%.

• Cash flows are discounted back to FY14F.

We arrive at a target price of INR124, presenting a potential upside of 23%. We are conservative in our valuations to the extent that we have assumed no leverage by the terminal year.


6

Fig. 1: Our DCF model (INR mn)

Cash flow FY14F FY15F FY16F FY17F FY18F FY19F FY20F FY21F FY22F FY23F FY24F

PBT 1,134 2,202 3,051 4,692 6,501 8,450 9,994 11,663 13,317 13,922 14,552

Depreciation 2,629 2,855 3,190 3,511 3,812 4,187 4,631 5,066 5,461 5,840 6,247

Tax (272) (528) (915) (1,408) (1,950) (2,535) (2,998) (3,499) (3,995) (4,177) (4,366)

Associate Income 75 75 75 75 75 75 75 75 75 75 75

Minority interest (6,750) (218) (257) (298) (346) (388) (413) (439) (467) (489) (511)

Change in WC 929 (138) 257 204 191 218 318 346 335 227 238

Capex 23,500 (3,537) (3,896) (3,247) (3,428) (4,921) (4,937) (4,733) (4,053) (4,369) (4,672)

Debt raised (27,275) - (1,344) (3,500) (5,000) (5,000) (1,500) (1,500) (2,000) - -

Equity raised 5,977 - - - - - - - - - -

Cash to equity (52) 711 161 30 (145) 85 5,170 6,979 8,673 11,030 11,564

Terminal cash flow 151,776

Total cash flow (52) 711 161 30 (145) 85 5,170 6,979 8,673 11,030 163,340

Year - 1 2 3 4 5 6 7 8 9 10

Cost of Equity 13%

Terminal growth 5%

NPV (52) 629 126 21 (89) 46 2,483 2,967 3,262 3,672 48,118

NPV (Mar 2013) 61,183

Value per share 124

Net debt / equity 0.38 0.36 0.32 0.25 0.17 0.09 0.07 0.05 0.03 0.01 -0.02

RoE 1.3% 2.7% 3.4% 5.0% 6.6% 8.1% 9.1% 10.5% 12.0% 12.5% 13.1%

Source: Nomura estimates

Fig. 2: Valuation compared to peers

* Note: Fortis’ RoE for FY14E as FY13E RoE is distorted due to gains from asset sales

Source: Bloomberg consensus for Not Rated (NR) stocks, Nomura estimates. Share prices are as of 30 April 2013.

Fortis currently trades at 33x FY15F P/E (FY15F EPS of INR3.09) at a significant premium to its peers. With a high asset base and associated operating leverage, we expect Fortis’ earnings growth to be higher vs peers beyond the explicit forecast period. We believe comparison on an EV/EBITDA basis is more appropriate. On EV/EBITDA Fortis trades in line with Apollo and also at a 13% discount to its regional peers.

Over the last three years the stock has corrected 37% vs +83% for Apollo. As indicated below, on a P/B basis Fortis has corrected from 3x in FY10 to 0.82x in FY13F. Over the same period, the P/B multiple for its peers has expanded.

P/B

(local currency)

Raffles Medical RFMD SP Neutral 3.42 1,516 32.8 29.9 26.5 11% 23.5 21.0 18.0 15.7% 4.8

IHH IHH MK Reduce 3.75 9,984 33.9 45.6 35.2 -2% 25.5 21.4 17.4 5.5% 1.8

KPJ Healthcare KPJ MK NR 6.07 1,297 28.8 24.5 22.0 14% 18.9 14.5 12.9 15.3% 3.5

Bangkok Chain BCH TB NR 21.1 822 28.0 25.5 22.1 13% 17.7 14.6 13.0 24.0% 6.2

Bangkok Dusit BGH TB Buy 169 8,890 32.8 35.8 30.4 4% 23.3 20.7 17.9 23.1% 7.1

Bumrungrad Hosp BH TB Neutral 82.25 2,040 22.0 25.4 22.5 -1% 17.6 16.3 14.2 35.5% 6.9

Ramsay HC RHC AU Neutral 32.29 6,690 26.6 23.0 20.2 15% 14.8 11.9 10.8 19.4% 4.7

Average 29.3 30.0 25.6 7% 20.2 17.2 14.9 19.8% 5.0

Apollo Hospitals APHS IN Buy 834.2 2,161 33.6 27.3 22.6 20% 18.3 15.2 12.7 11.9% 4.0

Fortis Healthcare FORH IN Buy 101.15 763 -33.3 72.9 32.7 14.7 15.5 12.7 2.2% 0.8

FY13/CY12

Growth (FY13-

15)RoE

(FY13)

EV / EBITDA

FY13/CY1

2FY14/CY13

FY15/CY14

P/E

FY14/CY13

FY15/CY14Company

BBG Ticker Rating

Mcap (USD

m)FY13/CY12


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Fig. 3: Fortis vs. peers on price to book value (x)

Note: The ratios are point estimates and not time series; eg, FY12 price / book is equal to market cap as of 31 March 2012 divided by shareholders’ equity for FY12.

Source: Bloomberg, Nomura estimates

In our opinion, the correction in the Fortis’ share price is due to higher leverage, change in management’s business strategy and corporate restructuring, which created greater uncertainty. Fortis’ financials and business details are addressed later in the report. We expect investors’ confidence to rise with stability in Fortis’ business, accompanied by gradual improvement in the company’s financials.

Our TP implies a P/B of 1.1x on FY14F. ROE is low at ~3% (FY15F). We expect Fortis to be on a consolidation mode and margins and return ratios to increase with growth. Over the next five years, we estimate average incremental RoE to be ~33%.

Financials We expect steady revenue CAGR at 17.6% over FY13-15F for Fortis, ex Dental Corp. We exclude DC as the company would sell its stake in the entity in Q1FY14, as per management. DC was a high margin business with 9MFY13 EBITDA margin at ~18%. Thus, exclusion of DC would bring down consolidated margins in the near term. We project EBITDA margin to decline to 8.7% in FY14F vs 11.4% in FY13F. Margin compression is also, to an extent, driven by commissioning of new hospitals in FY14F, in our view. However, we expect margins to improve from FY14F levels on higher utilisation of newly commissioned facilities and dividend income from RHT. We note that Fortis will not receive any dividend from RHT until FY14, as per the RHT listing prospectus. We estimate FY16F EBITDA margin to retrace back to 11%. ROE is low currently at 1-3% (FY14-15F), but should improve as asset turnover increases; we forecast average incremental ROE over next five years at ~33%. Based on our calculations, balance sheet leverage should come down substantially by end-FY14F. Net debt-to-equity, which was at 1.98x in FY12, should come down to 0.38x by FY14F on account of: a) creation and listing of RHT, a healthcare trust which now holds most of the Indian hospital business’ assets; b) stake sale in SRL to private equity; c) fresh equity issuance to meet the SEBI requirement of the maximum promoter stake; and d) sell-off of stake in Dental Corp.

Revenue outlook: FY13-15F CAGR of 17.6% ex DC We classify revenue streams into a) India Hospital Business; b) International Business ex Dental Corp; c) Dental Corp and d) Diagnostics. Fortis has announced sale of its entire stake in Dental Corp and the entity is unlikely to contribute beyond Q1FY14F. As indicated below, the India Hospital segment should remain as Fortis’ key growth driver.

1.76

2.14

3.71 3.96

4.70

1.67

2.73

3.10

3.43

3.95

1.45

3.09

1.86

1.25

0.82

-

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00

FY09 FY10 FY11 FY12 FY13E

Bangkok Dusit Apollo Hosp Fortis Healthcare


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Fig. 4: Revenue mix (INR mn) We estimate FY13-FY15F revenue CAGR of 17.6% (ex Dental Corp) Revenue (INR mn) FY12 FY13F FY14F FY15F CAGR (FY13-15F)

Hospital India 19056 22860 27572 33730 21.5%

International (ex DC) 2383 13573 15241 16675 10.8%

Dental Corp 3997 17631 4628 0

Diagnostics 4340 5659 6711 7860 17.9%

Other Op Income 410 575 632 695 10.0%

Gross operating income 30186 60298 54784 58961 -1.1%

Gross operating income (ex-DC) 26189 42667 50156 58961 17.6%

Note: Revenue = Gross operating income minus discounts


Key revenue drivers Fortis’ revenue growth is driven largely by its Indian hospital business. We expect the hospital business to register a FY13-15F CAGR of 21.5%. Excluding Fortis’ pipeline projects (Gurgaon, Hyderabad, Chennai, Ludhiana Phase I and II), we expect the India hospital business to expand at a CAGR of 15.6% over the same period. Revenue and EBITDAC (EBITDA before payment of fees to RHT) contributions from these new facilities are estimated at 5.2% and 2.7%, respectively, of consolidated FY15F. Growth in the hospital business is also likely to be led by improvement in ARPOB.

Fig. 5: Split of revenue growth between existing and new hospitals (INR mn)


14,955

19,056

22,815

26,406

30,630

- - 45 1,166

3,100

-

5,000

10,000

15,000

20,000

25,000

30,000

35,000

FY11 FY12 FY13E FY14E FY15E

Existing Hospital revenues Pipeline revenues


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Fig. 6: Improvement in ARPOB (INR mn/year), operating beds, occupied beds in India Hospitals


We see scope for improvement in ARPOB for Fortis. In Figs. 6 and 7 we compare ARPOB of Fortis with Apollo and also with regional peers. Average length of stay (ALOS) which is a measurement of efficiency and a driver of ARPOB, also show scope for improvement, in our assessment.

Fig. 7: Comparison of ARPOB

INR mn /year FY13F FY14F FY15F

Fortis ARPOB 10.16 10.66 11.23

Apollo ARPOB 11.50 12.31 13.19


Fig. 8: Comparing operational parameters We see scope for improvement

CY11/FY12 ARPOB

(INR mn)ALOS (days)

EBITDA margins (%)

IHH Total 24.1 2.99 19.6

Singapore assets 40 3.29 15

Parkway Panti- Malaysia 13 2.60 26

Turkey assets 29 3.40 20

Bangkok Dusit 21.6 2.90 23.2

Bumrungrad Hospital 35.7 NA 24.9

RHC Australia 29.8 NA 15.6

Fortis Healthcare (India hospitals) 9.7 4.00 12.7

Apollo Hospitals (Hospital margins) 10.6 4.85 17.9

Source: Company data, Nomura research

• We expect SRL to register revenue FY13E-15F CAGR of 17.9%. We believe growth in SRL will be driven by increasing utilization levels and addition of pathlabs.

• Growth in the international business ex-DC is likely to be largely driven by growth in sales of Hoan My.

Margins should improve from FY15F We define EBITDA and EBITDAC margins separately. EBITDAC is EBITDA before the impact of net rent paid to RHT. Net rent is the rent paid net of costs transferred to RHT and dividend income gained from RHT. EBITDA is post net payments made to RHT.

We believe Fortis’ EBITDAC margin is currently suppressed at 13.5% (FY13F). Based on our observations the lower margins are on account of lower ARPOB, the newly

2,596 2,830

3,386

3,801

4,313

1,810 2,105

2,397

2,773

3,233

9.1

9.7

10.2

10.7 11.2

0.0

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-

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5,000


No. of Operating beds (RHS) No. of Occupied Beds (RHS) Fortis ARPOB (INR m / year)


10

commissioned hospitals and lower utilisation in the SRL business. Below, we split the EBITDAC margin into various segments. Fig. 9: EBITDAC margin split

EBITDAC margins FY13F FY14F FY15F

India Hospitals 14.3% 14.8% 16.1%

International business 13.1% 12.9% 13.4%

SRL 13.0% 15.0% 17.0%

Consolidated EBITDAC 13.5% 14.2% 15.5%


Fig. 10: Comparison of the Hospital Business margin with Apollo

Hospital business margins FY13F FY14F FY15F

Fortis 14.3% 14.8% 16.1%

Apollo 17.4% 17.4% 17.2%


We note that Fortis’ hospital business margin is almost ~300bps lower than that of Apollo. We note that Apollo in its reported financials deducted doctors’ fees from revenue whereas Fortis shows it as a cost. For the purpose of this comparison we have made requisite adjustments in Apollo’s margin (assuming 22% of Apollo’s revenues as doctors’ fees). We believe the lower margin is primarily due to relatively lower ARPOB (including doctors’ fees) which we believe is a function of case mix.

We expect Fortis Hospital business EBITDA margin to improve as case mix improves. For instance, we expect higher contribution from high margin segments like Orthopaedics and Oncology.

Fig. 11: Specialty revenue split (FY10) High contribution from cardiac segment


Fig. 12: Specialty revenue split (3QFY13) Lower contribution from low margin cardiac segment


The improvement in margins should also led by improved profitability of newly commissioned facilities, eg, Gurgaon and higher utilisation at SRL.

We estimate that for SRL, margins would expand from 10% in FY12 to 17% in FY15F led by better utilisation. As per Fortis, utilisation of the labs is low at ~35%. In our longer-term projections, we are building in a peak EBITDA margin of 20% for SRL from FY18F onwards. As per management, the diagnostic business could reach peak margins of 25%. Compared to international peers, EBITDA margins for SRL are much lower despite

Cardiac, 43%

Orthopaedics, 7%Neuro, 6%Renal, 4%

Pulmonology, 3%

Oncology, 3%

Gastroenterology, 2%

Multispecialty, 18%

OPD & Others, 14%

Cardiac, 35%

Orthopaedics, 8%

Neuro, 6%

Renal, 5%Pulmonology,

2%

Oncology, 4%

Gastroenterology, 4%

Multispecialty, 17%

OPD & Others, 19%


11

lower employee costs. Thus, with increased volumes we expect overheads (particularly lease rental) to be absorbed leading to expansion in margins. Fig. 13: FY15E EBITDA margins for SRL and regional peers Average EBITDA margins for international peers is at 23% for FY15F vs. our projection of 17% for SRL

Note: Bloomberg estimates for peers; Nomura estimates for SRL

Source: Bloomberg, Nomura estimates

Overall, we estimate Fortis’ EBITDAC margin to improve by 174bps in FY15F over FY13F. The net rent paid as percentage of revenue should decline over a period of time resulting in improvement in EBITDA margins. The net rent paid out increases in FY15 as there is a step jump in fees to be paid to RHT for the Gurgaon clinical establishment. Fig. 14: EBITDA and EBITDAC margins


Decline in leverage Post acquisition of the international entity, net debt had increased to INR64bn as of end-FY12, leading to net debt-to-equity to rise to 1.98x.

22%23%

19%

27%

23%

17%

0%

5%

10%

15%

20%

25%

30%

Quest Lab Corp Sonic Primary Health Average SRL

Quest Lab Corp Sonic Primary Health Average SRL

13.5% 13.5%14.2%

15.5%16.6%

17.5% 18.0% 18.3% 18.6% 18.9% 19.0%

13.5%

11.4%

8.7%9.8%

11.0%12.0%

12.6%13.2% 13.7% 14.2% 14.5%

0.0%

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2.0%

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FY12 FY13E FY14E FY15E FY16E FY15E FY18E FY19E FY20E FY21E FY22E

EBITDAC margin (LHS) EBITDA margin (LHS) Net rent as % of consolidated sales (RHS)


12

Fig. 15: Increase in debt levels in FY12 (INR mn) The international acquisition contributed significantly to increase in net debt In FY12


In our view, debt is likely to reduce substantially by end-FY14F on account of: a) stake sale and listing of RHT; b) selling its stake in Dental Corp; c) reducing promoter stake by fresh issue of shares and d) stake sale in SRL.

Fortis realised INR21.7bn from dilution in RHT and INR14.8bn from divestment in Dental Corp. Further, Dental Corp has debt of INR7.5bn on its balance sheet, which will be transferred to the acquirer on divestment, which is expected by the company to be consummated by 1QFY14.

Additional equity issuance to comply with SEBI requirements: The promoter group currently owns 81.5% of the company. As per the SEBI guidelines, the promoters have to bring down their stake to below 75% by June 2013. To comply with the requirements, the company has announced plans to issue 35-45mn fresh equity shares. We are penciling-in issue of 35mn shares at the CMP of ~INR100/share, resulting in cash inflow of INR3.5bn. Further, the company also announced plans to issue up to 28.6mn equity shares to IFC Washington to raise up to USD45mn and issue FCCB worth USD55mn. In our model, we are building in an issue of 24.8mn shares to IFC at the CMP of ~INR100/sh, which would enable Fortis to raise USD45mn.

As a result of these transactions, we estimate that net debt-to-equity should come down to 0.38x by end-FY14F.

9,201

64,298

47,838

9,300 503 -2,544

-

10,000

20,000

30,000

40,000

50,000

60,000

70,000

FY11 Net Debt International acquisition

SRL acquisition Net profit + Depn

Others FY12 Net Debt


13

Fig. 16: Improvement in net debt (INR mn)


Assessing the interest burden

We believe the creation of RHT was only a marginal incremental positive for Fortis. As we highlight below, the impact would be approximately INR214mn for FY14F which is ~1% of the money raised through RHT. Fig. 17: Impact of RHT stake sale on Fortis’ P&L

INR mn FY14F

Without RHT

EBITDAR 7,667

Net service fees -

EBITDA 7,667

Other income 1,488

Depreciation 2,939

Interest Cost 5,296

EBT 920

With RHT

EBT with RHT 1,134

Variance 214


Though RHT is a marginal incremental positive, we think redemption of FCCB and preference share should put upward pressure on interest costs. No interest expense is provided for in the P&L for the outstanding FCCB of USD100mn, which is due for repayment in May 2015. Since the FCCB is out of money (conversion price is INR167/sh), we do not anticipate conversion. The FCCB carries a YTM of 5.54%. We estimate that redemption will lead to an outgo of ~INR7bn. Similarly, Fortis does not provide through P&L for interest on a USD262m redeemable preference share taken from the promoters. We estimate redemption of the preference shares in July 2013 resulting in cash outflow of INR15bn. This is repayable at a coupon of 5% p.a. by July 2013.

On our estimates, we build in repayment of USD100mn and USD262mn on the May 2015 FCCB and July 2013 preference shares, respectively. We also account for the USD55m issue to IFC Washington that is expected by the company to consummate in 1QFY14.

64,298

22,546

9,500

-3700 -5977 6,839

-21,000

-22,500

-4,913

-

10,000

20,000

30,000

40,000

50,000

60,000

70,000

FY12 Net Debt

RHT stake sale

Dental Corp sale

Capex Net prof it + Depn

SRL dilution

Fresh issue of equity



14

Fig. 18: Debt profile (INR mn)


Overall reduction in debt levels is expected by FY14F to substantially bring down interest costs. Fig. 19: Interest cost


Return ratio suppressed but likely to record improvement

Fortis’ return ratios are significantly suppressed. We analyse lower ROE through a Du Pont analysis. The low ROE is on account of both low margin and low asset turnover, in our view. Below we compare the various component ratios of Fortis and Apollo.

5090 5490 5490 8,518 8,518 3,168

13336 14384 143840 0

0

4666739726

33904

17985 1798521991

0

10000

20000

30000

40000

50000

60000

70000

FY12 9mFY13 FY13E FY14E FY15E FY16E

FCCB Redeemable Pref Share to Promoter Other Debt

6,426

2,416

1,978

2,419

-

1,000

2,000

3,000

4,000

5,000

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7,000

FY13E FY14E FY15E FY15E

Interest Cost


15

Fig. 20: Du Pont analysis of Fortis and Apollo Fortis lags Apollo due to relatively lower margins and asset turnover

Du Pont analysis Net profit /

EBITDA EBITDA /

Sales

Sales / Fixed

Assets

Fixed Assets /

Total Assets

Total Assets /

EquityRoE

Fortis FY14F 14.6% 8.7% 0.69 0.79 1.78 1.2%

Apollo FY14F 51.2% 17.3% 1.05 0.80 1.75 13.1%

Fortis FY15F 27.0% 9.8% 0.73 0.78 1.77 2.7%

Apollo FY15F 50.6% 16.9% 1.13 0.79 1.83 14.0%


As highlighted above, margins for Fortis are relatively low, which is primarily on account of lower ARPOB. The asset base is high on large acquisitions and thus the asset turnover ratios are materially lower for Fortis. For instance, intangible for Fortis is at INR69.5bn (FY13F estimate) is 54% of the total asset base. Going forward, we believe margins will improve and asset intensity should come down. Margin improvement should be driven by operating leverage both for the hospital and the diagnostic businesses.

Fig. 21: RoE likely to improve as revenues ramp up


India Hospitals: foundation in place should deliver growth According to the company, Fortis is the second-largest private hospital chain in India (by owned bed capacity) with >6,400 beds under management (including >4800 owned and 1600 managed beds).

In India, Fortis has an extensive network of 68 hospitals/healthcare delivery centres comprising of 27 owned and operational, 28 managed and 13 under development facilities with 4,832, 1,600 and 3,645 beds, respectively, in terms of total capacity. Of the 13 facilities currently under development, three are expected by the company to be commissioned in the near term (over the next two quarters). These are in Gurgaon, Ludhiana and Arcot Road Chennai. These three hospitals have total capacity of 1,400 beds, which is almost 30% of the current bed capacity. However, we expect capacity to be added only in phases. The three newly commissioned hospitals should contribute

1.3%

2.7%3.4%

5.0%

6.6%

8.1%

9.1%

10.5%

12.0%

0.0%

2.0%

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6.0%

8.0%

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14.0%

FY14E FY15E FY16E FY17E FY18E FY19E FY20E FY21E FY22E

RoE

Three greenfield/brownfield hospitals in Gurgaon, Ludhiana and Chennai are expected by the company to be commissioned over next six months and increase bed capacity by 30%


16

39% of the incremental hospital revenues over FY13-15F. Unlike in the past, we expect growth to be driven through organic expansion and not through acquisitions.

Fig. 22: Key hospitals

Hospital Category Territory CareTotal

Capacity Operational

BedsInstalled Capacity

Fortis Hospital, Mohali Greenfield Punjab Quaternary 350 279 300

Fortis Hospital, NOIDA Greenfield NCR Quaternary 350 191 200

EHIRC - Delhi Brownfield NCR Quaternary 340 310 340

Fortis Escorts Hospital, Jaipur Greenfield Rajasthan Tertiary 320 207 320

Fortis Escorts Hospital, Faridabad Brownfield NCR Secondary 210 210 210

Fortis Escorts Hospital, Amritsar Brownfield Punjab Secondary / Tertiary 230 153 166

Fortis Malar Hospital, Chennai Brownfield Tamil Nadu Secondary / Tertiary 225 153 178

BG Road, Bengaluru Brownfield Bengaluru Quaternary 451 243 255

Mulund, Mumbai Brownfield Mumbai Quaternary 567 236 567

Shalimar Bagh, New Delhi Greenfield NCR Tertiary 550 130 262

Anandpur, Kolkata Greenfield Kolkata Tertiary 414 126 143

Gurgaon, Haryana* Greenfield NCR Tertiary 1,000 - -

Ludhiana 1, Punjab* Greenfield Punjab Tertiary 200 - -

Ludhiana 2, Punjab* Greenfield Punjab Quaternary 75 - -

Hyderabad* Greenfield Andhra Pradesh Tertiary 400 - -

Arcot Road, Chennai* Brownfield Tamil Nadu Tertiary 200 - -

*yet to be commissioned (as of FY13)


Fig. 23: Growth has been driven by acquisitions in the past (INR mn)

Note: Inorganic revenues include SRL, Escorts, Wockhardt, Malar and International entity sales.


3,213 3,575 5,169 7,533 9,291 3,377 5,804

9,659

22,307

50,380

51%

62%65%

75%

84%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

-

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40,000

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60,000

70,000

FY09 FY10 FY11 FY12 FY13E

Organic Revenue Inorganic Revenue Inorganic as % of total


17

Fig. 24: No. of beds scaling up We expect occupancy rates to dip in the near term on new bed additions


Average occupancy across operational hospitals is 74% as of FY12, with an average ARPOB (average revenue per occupied bed) of INR9.1mn/year and ALOS (average length of stay) of 4 days. We expect ARPOB to have a CAGR of 5% over FY13-15F and beyond for our long-term projections. We see scope for improvement in these metrics beyond our explicit forecast period. Fig. 25: Average ARPOB (INR mn/Year)


Fig. 26: ALOS (days)


SRL acquisition lends a strong foothold in diagnostics

Fortis acquired 75% of SRL in May 2011 for a consideration of INR9.3bn, implying a valuation of INR12.4bn. Fortis further divested ~20% stake to private equity (PE) players at an implied valuation of >INR15bn in June 2012. Fortis will hold ~55% stake in SRL post dilution. The acquisition helped Fortis to integrate vertically while SRL also helps in generating leads for Fortis hospitals.

SRL has emerged as the largest diagnostic chain in the country, according to IMaCS, in a highly fragmented domestic market. The company operates through a network of 240 labs, 12 wellness centres and ~1,300 collection centres across the country. In our assessment, the volume of tests done at SRL is almost 3x the amount of tests done by the nearest competitor.

SRL strengthened its leadership in India through the acquisition of Piramal Diagnostics in August 2010, a landmark deal, in our view, in the Indian diagnostics sector. Piramal’s complementary offering catapulted SRL to the position of India’s largest diagnostics chain, with services spanning across pathology and radiology, according to the company. In contrast to SRL, which operates on a hub-and-spoke model, Piramal Diagnostics had

2,596 2,830

3,386

3,801

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1,810 2,105

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70%

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No. of Operating beds (RHS) No. of Occupied Beds (RHS) Fortis Occupancy rate

Acquisition of Piramal Diagnostics was highly complementary


18

an independent centres model. The Piramal business is largely dependent on walk-ins, which contribute almost 97% of sales (source: company data). SRL’s hub-and-spoke model depends on sample collection at collection centres, contributing 89% of sales with the remaining 11% being walk-ins (source: company data). Before the Piramal acquisition, SRL had little presence in radiology. Through the Piramal acquisition, SRL acquired 13 radiology labs. The acquisition also expanded SRL’s geographic presence. SRL had a limited presence in southern India. The Piramal acquisition helped SRL expand its presence in the south — Piramal has an extensive network in Kerala.

We estimate that SRL would register revenue CAGR of 18% over FY13-15F and margins would expand from 10% in FY12 to 17% in FY15F, led by better utilization. As per Fortis, utilisation of the labs is low at ~35%. In our longer-term projections, we are building in a peak EBITDA margin of 20% for SRL from FY18F onwards. As per management, the diagnostic business could reach peak margins of 25%. Compared to international peers, the EBITDA margins for SRL is much lower despite lower employee costs. Thus, with increased volumes we expect overheads (particularly lease rental) to be absorbed, leading to expansion in margins. Fig. 27: SRL’s quarterly revenue (INR mn) and margins


Fig. 28: SRL’s annual revenue (INR mn) and margins


International operations Fortis announced the acquisition of its international sister concern in September 2011 for an enterprise value of ~USD940m. The acquisition provided Fortis with an entry into the dental care and day care businesses. The acquisition of the international operations made Fortis the owner of one of the largest healthcare delivery networks in Asia Pacific. The international entity had operations in nine countries – Hong Kong, Australia, New Zealand, Singapore, Sri Lanka, Dubai, Vietnam, Mauritius and Canada. The acquisition added 8 hospitals and more than 1,700 beds to Fortis’ capacity.

620

12701220 1220

1370

1506

1372

14.5%

11.5%

7.6%7.0%

13.9%

15.9%

10.2%

0.0%

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4.0%

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0

200

400

600

800

1000

1200

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1600

Q1FY12 Q2FY12 Q3FY12 Q4FY12 Q1FY13 Q2FY13 Q3FY13

Revenues (LHS) EBITDA margins (RHS)

4,340

5,659

6,711

7,860

9.7%

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FY12 FY13E FY14E FY15E

Revenues (LHS) EBITDA margins (RHS)


19

Fig. 29: International assets revenue and EBITDA (INR mn) and EBITDA margins

Note: FY11 and FY12 figures are pro forma; we expect Dental Corp divestment by end-1QFY14F.


Fig. 30: Key international operations at the time of acquisition


The acquisition resulted in a stretch in Fortis’ balance sheet as the debt taken to acquire the company in an all-cash deal increased Fortis’ leverage to almost ~2x debt equity.

17,312

22,302

31,204

19,869

16,675

2,193 3,056

4,088 2,569 2,241

12.7%

13.7%

13.1%

12.9%

13.4%

12.0%

12.2%

12.4%

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-

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FY11 (P) FY12 (P) FY13E FY14E FY15E

Rev enue (LHS) EBITDA (LHS) EBITDA margins (RHS)

Countries Key Operation

Hong Kong Primary Care (580 centres)

Australia / NZL Dental care (174 centres)

Sri Lanka Super Specialty Hospital (1 hospital, 350 beds)

Vietnam Integrated Healthcare Provider (6 hospitals, 1100 beds)

Singapore Super Specialty Hospital (1 hospital)

Dubai Diagnostic Labs

Mauritius Multi Specialty Hospital (1 hospital, 120 beds)


20

Fig. 31: International acquisition led to significant increase in debt levels (FY12) (INR m)


Divesting Dental Corp, as it had limited success with expansion

Dental Corp (DC) was the largest international asset that Fortis acquired; we believe it accounted for c.35% of the total acquisition consideration. DC is the market leader in Australia (as per management) and targeted the top 30% of that country’s the dental market. This segment enjoyed higher margins than rest of the international business for Fortis. DC’s EBITDA margin was 18.1% in 9MFY13 vs the company average of 13.5% (EBITDAC, pre-RHT). DC contributed 39% to EBITDAC in 9MFY13.

On an expanded base, we think DC’s growth prospects were limited in Australia. Further, the scale-up efforts outside Australia/NZ had limited success. Hence, Fortis decided to divest the business. In December 2012, Fortis decided to divest its ~64% stake in DC for INR14.8bn. The transaction is expected by the company to be executed by end-1QFY14. DC had debt of INR7.5bn on its balance sheet, which will be transferred to the new owner as part of the transaction. Thus, the transaction values the DC venture at ~INR22bn. As per Fortis, it would not make any material loss or profit on the disposal of stake in DC. We believe that FY13F and FY12 revenue growth in DC was largely driven by acquisition of practices and depreciation of the Indian rupee against the Australian dollar. We estimate that organic growth in DC over the last two years was in low single digits.

Other Key assets in the international business:

Quality Healthcare: Expanding service offerings

Quality Healthcare is a day care business asset based primarily in Hong Kong. This is the largest primary healthcare service provider in Hong Kong. Quality Healthcare is “asset light” as almost 520 centres (out of ~600 centres) are operated but not owned. Fortis also bought CMDG Diagnostics based in Hong Kong to complement Quality’s capabilities. CMDG Diagnostics has 5-6 diagnostic centres in Hong Kong. With this acquisition, Fortis currently operates one of the largest radiology networks in Hong Kong.

Since the acquisition, an effort has been made by the company to move up the value chain and offer specialty services. This has been one of the key margin drivers in the recent past. Quality Healthcare’s EBITDA margins expanded from 6-7% in FY11 to 8-10% currently. We expect EBITDA margins to continue to expand as contribution of specialty services increases.

Fortis is also exploring the possibility of entering the hospitals segment through Quality Healthcare. In 2012, the company had submitted tenders for two hospitals in Hong Kong. As per management, the cost of setting up a hospital in HK is high. For instance, to set

9,201

64,298

47,838

9,300 503 -2,544

-

10,000

20,000

30,000

40,000

50,000

60,000

70,000

FY11 Net Debt International acquisition

SRL acquisition Net profit + Depn


Entering into the Hong Kong Hospital market would entail higher risk, in our view


21

up a 500-bed hospital in Hong Kong, the estimated cost is USD500mn. Besides financial commitment, operating restrictions increases the risk profile, in our view. However, the company has not had much success in this area as of now.

We believe that revenues from Quality Healthcare and CMDG Diagnostics would continue to grow at mid- to-high single digits led by an increase in average revenue per centre and marginal increase in number of centres. We are not building in any impact of the potential expansion in the hospital segment. As well, Fortis intends to use the platform to enter China, which is also not factored into our estimates, given limited visibility at this stage.

Fig. 32: Quality Healthcare (INR mn)

Note: FY11 and FY12 figures are pro forma.


Hoan My: A leading healthcare provider based in Vietnam

Hoan My has five full-service hospitals and three clinics across Central and Southern Vietnam with 800 beds. Since its acquisition by Fortis, Hoan My has been able to ramp up occupancy levels from 60% in FY11 to 75% in 2QFY13. Fortis also added a new 200-bed facility to the entity to replace an older facility.

We expect Hoan My to register a FY13-15F revenue CAGR of 22%, aided by improvement in revenue/bed and depreciation of the INR vs the VND (Vietnamese Dong). We also expect margins to improve from 16% in FY12 to 23% by FY15F on the back of better realizations and improved case mix.

6,501

7,550

9,347 9,970

10,632

423 643 776 897 983

6.5%

8.5%

8.3%9.0% 9.3%

0.0%

1.0%

2.0%

3.0%

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-

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4,000

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10,000

12,000


Revenue (LHS) EBITDA (LHS) EBITDA margins (RHS)


22

Fig. 33: Hoan My (INR mn)

Note: FY11 and FY12 figures are pro forma.


Creation of RHT Religare Health Trust (RHT) was created as Fortis endeavored to move to an asset light model. Religare Health Trust (RHT) was established following the restructuring of Fortis Healthcare. The restructuring resulted in the separation of the ownership of the clinical establishments (hospital infrastructure) and the operations and management of certain hospitals. RHT received ownerships of the clinical establishments. RHT will hold 11 clinical establishments, including Gurgaon, which is being commissioned. In addition, it holds four greenfield clinical establishments which are expected by management to be operational over the next three years. Besides holding these 15 assets, as part of the restructuring two hospitals were transferred completely (ie, infrastructure and operations) to RHT. Details of the initial portfolio are shown in the following figure. Post the restructuring, RHT (the hospital services companies), which owns the clinical establishments in the portfolio, has entered into agreements with Fortis Healthcare. As per the agreement, RHT would provide OPD (out-patient department) and radio-diagnostic services, ie, RHT incurs the costs associated with these operations. In addition, RHT will make available the infrastructure for use by Fortis Healthcare. Fortis in turn will pay service fee to use the facilities.

1,210 1,390

2,676

3,345

4,014

284 226

575 753

923

23.4%

16.3%

21.5%22.5% 23.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

-

500

1,000

1,500

2,000

2,500

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4,000

4,500


Revenue (LHS) EBITDA (LHS) EBITDA margins (RHS)


23

Fig. 34: Hospitals transferred as part of RHT

Note: Operating beds and installed capacity as of Sep 2012


Fig. 35: Relation between FOC and HSC


Key structure highlights RHT is a trust managed by trustee manager Religare Health Trust Trustee Manager Pte. Ltd. RHT has entered into hospital and medical services agreements (HMSAs) with the Fortis group. The term of each HMSA is for an initial 15 years and is extendable by mutual consent for another 15 years. However, the initial term for the provision of radio-diagnostic services is three years and Fortis can extend the term at its own discretion. In case the radio-diagnostic services are not extended, the service fee may be reduced accordingly as mutually decided.

Under the HMSAs, RHT is to provide the following to Fortis:

• Making available and maintaining RHT clinical establishments;

• OPD services;

• Radio-diagnostic services; and

Assets Type of careOperational

BedsInstalled Capacity

Amritsar Secondary & Tertiary 153 166

Bengaluru, BG Road Quaternary 239 255

Chennai, Malar Secondary & Tertiary 170 178

Faridabad Secondary 210 210

Jaipur Tertiary 207 320

Kolkata Tertiary 126 373

Mumbai, Kalyan Tertiary 44 52

Mumbai, Mulund Quaternary 236 567

New Delhi, Shalimar Bagh Tertiary 130 350

Noida Tertiary 191 200

Gurgaon Tertiary N.A. 450

Ludhiana Quaternary N.A. N.A.

Chennai Tertiary N.A. N.A.

Hyderabad Tertiary N.A. N.A.

Greater Noida Tertiary N.A. N.A.

Bengaluru, Nagarbhavi Secondary 45 45

Bengaluru, Rajajinagar Secondary 31 31

Operating Hospitals

RHT Clinical Establishments

Greenfield Clinical Establishments

Fortis OperatingCompany

Hospital Service Company

Equity / Loan

OPTG ExpBase Fee

Financial Support

• Security deposit for expansion• Advance fee to meet tax requirements• Tech renewal fund

Interest / Taxes

CAPEX

Variable Fee


24

• Ancillary services and facilities (ie, pharmacy, cafeteria, ATM and other amenities).

Fortis is responsible for, among other things, operating and managing all clinical, medical surgical and other healthcare-related business. Fortis has no ownership rights on the facilities or any super structure thereon including the clinical establishments.

Fortis pays the hospital service companies (HSCs) a service fee comprised of a fixed base fee increasing at 3% every year and a variable fee at 7.5% of the revenue of the hospital. A technology renewal fee must be paid into a technology renewal fund to fund the replacement, refurbishment and/or upgrade of medical equipment owned or used by the HSCs. These fees are paid quarterly.

Phase one construction of the Gurgaon clinical establishment is complete. A base service fee of INR341mn, INR429mn and INR1.12bn will be paid in FY13, FY14 and FY15, respectively. No variable service fee will be paid in FY13 and FY14. In FY15, a variable service fee of 7.5% of revenues will be paid to RHT.

RHT is responsible for all investments in the hospitals for the purpose of capacity expansion, major modification to/upgrade of the clinical establishments and the fixtures, fittings, equipment and other assets owned by RHT at its own cost, and in a time-bound manner on the request of Fortis subject to mutual agreement. An interest-free commitment fee equivalent to 25% of the estimated cost of such capacity expansion and/or major modification is to be deposited by Fortis with RHT, which would be returned on completion of the expansion/upgrade.

Fortis has granted a right of first refusal (RoFR) to the trustee manager in respect of any proposed offer by Fortis to sell any medical and healthcare infrastructure assets located in Asia, Australasia and emerging markets in the rest of the world.

A reverse RoFR also exists by which Fortis has the first right of refusal on any clinical establishments proposed to be sold by RHT.

What does the creation of RHT mean for Fortis? • Creation of an asset light model: Through the creation of RHT, Fortis moves to an asset

light model. The assets which are not currently transferred to RHT, most notably Escorts Heart Institute, may be transferred to RHT at a later date, in our view. Also, the new green / brownfield hospitals in Ludhiana (Phase I) and Chennai (Arcot Road) may also be transferred. Fortis may undertake new expansion plans in India and abroad in collaboration with RHT, wherein RHT takes up a major part of the capex. Fortis would be responsible for installing medical equipment as a part of capex for new hospitals partnered with RHT.

• The RHT listing potentially acts as a source of stable finance in future in case Fortis needs to raise capital for expansion.

RHT deal increases the near-term risk to profitability Fortis raised INR22bn via a dilution of its stake in RHT. The raised cash was used to repay debt on Fortis’ balance sheet.

However, the deal adds operating leverage to the P&L and increases fixed costs, posing a threat to profitability in case revenue growth underperforms our expectations significantly. As highlighted above, Fortis has agreed to pay a fixed fee and a variable fee to RHT. The total fees paid to RHT less the costs transferred to RHT is 46-48% of the EBITDAC over FY14-15F. Approximately 72% of the fees are fixed and have to be paid irrespective of performance of the underlying hospitals. As the fixed fee only show a 3% CAGR vs EBITDAC growth of 16.7% over FY14-22F, we expect operating leverage to play out over time. However, in the near term, slippage in ramp-up, particularly in new hospitals like Gurgaon presents a potential downside risk to our earnings estimates.


25

Fig. 36: Fixed and variable fees (INR mn)


Fig. 37: EBITDA and EBITDAC projections for hospitals sold to RHT (INR m) The deal with RHT has added operating leverage to Fortis' P&L

Note: EBITDA and EBITDAC are only for those hospitals that were sold to RHT


2,996

3,951 4,268

4,622 4,963 5,112

5,266 5,424

5,586

1,139 1,507

1,828 2,161

2,529

2,930

3,406

3,938

4,458

-

1,000

2,000

3,000

4,000

5,000

6,000


Fixed fee Variable fee

3,290

4,414

5,663

6,881

8,120

9,497

11,143

12,987

14,714

2,976

4,138 4,494 4,884

5,298 5,538 5,782 6,081 6,378

800 800 800 800 800 800 800 800314

1,076 1,969

2,797 3,622

4,759

6,161

7,706

9,135

-

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000


EBITDAC from RHT hosp Net service fees EBITDA from RHT deal Dividend Income


26

Appendix A-1

Analyst Certification

We, Saion Mukherjee and Aditya Khemka, hereby certify (1) that the views expressed in this Research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of our compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.

Issuer Specific Regulatory Disclosures The term "Nomura Group" used herein refers to Nomura Holdings, Inc. or any of its affiliates or subsidiaries, and may refer to one or more Nomura Group companies.

Materially mentioned issuers Issuer Ticker Price Price date Stock rating Sector rating Disclosures Apollo Hospitals APHS IN INR 834 30-Apr-2013 Buy Not rated Fortis Healthcare FORH IN INR 101 30-Apr-2013 Buy Not rated A4,A5

A4 The Nomura Group had an investment banking services client relationship with the issuer during the past 12 months.

A5 The Nomura Group has received compensation for investment banking services from the issuer in the past 12 months.

Fortis Healthcare (FORH IN) INR 101 (30-Apr-2013) Rating and target price chart (three year history)

Buy (Sector rating: Not rated)

Date Rating Target price Closing price 21-Jul-11 Neutral 165.15 21-Jul-11 170.00 165.15

For explanation of ratings refer to the stock rating keys located after chart(s)

Valuation Methodology We use the DCF method to value Fortis at INR124/sh, as we think metrics such as P/E or EV/EBITDA cannot fully value its business in the near term. The key assumption of our DCF model is a 5% terminal growth rate beyond FY24E. We use a cost of equity of 13%. Risks that may impede the achievement of the target price 1) High capex intensity – Hospitals entail high initial investment and back-ended returns. Thus, any change in competitive environment may adversely impact our projections. 2) Attrition of talent – As seen in the Delhi Escorts facility in the past, doctor attrition could adversely impact financials. Further, the lack of doctors in India and ever-increasing demand for skilled healthcare labour further compound this risk. 3) Regulatory changes – Hospitals can avail of various tax sops as per the present tax structure. Any adverse change or removal of these sops has a potential to reduce profitability.


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Apollo Hospitals (APHS IN) INR 834 (30-Apr-2013) Rating and target price chart (three year history)

Buy (Sector rating: Not rated)

Date Rating Target price Closing price 16-Nov-12 950.00 834.15 09-Mar-12 Buy 606.50 09-Mar-12 750.00 606.50

For explanation of ratings refer to the stock rating keys located after chart(s)

Valuation Methodology We value Apollo Hospitals at 27.5x blended FY14/15F EPS of INR34.5/sh. This gives us a target price of INR950/sh. Risks that may impede the achievement of the target price Key risks are delay in execution, inability to attract talent, increase in costs, increase in competition in mature clusters and changes in tax laws.


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Fortis Healthcare - Myirisbreport.myiris.com/NFASIPL/FORHEALT_20130503.pdf · Nomura | Fortis Healthcare May 3, 2013 3 Cashflow (INRmn) Year-end 31 Mar Notes FY11 FY12 FY13F FY14F

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