Goldman Sachs: India Healthcare Services

Initiating with Neutral sector stance We believe the Indian Hospitals sector can expect good long-term demand growth, and hospitals are investing to meet this demand. We think listed hospital company earnings will benefit from this expansion only from FY2010E-2011E, however. We suggest potential upside for investors is limited in the near-term and that the sector should be monitored for its long-term potential. We initiate coverage with a Neutral sector stance.

Industry dynamics – expanding to meet demand India lags most countries in healthcare infrastructure. However, driven by its growing middle class (100 mn households by 2010E), widening health insurance coverage (estimated growth of 20% CAGR), and a sharpening focus on the sector, healthcare is becoming more affordable for millions. As such, larger Indian healthcare groups are expanding to meet this rising demand. Over FY2008-FY2011E, combined planned capex by Fortis and Apollo is Rs15 bn (US$375 mn), equal to their combined FY2007 revenues.

Stocks in focus: Apollo and Fortis We initiate coverage on the two largest listed hospital groups in India. We believe Apollo Hospitals (APLH.BO, Sell) is overpriced and that potential upside from its existing business, which are mostly mature hospitals performing at their peak, is limited. With substantial capex needed to fund new projects and its growing pharmacy business, we think its margins will narrow, giving three-year EBITDA CAGR of 12% and EPS CAGR of only 3% over FY2008-FY2011E. We initiate with a 12-month DCF-based target price of Rs458, for downside potential of 6%.

We forecast Fortis Healthcare (FOHE.BO, Neutral) to offer comparatively higher growth — with 3-year sales CAGR of 30% and EBITDA CAGR of 52% over FY2008-FY2011E— but we think its flagship Escorts Hospital needs turning around and litigation overhanging this hospital will need resolving, before there can be greater clarity on Fortis’ future. We initiate with a 12- month DCF-based target price of Rs93, for upside potential of 22%.

Risks Downside: Delay in starting operations would prolong already substantial gestation periods for generating returns from these investments. Upside: We believe that any large-scale acquisition(s) could impact the top-line and bottom-line equations positively for both companies.

We believe the long gestation period for capital investments to yield operating returns in the hospital sector means that the combined capex of Rs15 billion capex planned by Apollo and Fortis over the next three years, will boost earnings from 2011E, and will serve to drag on profitability until then.

We expect healthcare services in developed economies like the US to grow at a CAGR of around 6%-7% over the next five years, whereas we estimate Indian healthcare services will grow at twice that rate, at 13% CAGR over CY2008E CY2013E. With fundamental demand for healthcare on a strong upward trajectory, we think the longer-term picture for Indian healthcare companies’ fundamentals is strong, and that earnings should strengthen once planned capex begins to generate operating returns.

Demand driven by gaps in provision amidst rising wealth We focus on exploring the basis for expansion plans laid out by Apollo and Fortis, assessing their returns on investment, and analyzing growth drivers in India’s healthcare industry. Therefore, we look at exploring the following themes (see sections below):

  • Characteristics of the healthcare industry – high capex, long gestation periods
  • Healthcare infrastructure and spend in India and future trends
  • Growth drivers to sustain demand
  • Significance of the private healthcare sector in filling the demand-supply gap
  • Rising middle class population with greater disposable income of Indians
  • Relevance of increasing chronic “modern lifestyle” diseases for the sector

Valuation: comparison with global and regional peers: we use DCF Apollo Hospitals (Sell) is trading at a one-year forward P/E of 26.3X, which is a 37% premium to the global average of 19.2X and on a one-year forward EV/EBITDA of 13.5X, which is a 41% premium over the global average of 9.6X. Fortis Healthcare (Neutral) is trading at 38X on one-year forward EV/EBITDA multiple. In light of this, it would seem that both are trading at multiples that are overly-generous compared with regional ASEAN peers, or with global US and EU peers .

We believe Apollo can be compared to its global peers because its hospitals are mostly mature and provide steady revenues and occupancy rates, similar to global peers in developed economies. For Fortis, however, we believe near-term multiples are less applicable as a gauge on valuation because it is still ramping up and is poised to offer greater growth (3-year sales CAGR of 30.1% vs. Apollo’s 16.7%). Near-term multiples such as P/E and EV/EBITDA would not capture the benefits of the capex that these companies are incurring.