Booster shot

Why Apollo Hospitals makes for a safe bet in the booming healthcare industry

It is unusual to hear the finance team in hospitals talk about medical outcomes. For doctors, medical outcome is the Holy Grail, while keeping a tight leash on costs is what finance guys do. But Suneeta Reddy, who spearheads the finance function as joint managing director of Apollo Hospitals, keeps telling her teams to focus on medical outcomes rather than worry about costs. “The Apollo model is built on clinical excellence. Without that, we would not have the pricing power or the volumes that have been essential drivers of our growth.” she says, sitting in her swanky office overlooking a terrace garden on the 12th floor of the new corporate office in Chennai. “There is a demand-supply gap but there are a number of hospitals coming up. The choice is with the customer and we want to ensure the decision tilts towards us by focusing on medical outcomes.” she says. 

With over 8,000 footfalls a day across its 51 hospitals, Apollo Hospitals is certainly the preferred choice of many patients. It has a capacity of 8,420 beds spread across 38-owned hospitals (6,382 beds) and 13 managed hospitals (2,038 beds), making it one of Asia’s leading healthcare providers. It also owns a network of primary clinics, a health insurance company and a retail pharmacy business — one of the largest in India, with a network of close to 1,500 outlets — thereby having a presence at almost every point of the medical value chain. “Somewhere along the line all the businesses fit nicely, helping us capture the mind share of the consumer and making it easier for them to access the system,” points out Reddy.  

Started as a 150-bed hospital in Chennai in 1983 by Prathap C Reddy, a cardiologist who returned to India after a long stint in the US, Apollo has come a long way, riding on the huge unmet demand in the healthcare space. Healthcare infrastructure falls woefully short in India. For instance, the number of beds per 10,000 people in India is just nine, compared with 42 in China and 33 in the UK (see: Ill-equipped). In a market where out-of-pocket spending on healthcare is significantly higher than state spending and with the government system in no position to cater to the healthcare demands of the populace, private players such as Apollo Hospitals have benefited largely from the growing demand for healthcare, particularly from the middle class. Between FY08 and FY13, revenue has grown at an average 25% with earnings growth coming in stronger at 29%.

Given that healthcare needs in India are still largely under-served, it is unlikely this growth will prove to be a flash in the pan. But Apollo is leaving nothing to chance. To sustain its growth rate, the company has planned over 2,685 beds in the next three years; around 1,000 will be added in the current fiscal. Of the 1,000, 30% are in Chennai, 50% in its Reach Hospitals and the rest in Bengaluru (see: Bed and butter). According to Perin Ali, analyst at Edelweiss Securities, these additions will contribute around 30% to growth over FY13-15.  

Eager to grow

While the main cluster at Hyderabad, with 930 beds, will see no addition, it has big plans for Chennai. The original hospital in Chennai, with operational bed capacity of 1,267, is one of the company’s largest and busiest; Apollo is now working on decongesting this facility by setting up separate outpatient care and adding a multispecialty hospital. The two cities together contribute around two-thirds of standalone healthcare revenue. Now, Apollo is looking to develop Bengaluru as its third major cluster in South India. It has just commissioned a new hospital in the city’s Jayanagar area and looking to double bed count by commissioning another hospital in the city later this year. 

And even as Apollo looks to be the dominant healthcare provider in big cities, reaching a wide urban population, it is also looking to cater to the healthcare needs in tier 2 and tier 3 towns through its chain of Reach hospitals. Since 2008, Reach hospitals have been set up at Karimnagar in Andhra Pradesh and Karur and Karaikudi in Tamil Nadu; in Q4FY13, a fourth centre was opened at Ayanambakkam, a Chennai suburb. “As real estate costs are much lower, these hospitals turn break even at the operational level within 18 months, compared with a super-speciality where it takes a minimum 24 months to break even,” says Reddy. Little wonder, then, that Apollo is looking to expand the Reach network: three new hospitals are coming up in Nellore, Trichy and Nashik and the management expects a third of its revenues to come from these hospitals in the next three to five years. 

While bed additions are important to sustain growth in the hospital business, in capital-intensive ventures it is more important to improve the efficiency of existing assets. Asset utilisation in a hospital can be increased by reducing the average length of stay (ALOS) of patients, and over the past five years, Apollo has brought its ALOS down from 5.18 days to 4.65 days (see: Stay less, pay more). Now, with the introduction of robotic surgery across specialisations, which is expensive but where the recovery time is three times faster, the company feels there will be no need for bed additions in the metros after its planned expansion till 2016. Currently, its 6,382 owned beds have an occupancy rate of 72% (as on FY13). 

Increasing revenues from beds also plays a critical part in improving the overall profitability of the business. This is a function of the case mix, growth in inpatient volumes and the pricing power of the hospital, all three of which work in Apollo’s favour. Over the past five years, average revenue per bed (ARPOB) has increased by 8.6% and the company expects the growth in ARPOB to remain in the same region in the next couple of years as well. 

Goodwill at par

The proposed capex will cost Apollo ₹2,200 crore, which will be funded through equity infusion and debt. So far, the company has already invested over ₹600 crore. While some media reports said the company is looking to raise around $400 million by selling 51% to 75% stake in a business trust that would hold its property assets and list in Singapore, the management has indicated it may not go in for listing in the near term, given the current tax implications. “They don’t need to go in for a business trust to fund their current plans,” adds Prashant Nair, deputy head of research, Citi India. “One of the things we like about Apollo is its strong balance sheet. The debt-equity ratio is low and its ability to fund most of its expansion plans through own cash generation has improved.”

At the same time, Apollo founder Prathap Reddy himself has confirmed that PCR Investments (a privately-held firm by the promoters) is in talks with private equity bulge firm KKR, looking to sell 7% stake in the investment arm (which would translate into 3-4% stake in Apollo Hospitals). The investment would come on the heels of the exit of Apax Partners, which invested ₹427 crore for 11.4% stake in 2007 only to sell its stake completely this year. Shashank Singh, MD, Apax Partners India, who worked closely with Apollo on, among other things, bringing the pharmacy business to profitability, is definitely not complaining.

His firm is said to have made a 3X return on its investment in Apollo. “We liked the management and the fact that they were able to attract and retain the best talent, which really helped them in execution,” says Singh. “Despite being a tightly-run family business, they were always willing to listen and make changes to the business that would enhance return for all the stakeholders.” 

With happy investors on its side and a net debt/equity ratio under 0.5 times, the company is confident of raising funds as and when required. “The management has been very focused on return on capital and has been careful in selecting their projects. Both factors are very important in capital-intensive businesses such as hospitals,” says Citi India’s Nair.  

But Apollo is looking to take advantage of the change in FDI regulations in retail and divest a portion of its pharmacy business as operations turn profitable. “We are talking to several people and are looking at divesting some stake in our retail pharmacy business at a certain time. But right now we are improving our profitability and gaining critical mass. The cash from the stake sale will help us reduce our overall debt levels and help us grow faster,” says Reddy. In the next three years, the company plans to add 500 pharmacies, taking the total to 2,000. Currently, the pharmacy business contributes approximately 29% to overall revenues. Apollo also makes around 50-60% gross margin on private labels compared with 22% on branded medicines and it hopes to increase the share of private label sales from 5% to 20% in the next three years. 

While there remains a huge unmet need in healthcare, competition in the space is increasing with affordable models emerging as mainstream options. “Healthcare is becoming a price-sensitive market and there are some who wonder why Apollo is charging a premium, but in the end it is about quality. We are doing high-end work and we are doing it better than others,” says a confident Reddy. She believes that creating a sustainable model in healthcare, more so in the affordable space, is a challenge. “Everyone thinks healthcare is the place to be, but they don’t realise it is an uphill task to really scale up operations and maintain quality.” 

Patient growth

What’s the prognosis for Apollo? The management believes that expansion plans will help sustain revenue growth rates at 20% over the next two to three years. “Despite a larger revenue base, it is what we have set up ourselves to achieve and there is a definitely a market that will allow us to do that,” says Reddy. Analysts, too, think Apollo should meet its target with consensus estimates for revenue and earnings growth at 23% and 25%, respectively, for the next two years riding on the back of increasing insurance penetration and medical tourism. The stock, which has nearly doubled over the past three years, from ₹461 to ₹915 currently, trades at 14 times estimated FY15 EV/Ebitda compared with Fortis, which trades at 22 times estimated FY15 EV/Ebitda. Analysts believe that since the hospital business in India is still in an investment phase, EV/Ebitda is a better valuation parameter compared with earnings multiple. But, given the growth prospects in the healthcare industry, expansion plans, strong balance sheet and peer valuation, Apollo Hospitals still looks the most attractive bet in the listed healthcare space.