>INDIAN HOSPITALS (CITI)

Steady Progress: Execution Is Key

■ Steady progress — Both Apollo and Fortis reported strong results for the first three quarters of FY09, with positive trends on occupancy and pricing. Although Apollo’s pharmacy operations remained a drag on overall profitability, the hospitals division continued to excel. Fortis, on the other hand, was buoyed by an impressive turnaround at Escorts, removing a key overhang for the stock.

■ Expansion plans — Despite tighter availability of capital, Apollo and Fortis maintain aggressive expansion plans. While Fortis intends to add c.4,000 beds by 2012 (organic and inorganic), Apollo plans to add c.3,000 beds over the same period. We see these as additions as exceptions, rather than the rule, for the sector, as smaller players adopt a more cautious stance. Inability to grow, due to scarcity of capital, may also trigger consolidation, which should favour larger players.

■ Low leverage offers comfort — The sector is largely under leveraged (net D/E of 0.33x in FY10E), especially given it is still in an investment phase. Both Apollo and Fortis appear comfortable on the funding side, at least with respect to the next 1-2 years, in our view. Beyond that, however, efficient execution and ability to generate cash from the existing set of hospitals will be critical.

■ Risks to growth — While we remain positive on the long term prospects for the sector, the current macro environment, especially falling income levels, could pose some risk to demand and impair the ability to take price hikes. At the same time, capital constraints could hinder expansion plans at the aggregate level, although Apollo and Fortis appear comfortable on this front.

■ Apollo is our preferred play — We expect hospital stock valuations to be subdued over the near-term as execution risks, low capital efficiency, and lack of sufficient liquidity (due to low market cap), continue to weigh on multiples. Apollo Hospitals (1M) remains our preferred play in this space at these levels, based primarily on its attractive valuation, while we retain our Sell (3H) rating on Fortis Healthcare.

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