Fortis to unlock significant value by demerging its SRL subsidiary & partially unwinding its REIT capital structure
Fortis Healthcare Limited is a leading integrated healthcare delivery service provider in India. Itstarted its journey with the first hospital in 2001 in North India and during the course of 15 years has grown to become a leading chain of super specialty hospitals in India with presence in day care specialty, diagnostics, and tertiary and quaternary care.
The healthcare company is a high quality tertiary player levered to the high‐potential of the national capital region (NCR) and North India market. These include the world renowned Escorts Heart Institute and the erstwhile Wockhardt facilities. Its flagship, the Fortis Memorial Research Institute (FMRI), Gurugram, has become a landmark in the region for its exceptional clinical services and patient care. Presently, as of 2016, the business operates its healthcare delivery services in India, Dubai, Mauritius and Sri Lanka with 45 healthcare facilities including projects under development, approximately 4,600 operational beds and over 9,000 potential beds.
In India, the company is one of the largest private healthcare chains comprising a network of 42 healthcare facilities, including 30 operating facilities, six satellite and command centres located in public and private hospitals and six healthcare facility projects which are under development or are green-field land sites.
Fortis’s diagnostics business, SRL, has a presence in over 600 cities and towns, with an established strength of 314 diagnostic centres including 161 self‐operated laboratories, 108 laboratories inside hospitals, including 27 labs located in Fortis’s healthcare facilities, 18 wellness centres and three international laboratories. It also has over 7,200 collection points, which include 98 collection centers that are owned and 61 collection centres at international locations.
In 2016, Fortis healthcare had acquired 51 per cent economic interest in Fortis Hospital Limited (FHTL), a subsidiary of the Religare Health Trust (RHT). EBITDA grew 38 per cent, benefiting from lower business transaction fee post the FHTL transaction.
The healthcare rebounded with good numbers in 2018 first quarter post demonetisation impacts in the last quarter of fiscal 2017. Revenue and EBITDA grew by 3 per cent and 38 per cent, respectively. Over all, the metrics have been broadly in line with the performance. Price control on stents was absorbed and business was back to normal. For the quarter, EBITDAC margin is 13.3 per cent and the management believes the margin will expand to 16 per cent by year end.
The management has given its guidance for fiscal 2018 revenue growth to be high single to double digit; it believes that growth trajectory will improve to double digit in the second half of the year.
In the last one quarter, stock has corrected by 25 per cent hit by leverage issue at promoter’s end. At the current market price of Rs 166, the healthcare is now trading at 13.4 times its expected 2019 EBITDAC versus average sector multiple of 18 times and it is forecasted that hospital revenue CAGR of 11 per cent will drive to 18 per cent EBITDAC CAGR over the period 2017-19. The free cash flow generation from 2019 onwards will lead to re‐rating.
Focus on asset light expansion, improvement in operating metrics
Fortis’s focus is on asset‐light brown-field expansion and sweating its assets to improve operating metrics. They reiterated focus on brown‐field expansion, cost management and clinical excellence, hinging on which it expects to improve hospitals’ EBITDA margin to 20 per cent.
Hospitals Business
The hospital business’s revenue consists of 82 per cent share of the total business. It grew 3 per cent despite witnessing the impact of demonetisation and price controls on stents even in the first quarter of 2018. The management expects growth to revive during rest of the year in the upcoming quarters with strong double digit growth in hospital business in the second half of fiscal 2018. Margins for the hospital division are expected to be 16 per cent by end of the financial year 2018 and improve by 1.5 per cent every year beyond that. The healthcare service provider aims to bring the margins to 20 per cent levels. The EBITDAC margin for the division will improve 140bps.
The key operational parameter of the hospital business – average revenue per occupied bed (ARPOB), grew 3 per cent year on year and the occupancy declined due to high base 71 per cent against the previous sequential year.
The corporation is on track with cost control targets. However, metros, where higher quality stents are used, have been impacted by stent pricing. Fortis has initiated steps to mitigate the impact.
The current margin for Fortis Escorts Heart Institute (FEHI) is at 10 per cent; expected to further improve. FEHI will be opening a new dialysis unit in partnership with Fresenius.
The capital expenditure required for the hospital includes 12 hospitals under Religare Health Trust (RHT). RHT is investing for 200 beds at BG Road, in Bengaluru and the new Ludhiana hospital.
Diagnostics Business: SRL and its de-merger with Fortis
Diagnostic business comprises 18 per cent of total Fortis business, it grew 10 per cent from previous sequential year, driven by higher volumes, but margins remained under pressure.
For the first quarter of 2018, the margins for SRL business declined; the management is confident of improving SRL margins post the temporary blip in the first quarter. From the second quarter onwards, SRL margins are to improve 100bps each year. The EBITDA margin for the division was impacted by product mix, employee cost and promotion expenses, which increased 20 per cent. The division has added 12 new labs. Despite high base, good growth is expected in second quarter. Witnessing good growth in the in‐house hospital management business, the division will not enter into a price war.
Fortis has multiple levers in place to unlock significant value by demerging its 56 per cent subsidiary Super Religare Laboratories (SRL) Diagnostics which can unlock value of Rs 53 per share and partially unwinding its REIT capital structure, on which the healthcare service provider pays a yield of 13 to 14 per cent. The de-merger of Fortis Healthcare with SRL Diagnostics is at final stages of hearing with The National Company Law Tribunal (NCLT), Chandigarh for approval. The promoters hold 27 to 28 per cent stake.
The imaging business will contribute five to six per cent as path business is growing at faster pace, and will be careful about expanding the high capital expenditure imaging business.
Financials
The management alluded the guidance for the capital expenditure to be Rs 200 to Rs 250 crore and the Business Trusts (BT) costs to be Rs 280 to Rs 300 crore in 2018.
Owing to 100 per cent consolidation of Fortis Hospital Limited, a subsidiary of the RHT by way of acquiring 44,39,040 Compulsory Convertible Debentures (CCDs) of Rs 1000 each issued by FHTL and transaction related borrowings, the interest cost jumped 53 per cent YoY.
There aren’t any specific plans for fund raising; it was just an enabling resolution, which was expiring. The cash balance of Rs 300 to Rs 400 crore is required for operational use by the healthcare. The balance is investment in mutual funds and cash at subsidiaries which cannot be up‐streamed.
Key Risks
The key risks for this chain of hospitals include possible disassociation of specialist physicians from the hospitals; the rising infrastructure costs could restrict investment and also, subsidiaries may be unable to sustain its profitability. The main aspect for Fortis is that success of its business depends on expansion of network.