Healthcare Services Unmet Demand Conundrum; Initiating Coverage

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1 India Healthcare Healthcare Services Healthcare Services Unmet Demand Conundrum; Initiating Coverage Key Takeaway Indian hospitals need to alter their business model to focus on affordable healthcare and patients outside Tier-I cities to sustain the rich valuations. The premium segment is slowing on rising competition and narrowing supplydemand gap with margins under pressure too. In this context, NARH and HCG (we initiate with Buy) appear best placed given their growing presence outside Tier-I cities. We initiate on APHS with Hold as growth/margins challenges may endure. Slowing growth puts valuation at risk: Indian hospitals trade at par (17x FY19E EV/EBITDA) with global peers (18x) despite lower return profile due to higher growth expectations. However, growth in most existing hospitals has moderated over the past eight quarters, led by increased competition and narrowed supply-demand gap in the premium segment. Hospital managements have also indicated that growth (single digit) will be largely led by pricing and mix. We expect margins also to be under pressure due to competition (higher costs) and government policies (lower pricing). EQUITY RESEARCH INDIA Government intervention to continue: We believe government policies will continue, with focus on access, quality and affordability. We expect most medical products to come under price caps, though hospitals should be able to offset the impact through service costs over the medium term. The key reform to watch will be any steps to increase insurance coverage, including a semi-universal scheme for a majority of the population. Addressing the latent demand requires a new model: While India has significant supply-demand gap (seven beds per 10k, vs 27 global median), the unmet demand is outside the top cities and at affordable pricing. However, corporate hospitals have struggled to address this market due to their cost structure and capex model. Companies need to work on cost reduction with a focus on standardisation and new doctor engagement policy to address this segment and benefit from government moves on access. In addition, an assetlight model, which will reduce both capex and set-up time, is needed to be able to expand in Tier II cities. Consequently, we prefer companies with large presence outside Tier I cities (HCG and NARH) and those positioned towards the premium segment (NARH). Narayana and HCG preferred picks: The Indian hospital sector is trading at 17x FY19E EV/EBITDA on expectations of 20% EBITDA CAGR over FY17-20E. We initiate on HCG with Buy and Apollo Hospitals at Hold. We retain Buy on Narayana. Narayana, in our view, with its focus on affordable care, looks the best placed to address the large latent demand. We expect it to report 25% EBITDA CAGR over FY17-20E; retain Buy with a PT of Rs390. HCG's hub and spoke model and oncology specialization has allowed it to profitably expand outside Tier I cities (c40% beds outside Tier I). It has also shown strong execution, achieving breakeven in most new centers in c12m. With large expansion phase coming to close, we expect it to report 27% EBITDA CAGR over FY It is trading at a discount to peers at 15.7x FY19E EV/EBITDA and we initiate with Buy and PT of Rs325. Apollo - While we expect 19% EBITDA CAGR over FY17-20E for Apollo, we estimate its core hospital business EBITDA to grow at 11%. Its key markets are seeing increased competition. While the company is working on improving payer mix, this limits growth over the medium term, as the large market is not targeted. With the stock trading at 17.5x FY19E, we initiate Piyush Nahar * Equity Analyst pnahar@jefferies.com Sagar Sahu * Equity Associate ssahu@jefferies.com * Jefferies India Private Limited ^Prior trading day's closing price unless otherwise noted. at Hold with a PT of Rs1,150. Mkt. Cap Price Cons. Current EPS Estimates Valuation (P/E) Company Name Ticker (MM) Rating Price^ Target Next FY Apollo APHS IN INR152.0BN HOLD INR1, INR1, INR15.88 INR19.12 INR x 41.5x HCG HCG IN INR23.2BN BUY INR INR INR2.61 INR2.66 INR4.90 NM 55.2x Narayana Hrudayalaya NARH IN INR62.3BN BUY INR INR INR4.10 INR4.70 INR x 38.1x Please see analyst certifications, important disclosure information, and information regarding the status of non-us analysts on pages 72 to 77 of this report.

2 Executive Summary We believe the Indian healthcare industry needs a new business model to address the demand-supply gap. The premium segment, especially in Tier I cities, is maturing and competition is rising. This, along with government focus on affordability, would impact margins and growth for most hospitals. We believe hospitals need to focus on new doctor engagement and capex model to sustain growth premium. We believe that Narayana Hrudayalaya (NARH) is the best placed with its affordable healthcare strategy. We initiate coverage of Healthcare Global (HCG) at Buy; its selective focus and specialization provide strong growth drivers. We are cautious on Apollo Hospitals (APHS) and initiate coverage at Hold, as we believe rising competition will its keep margins and return ratios under pressure. Capacity shortage but not uniform The Indian healthcare industry is capacity-constrained with just seven beds per 10,000, vs the global median of 27. However, the supply gap is not uniform with unmet demand outside top cities and, more importantly, at affordable pricing. Private players have found it difficult to address the affordable segment due to cost structure. We expect the industry to grow at 12% CAGR, led by increased supplies and spending capabilities of patients. Government intervention to continue Healthcare will be a major policy focus for the government, in our view. We expect pricing caps to encompass most medical devices and implants. Hospitals should be able to offset the impact mainly through fee changes over medium term. The caps on hospital service fees, we believe, are unfeasible but can occur for some time due to political pressure. The key structural change is any move on increasing insurance healthcare access. This would allow access for a larger population, driving increased volumes to hospitals, consequently reducing charges. Hospitals will need to change their operating model and cost structure to be able to address this, though. Need a new business model Indian hospitals trade at par with regional peers despite lower return ratios due to better growth potential. However, the target market of most private hospitals is the premium segment (Tier I cities and high income), which is maturing. In addition, the government s focus on increasing affordability necessitates a change in business model. The key hurdles in targeting the affordable segment are doctor engagement, standardization and capex. Hospitals have started working on this, but it is still early days for most. NARH looks best placed; retain Buy Narayana looks the best placed hospital player. Its affordable focus allows it to target the largest growth segment. It is a beneficiary of any government move to increase access and is the least impacted due to pricing caps. The partnership model allows profitably expansion beyond Tier I cities. We expect improving maturity profile to drive 196bps margin improvement and 25% EBITDA CAGR over FY17-20E. Retain Buy. Risks: key man risk; delay in ramp-up of hospitals. APHS in transition; initiate at Hold Apollo hospital business is seeing increased competition which is driving margins and RoCEs lower. We expect APHS to restart capex from FY19 led by competition and expect Hospital EBITDA CAGR of 11% despite the 30% capacity addition over the past three years. Strong growth in pharmacy (19% CAGR) and turnaround in AHLL though would drive EBITDA CAGR of 19% over FY The stock is trading at 17.5x FY19 EV/EBITDA in line with peers despite slower growth and outlook. We initiate with Hold rating and SOTP based TP of Rs1,150 (FY19E EV/EBITDA 19x). Key risk: Mumbai ramp-up; AHLL turnaround HCG niche player; initiate at Buy HCG, in our view, is well positioned to succeed in the oncology space. It model allows for profitable expansion into Tier II cities. We expect it to report 27% EBITDA CAGR over FY The stock is trading at 15.7x FY19 EV/EBITDA, a discount to the sector. We expect the discount to narrow as new centres ramp-up driving strong growth. We initiate at Buy and SOTP based PT of Rs325, valuing it at 18.5x FY19E EV/EBITDA. Key risks: price cap and competition. page 2 of 77

3 Table of Contents EXECUTIVE SUMMARY... 2 KEY CHARTS... 4 CAPACITY SHORTAGE BUT NOT UNIFORM... 8 Affordable healthcare need of the hour... 8 Large supply-demand gap outside Tier I cities... 8 Lack of insurance makes pricing key Industry expected to grow at 12% GOVERNMENT INTERVENTION TO CONTINUE Healthcare to become a key political issue Price caps to continue Cap on services unfeasible, in our view Focus on quality Universal health insurance a possibility? NEED A NEW BUSINESS MODEL Premium valuations driven by growth potential Current model geared towards premium segment Need to change model WHO IS BEST PLACED TO SUCCEED? NARAYANA HRUDAYALAYA LOOKS BEST PLACED Only large player in the affordable segment Strong mature segment growth validates potential Not just a cardiac hospital Improving mix to drive margin improvement Best placed hospital play; retain Buy Financials APOLLO HOSPITALS NEED TO READJUST; INITIATE AT HOLD APHS diversified healthcare service player Hospitals rising competition putting pressure on growth Pharmacy key growth driver Apollo Health and Lifestyle (AHLL) In early stage Low capex near term to drive 19% EBITDA growth Initiate at Hold Risks Management profiles Financials HCG IN NICHE PLAYER; INITIATE AT BUY Niche focus Expect 27% EBITDA CAGR led by ramp-up Initiate at Buy Valuation Risks Management profiles Financials page 3 of 77

4 Key Charts Exhibit 1: Indian hospitals trading at par with regional peers Exhibit 2: despite lower margins and returns Source: Bloomberg, Jefferies estimates Source: Bloomberg, Jefferies estimates Exhibit 3: due to expectation of strong growth Exhibit 4: Actual growth though has slowed Source: WHO Source: Jefferies estimates, Company Data Exhibit 5: in both volume and value terms Exhibit 6: as demand-supply gap is not uniform Source: Health Action International, IMF, Jefferies page 4 of 77

5 Exhibit 7: and urban markets are now well covered Exhibit 8: Healthcare in India is cheap but not affordable Source: WHO, CIA Factbook, Crisil Source: Jefferies, Company Data Exhibit 9: with large variation in pricing (Rs) Mumbai - 1 Chennai -1 Hyderabad -1 Hyderabad -2 Mumbai - 2 Public hospital Bangalore -1 Angiogram K 15K 18K 10K 12-20K 8.6K 14-18K Narayana Angioplasty K 80-90K 75K K 25.3K 110K 54K-118K Coronary bypass 350K K 250K K 107K 350K 110K - 250K Source: Jefferies Exhibit 10: and management commentary suggests most hospitals not addressing the affordable segment Hospital Comments Reduced participation in certain government schemes like EHS, ESI etc. in Bangalore. HCG Faces issues in recovery of funds Yield from a scheme patient typically 10-20% lower than a regular patient at the lower end of price band. NARH Payment cycles from scheme patients have been quite bad. Also seeing a lot of misuse of these schemes Conscious decision to rationalize the subsidized scheme patients from the payor mix to improve profitability. APHS Not subscribed to Aarogyasri scheme in Telangana, reducing addressable market size to 10%. Rush to fill beds by a few new patients by focusing on government scheme patients Source: Jefferies, company data Exhibit 11: due to the high cost structure Narayana Apollo Fortis Kovai HCG Hospital Revenue Inpatient revenue Outpatient revenue Other Op Income Expenses Consumable Doctors + Consultants Doctor's payments Consultant Charges Other Employee Expenses Business Trust Costs Other Expenses EBITDA Depreciation EBIT Note: P&L for each hospital is Indexed with Revenues at 100; Source: Company data, Jefferies estimates page 5 of 77

6 Exhibit 12: Further, reach outside Tier I is also limited for most Exhibit 13:..due to capex model limiting growth Source: Jefferies estimates, Company Data Source: Jefferies, Company Data Exhibit 14: In addition to growth, margins are under pressure Exhibit 15: led by competition and government pricing Source: Jefferies estimates, Company Data Exhibit 16: Given this, hospitals targeting affordable segment & smaller cities to report best growth CAGR Exhibit 17: supporting premium valuation Source: Jefferies estimates, Company Data page 6 of 77

7 Exhibit 18: Narayana and HCG better placed than peers over medium term our preferred picks Target market Doctor engagement Capex Model Execution track-record Overall Narayana HCG Apollo Note: Size of red pie indicates our score Source: Jefferies estimates Exhibit 19: Valuation regional and domestic hospitals (1) Mkt Cap EV/sales EV/EBITDA Company Name BB Code Rating Price (US $m) Fortis Healthcare FORH IN NC Rs , Apollo Hospitals APHS IN Hold Rs , Healthcare Global HCG IN Buy Rs Narayana Hrudayalaya NARH IN Buy Rs Raffles Medical Group RFMD SP NC SGD , IHH Healthcare* IHH MK Hold MYR , Bumrungrad Hospital BH TB NC THB 216 4, Bangkok Dusit BDMS TB NC THB , Bangkok Chain Hospitals BCH TB NC THB , Asia Hospitals Av Note: closing prices as of 29 Aug, 2017 Source: Company Data, Jefferies estimates, NC data from Bloomberg; covered by co-brand research partner KAF-Seagroatt & Campbell Securities Sdn Bhd Exhibit 20: Valuation regional and domestic hospitals (2) Mkt Cap P/E P/B Company Name BB Code (US $m) Fortis Healthcare* FORH IN 1, Apollo Hospitals APHS IN 2, Healthcare Global HCG IN Narayana Hrudayalaya NARH IN Raffles Medical Group* RFMD SP 1, IHH Healthcare IHH MK 11, Bumrungrad Hospital* BH TB 4, Bangkok Dusit* BDMS TB 9, Bangkok Chain Hospitals* BCH TB 1, Asia Hospitals Av. 3, Note: closing prices as of 29 Aug, 2017; * indicates non covered companies Source: Company Data, Jefferies estimates, NC data from Bloomberg page 7 of 77

8 Capacity shortage but not uniform The USD60bn Indian healthcare industry is capacity-constrained with just seven beds per 10,000, vs the global median of 27, and only 0.6 doctors per 1,000, vs the global average of 1.5. However, the supply gap is not uniform. A majority of the latent demand and capacity shortages are outside top cities (which are well served) and, more importantly, in the lower affordable pricing segment. However, private players have found it difficult to address the affordable healthcare segment given its cost structure. We expect the industry to grow at 12% CAGR going forward, led by increased supplies and spending capabilities of patients. Affordable healthcare need of the hour The Indian healthcare delivery industry stood at Rs3.8tn in value terms in , representing 4% of the GDP. However, the industry is highly underserved in terms of infrastructure both doctors and beds well below the global average and even peers. While there is a substantial healthcare infrastructure gap in India, a significant part of the demand, in our view, is for affordable healthcare. While India has one of the lowest prices for medicines and procedures globally, most of the services are still unaffordable for a majority of the population. This is due to three factors: 1. Healthcare infrastructure in Tier I cities is now at the global average vs the lowest levels globally in areas outside Tier I cities. Healthcare still a discretionary spend for a majority and price is a criterion 2. For a majority of the population, healthcare is still a discretionary spend and price is a major criterion. 3. Government send on healthcare is one of the lowest globally. Given this, we believe that a substantial portion of the healthcare infrastructure gap will have to be filled by affordable healthcare and outside Tier I cities. Highly underserved doctors and beds well below global and peer average Large supply-demand gap outside Tier I cities India s healthcare infrastructure lags most global peers, both in terms of the number of facilities and doctors, especially outside Tier I cities. The bed density in India is approximately seven per 10,000 persons, below the global median of 27 beds as well as that for other developing nations such as Brazil, Malaysia, Vietnam and Indonesia. Exhibit 21: Healthcare infrastructure much below global peers Source: WHO page 8 of 77

9 Infrastructure weakest in areas outside Tier I cities Gap not uniform While the overall supply gap is large, the spread is not uniform. Most Tier I cities are well served and some are even in an over-supply situation. The average bed density in urban areas is 25 beds per 10,000 person, at par with the global average. However, the situation outside Tier I cities is adverse. The bed density for rural India is only two per 10,000 persons, less than 10% of urban India. Exhibit 22: Hospital beds availability in rural India much below average India - Urban India - Rural India - Overall Global Bed density per Source: CRISIL As Exhibit 23 shows, there is a wide gap geographically too. Healthcare facilities are significantly lacking in northern India, while south India, in fact, has better infrastructure than the global average. Exhibit 23: Wide regional disparity in hospital infrastructure Note: Only government hospitals data; Source: National Health Profile, 2017 page 9 of 77

10 Tier I cities becoming overserved The concentration of healthcare facilities in Tier I cities and certain cities/states has, in fact, resulted in some oversupply situations. As Exhibit 24 highlights, cities like Hyderabad/Chennai/Delhi are reaching an oversupply situation. Exhibit 24: Management commentary from hospitals indicate oversupply in Tier I cities Hospital Comments Narayana NCR a highly competitive market but expect brand and quality service to hold them in good stead Exited Hyderabad due to the high competition HCG Revenues plateauing in Karnataka cluster due to focus on better mix. Focused on reaching more patients by capturing market in Tier II/III cities. Apollo Decline in occupancy noticed in the Hyderabad cluster due to competitive landscape and rationalization of payee profile. Added capacity in Chennai cluster to maintain market share; else, peers would have captured that share Amount that competition is spending on guarantee money is far higher but not reflected in pricing Fortis Revenues in Bangalore hospital have come off slightly due to the competitive environment Industry has matured and growth will be in single digit organically Source: Jefferies, company data Shortage of practising doctors only 1 for 1,700 people Most student doctors move abroad due to lack of medical seats in India Shortage of doctors In addition to shortage of beds, there is a significant shortage in the number of practising doctors vs the number required. India currently has only one doctor for every 1,700 people, much below peers such as Brazil, China and Russia. A key factor for this has been lack of medical seats, especially at the post-graduate level. This has resulted in a significant number of doctors moving abroad to complete their post graduate degrees. The distribution of doctors also show similar trends, with bed availability at less than 1 doctor for every 2,000 persons in rural India vs 1+ doctor per thousand in urban. Only 3% of total specialist physicians present in the country cater to rural demand, which houses 70% of the population. Exhibit 25: India has one of the lowest number of physicians Exhibit 26: Less than one doctor for every 2,000 persons in rural India Source: CIA Factbook Source: WHO page 10 of 77

11 Exhibit 27: Number of medical college admissions in the country not growing fast enough Exhibit 28: to improve doctor density in various parts of the country Source: National Health Profile, 2017 Source: National Health Profile, 2017 Private sector driven government spending only 32% of overall spend Per capita government spend 10% of Brazil Private sector driven industry The Indian healthcare industry is dominated by the private sector. The government spend accounts for only 32% of the overall spend (2013), one of the lowest globally compared with both developed countries and peers like Brazil, Malaysia and Thailand. Even absolute spend per capita (PPP adjusted) is well below the global average and peers. In fact, India s government spend per capita is only 15% of Malaysia s spend and 10% of Brazil s. Exhibit 29: Healthcare delivery industry is largely 20% Share in Out patient care (%) Exhibit 30: private sector driven 80% Private sector Govt. Source: WHO Source: WHO page 11 of 77

12 Exhibit 31: Government spend is below global standards Exhibit 32: both for share and absolute spend 5,000 4,307 4,000 3,000 2,776 2,000 1, USA UK Brazil Malaysia India Per capita government spend (PPP adjusted USD) Source: WHO Global Healthcare Expenditure Database Source: WHO Global Healthcare Expenditure Database Lack of insurance makes pricing key High OOP and low income limits access to treatment for majority Treatment costs in India are much below global costs. However, most of the spend in India is out-of-pocket (OOP) and this, combined with low income, makes pricing a key factor in accessing healthcare services. The government spend on the healthcare sector is one of the lowest globally and insurance coverage is only c20%. With the rapid expansion of the hospital infrastructure by the private sector, the top end of the population pyramid is now well served. The incremental demand is now at more affordable prices. This is reflected in the fact that the growth in mature hospitals across various companies is now in low- to mid-single-digit despite the excess capacity, indicating demand growth is now low. Exhibit 33: Growth plateauing in mature hospitals Hospital Growth Comments on Mature Hospitals Apollo 6% Inpatient volume growth of only 1% in Chennai as well as Hyderabad cluster. Max Single digit Performance on mature beds a bit under pressure relative to overall network. Fortis Single digit Key markets have matured and inherent growth tol be in single digits Source: Company data Out-of-pocket expenditure: - 62% of total health care expense - 86% of private healthcare expense Increased push towards access to insurance Largely out-of-pocket spend in India The healthcare spend in India is at just 4% of GDP well below global standards and also below most peers. According to the WHO, while 58% of the total healthcare expenditure in India is borne by consumers directly (without insurance coverage or reimbursements), this proportion rises to a very high 86% for private healthcare services. Health insurance penetration at just 20% of the population is a major impediment to growth for the industry. The commercial insurance providers account for only 20% of the schemes, with the rest being government or government-sponsored schemes. There is an increased push by the government, though, to increase access to insurance. The new government has started a significant push to increase health insurance with focus on Rashtriya Swasthya Suraksha Yojana (RSSY). RSSY provides health cover of Rs100,000 per family. page 12 of 77

13 Exhibit 34: Healthcare spend well below global standards Exhibit 35: as OOP share is much ahead of peers Source: WHO Global Healthcare Expenditure Database Source: WHO Global Healthcare Expenditure Database Generic prices in the UK and Canada in proportion to its per capita income lower vs India Low per capita Income limits the benefits of lower prices Healthcare prices in India are one of the lowest in the world and the average inflation in prices is just 2%. However, India s gross national income (GNI) per capita is also among the lowest in the world. It is worth noting in Exhibit 37 that generic prices in the UK and Canada in proportion to their per capita incomes are lower than that for India. The generic prices in countries like the US and Australia are 1-2x times than that in India. However, insurance penetration in these countries is much higher than that in India. Exhibit 36: Generic prices while low on absolute basis Exhibit 37: not as cheap when adjusted for income levels Source: Health Action International, IMF, Jefferies Source: Health Action International, IMF, Jefferies Government support not enough Healthcare spend by government is one of the lowest globally. With a majority of the population earning less than USD 4K pa, government support is a necessity, in our view, to address the health needs of the country. Until now, the government has focused on setting up hospitals and primary care centres. This has led to sub-optimal usage of funds, in our view, as retaining quality doctors at government salaries is an uphill task Insurance coverage and primary healthcare should be government s focus The government is now focusing on providing insurance coverage to the population and this, along with primary health centres, should be the focus of the government. Also, the government is moving towards a PPP model, which, in our view, is a possible solution to address the healthcare gap. The government, in its recent budget, announced two new initiatives. PPP for dialysis: The list of patients suffering from an end-stage renal disease increases by 220K every year. To reduce OOP expenditure for these patients, government plans to provide dialysis services in district hospitals. Funds for this page 13 of 77

14 National Dialysis services programme will be made available through the PPP mode. Apart from this, the government has also provided exemptions on basic customs duty, CVD and special additional duty on certain parts of kidney dialysis equipment. Health insurance scheme: In addition to the RSBY for those below the poverty line (BPL), which gives a cover of Rs30K for select diseases and treatments, a new health protection scheme to give a health insurance cover of Rs100K per household was introduced. Industry to grow at c12% over FY15-20E to Rs6.8tn Industry expected to grow at 12% Despite the large supply-demand gap and multiple growth drivers, the Indian healthcare delivery industry which stood at Rs3.8tn (US$60 bn), reflected in the 3.4bn cases for treatment, is expected to grow at 12% CAGR in line with GDP growth, according to CRISIL. The growth will be led by better access, increased income levels driving affordability and rising burden of non-communicable diseases (NCDs). This is mainly because a significant portion of the latent demand cannot be addressed economically currently. We expect the private hospital to adjust their business model over time to cater to this demand, as the oversupply in Tier I and premium segment increases. Exhibit 38: Industry expected to grow at a CAGR of 12% Indian health care industry size (in Rs tn) Source: CRISIL Exhibit 39: In-patient revenues expected to grow Exhibit 40: at a faster pace 19% 17% 81% 83% In-patient Out-patient In-patient Out-patient Source: CRISIL Source: CRISIL page 14 of 77

15 Multiple growth drivers There are multiple growth drivers for the healthcare industry rising population, increasing disease burden, increased reach of healthcare services, rising income and higher insurance penetrations. Increased life expectancy and declining infant => additional demand for healthcare delivery Rising population and disease burden India's population is expected to grow to over 1.4 billion by 2026, according to CRISIL, from approximately 1.2 billion in With the number of hospital beds at just seven beds per 10,000 persons, vs the global median of 27 beds, there is already a shortfall of nearly 2.5 million beds. In addition to the rising population, life expectancy is also increasing. With increased life expectancy and declining infant mortality comes the additional requirement for healthcare delivery services. Exhibit 41: Life expectancy and infant mortality Source: CIA Factbook Rising NCD burden Non-communicable diseases (NCD) burden in India is rising, with NCDs accounting for 60% of the deaths in 2012 vs 48% in This has been led by lifestyle changes, driven by rapid urbanisation, higher household income levels, and increasingly sedentary lifestyle, among other factors. The key NCDs in India are cardiovascular and neurological diseases, and cancer. Exhibit 42: Key non-communicable diseases in India Source: WHO Department of Health Statistics and Information Systems page 15 of 77

16 Healthcare spend per capita (USD) Large gap between doctor/person in urban vs tier IV cities and rural India Increased reach The gap between the number of doctors per person in Tier I cities and rest of India is still large. The government is making concentrated efforts to increase the reach in rural India with programs such as National Rural Health Mission (NRHM). The government spend on this program has been increasing steadily over the years. However, the reach has stagnated, with marginal increases in rural health centres. The focus is now on increasing compliance and improvement in facilities of the current centres. Exhibit 43: Government has been increasing spend on rural healthcare Exhibit 44: Number of rural centres have stagnated, though Source: Ministry of Health, GoI, Jefferies estimates Source: GoI, Jefferies Increase in disposable income to drive demand Rising income levels Affordability of quality healthcare facilities is major constraint for many Indian households. Nearly 59% of households in India recorded annual income of less than Rs0.2 mn in FY14, according to CRISIL. Rising income levels and consequentially disposable incomes should drive increased need from healthcare services in India. As Exhibit 45 shows, as household income rises globally, spend on healthcare also sees an increase. Exhibit 45: Healthcare spend is directly correlated to GDP growth 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 y = 2E-06x x R² = ,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 50,000 GDP per capita (in USD) Source: UN Rising insurance coverage The number of insurance policies has grown at 15% CAGR and premiums have grown at 17% CAGR over FY With increasing health insurance coverage, consequent health check-ups (mandatory for insurance coverage) should boost demand for a robust healthcare delivery platform. page 16 of 77

17 The government is putting in place insurance schemes like RSBY for rural India and BPL households While the private sector has focussed mostly on urban India and specifically the middle and upper income groups, both central and state governments have put in place insurance schemes for rural India and low income groups. The main scheme for them is the Rashtriya Swasthya Bima Yojana (RSBY), which provides insurance to below poverty line (BPL) households. Beneficiaries under RSBY are entitled to hospitalization cover up to Rs30,000 for most of the diseases that require hospitalization. Additionally, various state governments (mainly Tamil Nadu, Andhra Pradesh and Maharashtra) have introduced their own schemes. Exhibit 46: Number of policies has seen steady growth Exhibit 47: And so have premiums Source: IRDAI annual reports Source: IRDAI annual reports page 17 of 77

18 Government intervention to continue Healthcare access and affordability will be a major policy focus, in our view, and we expect further steps on this from the government. We expect the pricing caps (a key investor concern) to encompass most medical devices and implants. Hospitals will likely be able to offset impact through fee changes over the medium term. The caps on hospital service fees are unfeasible and undesirable, in our view, but can occur due to political zeal. The key structural change that we would watch for is any move on increasing insurance coverage either universal or semi-universal insurance scheme covering the majority of the population. This would allow access to a larger population, driving increased volumes for hospitals, consequently reducing charges, but hospitals will need to change their operating model and cost structure to be able to address this. Healthcare to become a key political issue Healthcare to become a key policy and political issue going forward Healthcare policy in India has been patchy with steps from the government across various areas primary care, tertiary hospitals, insurance, price caps but without any comprehensive plan. We expect healthcare to become a key policy and consequently a political issue going forward. The recent incident at a government hospital in Gorakhpur, Uttar Pradesh may hasten the process. Steps are already being taken, with caps on implant devices and also recent moves by certain state government to regulate hospitals. Exhibit 48: Multiple measures by the government over past two years Proposals/Actions Area of impact Details Cap on knee replacement Affordable healthcare Slashed prices of knee replacement systems by up to 69% and of stents by up to 85%. Cap on Cardiac Stents Affordable healthcare Capped prices of cardiac stent capping prices at Rs. 7,250 per piece for bare metal stents and Rs. 29,600 for drug eluting stents. Jan Aushidhi Stores Affordable healthcare 956 Jan Aushadhi Kendras opened as of March, 2017 vs 82 in May, Cap on Trade Margins Affordable healthcare New pharma policy calls for capping trade margins Dialysis Centres Increasing reach Dialysis facilities to be made available at each district centre as opposed to only state headquarters. AYUSH hospitals Increasing reach Approved proposals for setting up of 100 Ayurveda, Unani, Siddha, and Homeopathy (AYUSH) hospitals across the country. Rural stint for doctors Increasing reach Financial as well as non-financial incentives apart from making mandatory rural postings for doctors. Medical Colleges Non-communicable diseases Increasing reach PPP Tertiary care in non-metros PPP Proposal to create medical colleges in rural areas apart from giving preference to students from underserviced areas. Niti Aayog's proposal to rope in private healthcare providers to diagnose and treat certain noncommunicable diseases in district government hospitals. Niti Aayog's proposal pushes for PPPs focused on cancers, heart conditions and respiratory tract diseases in non-metros. Online Bloodbank database Technology use Launch of "e-raktkosh", an online database of blood banks in West Bengal. E-prescriptions Technology use E-prescriptions to be introduced to help doctors in prescribing generics. Computerized billing Technology use Compulsory bar-coding to be enforced to enable computerized billing. Prescription by generic names Branding only on fixeddoes combinations Faster Approvals Generics Generics Source: Jefferies, GoI, Livemint Every physician should prescribe drugs with their generic names legibly, preferably in capital letters. New rules for branding drugs - brand names only on fixed-dose combinations. Waive off clinical trials in humans for select drugs which are essential for Indian patients and were approved in developed markets. We see multiple steps from the government to increase affordability and access to healthcare services. While an overarching plan is lacking, we expect steps on four key fronts: Price caps on medical products we expect this to continue and encompass most products including implants. Increased focus on quality both drugs and services. Insurance schemes. page 18 of 77

19 PPP model for increasing infrastructure especially in speciality care. Focus on affordability and increasing reach Draft Pharma policy The Department of Pharmaceuticals has come out with a draft for the new pharma policy. The policy emphasises affordability: the drug pricing will be made more poor oriented while retaining at the same time its industry friendliness. While growth of pharmaceutical industry and concerns related thereto are important, more important is the overall objective of making quality drugs accessible to the poor patients at affordable prices The proposals in the draft policy can be clubbed under six heads: Quality Mandatory BA/BE Tests for all drug manufacturing permissions accorded by State/Central Drug regulator. Adoption of WHO s GMP and GLP by all manufacturing units. Pricing Seeks to bring down unreasonable trade margins for drugs offered to distributors, stockists and hospitals. Generics Policy of sale of single ingredient drugs by their salt name. Implementation of the principle of one company one drug one brand name one price. Branding allowed only on fixed dose combinations. Technology Use of e-prescription to aid and assist registered medical practitioners in prescribing medicines in the generic names. Development of e-pharmacy sector. Creation of authentic database on pharma sector. Enforcement of static bar code on drugs. Introduction of bar code reading and computerized billing. Make In India Preference for formulations produced from indigenously produced API and its Intermediates in government procurements. Peak customs duty on import of all APIs which can be indigenously manufactured. Miscellaneous Limits loan licensing by pharmaceutical companies. Cracks down on unfair marketing practices by restricting gifts and trips offered to doctors and pharmacists. page 19 of 77

20 Price caps to continue The past 18 months has seen increased government focus on pricing of various healthcare services and we expect this to continue. The National Pharma Pricing Authority in February capped the prices of stents, slashing prices by up to 85%. Additionally, the government put a six-month moratorium on prices of related services, preventing the hospitals from increasing service prices. As Exhibit 49 shows, the cap on stent prices led to sharp impact on the profitability of hospitals. Recently, knee cap implant prices have also been capped. Exhibit 49: Impact of cardiac stent price cap Hospital Rs Impact (mn) % of sales Comments on stent pricing Narayana 400 c2% Fortis Apollo 500 c1% 1. Significantly impacted the heart centres business, with revenues dropping c3% y-o-y and profitability coming down to 7.9% EBITDA margin. 2. Rationalized the procedure price to offset the loss 1. Impact felt in metros where more high end stents were used. 2. Some elements of mitigation put in place to offset the loss. 3. Although top line hit due to pricing cap, surge in volumes % EBITDA drop can be attributed to stent pricing cap. 2. Other items like knee transplant could be added to the list. 3. Hospitals are trying to ensure that the policy takes into account that these are input costs to the hospitals and hospitals should be able to charge appropriately for the service provided Max India 300 c2% 1. Revised prices from 1 April and taking other measures as well to offset this. Source: Company data, Jefferies Implant procedure cost skewed towards implant charges Currently, hospitals fees for implant procedures are skewed towards the cost of implants. Hospitals usually charge high mark-up on implant cost while the related service charges are low. Recently, the NPPA released a report showing the high mark-up in knee implants. Exhibit 50: Trade margins in Knee Transplants Source: Bloomberg, Jefferies estimates Expect increased price control We expect the government to bring most implants under price control over the next two years. In addition to the knee transplants and cardiac stents, the NPPA has been studying the price structure 19 types of implants, including catheters, and will likely cap all of these. Hospital likely to offset impact through fee changes While we expect more price caps, we do not believe this will impact hospital profitability over the medium term. We expect hospitals to recalibrate their pricing structure to normalize the margins on implants and increase their service fees. Most hospitals have already started working on this and we expect this to be fully recalibrated over the next 12 months. page 20 of 77

21 The cost for patients then will reduce by the amount of margins which are lowered for the channel and manufacturers who will be the most impacted. Cap on services is not feasible because of adverse impact on quality and reduced interest from private sector Cap on services unfeasible, in our view One of the recent moves by certain state governments which took us by surprise was the legislation moved by two states to cap prices of various hospital services. West Bengal has passed laws which authorize formation of a regulator who will study prices of various surgeries and put an upper cap for this. Karnataka has a similar bill tabled in assembly. There have been concerns that this could be done pan-india. We believe that capping service pricing is both undesired and also very difficult to implement. Private sector needed to meet supply gap as highlighted above, healthcare infrastructure in India is already lacking. The government does not have the resources to build the needed infrastructure and has not been able to maintain quality in the hospitals it runs either. Any cap on hospital services will lead to reduced interest from the private sector. This will have an adverse impact on quality additionally, it would also the impact quality of services, as focus turns on reducing costs to be able to service. Unorganized nature makes implementation difficult healthcare in India is largely out-of-pocket and unorganized. We believe that even with a cap on services, quality can continue to command a premium. Health insurance covers only c20% population. We expect Govt to take steps to improve coverage Focus on quality One of the key focus areas for government going forward, in our view, will be the quality of healthcare both products and services. We have already seen some steps on the drugs side, with higher regulatory requirements on bioequivalence and stability data, and also action on removing fixed-dose combination (FDC) drugs. We expect this to also increase to healthcare services side, though the nature and regulatory mechanism is not clear. Universal health insurance a possibility? Our view on the state role in healthcare is that it should act more as an enabler and payer. We believe that the government, instead of spending on building and maintaining infrastructure, should focus on providing insurance to a larger percentage of the population. Currently, only c20% of the population has any health insurance and this limits the ability of a large section of population to receive healthcare. As Exhibit 51 shows, currently, there are multiple state and central insurance schemes for different categories of patients. However, these cover only c15% of the population. The government has talked about universal coverage but there have been no concrete moves on the same. We expect movement on this front going forward as the next election nears. Increased insurance = higher volume but lower pricing An increased insurance coverage by the government will mean higher volumes for hospitals as affordability increases. However, this will also increase the bargaining power of government and allow it to drive down prices. Currently, most hospitals are not geared to address this market, as visible in the participation of hospitals in various government schemes. But if a large part of the market is under insurance, hospitals will need to adjust their structure. We discuss this in detail in the next section. page 21 of 77

22 Exhibit 51: Details of various government health insurance schemes Scheme State /Central No. of people (in mn) Rashtriya Swasthiya Bima Yojana Both Aam Aadmi Bima Yojana Both 45.2 Employment State Insurance Scheme Central Government Health Scheme Universal Health Insurance Scheme Ex Servicemen Contributory Health Scheme Centre Centre 3.67 Centre 3.7 Rajiv Aarogyasri (AP) State 70 Details Provides health insurance coverage for Below Poverty Line (BPL) families. Entitled to hospitalization coverage up to Rs30,000/- for most of the diseases that require hospitalization. Social Security Scheme for rural landless household, as a premium of Rs200/- per person per annum. Multidimensional social security system tailored to provide socio-economic protection to worker population and their dependents. Besides full medical care for self and dependents, that is admissible from day one of insurable employment, the insured persons are also entitled to a variety of cash benefits. The existing wage limit for coverage is Rs15,000/- per month. Comprehensive health care facilities for the Central Govt. employees and pensioners and their dependents residing in CGHS covered cities. Medical expenses up to Rs30,000/- towards hospitalization on floater basis for the entire family. Death cover due to an Rs25,000/- to the earning head of the family. Compensation due to loss of earning of the earning Rs50/- per day up to maximum of 15 days. Centre 4.4 Provide comprehensive coverage to ex-servicemen and their dependents. Kalaignar (TN) State 35 Healthcare facilities for BPL Families. Vajapayee Arogyasri Scheme (KN) Chief Minister's Comprehensive Health Insurance Scheme (TN) Megha Health Insurance Scheme (Meghalaya) Source: Jefferies, GoI State 1.4 State 1.3 Financial protection to families living below poverty line up to Rs2 lakhs in a year for the treatment of serious ailments requiring hospitalization and surgery. The benefit on family is on floater basis i.e. the total reimbursement of Rs.1.50 lakhs can be availed. Provide financial protection to families living below poverty line for the treatment of major ailments, requiring hospitalization and surgery. Free medical and surgical treatment to the members of any family whose annual family income is less than Rs72,000/-. Coverage up to Rs100,000/- per family per year on a floater basis for the ailments and procedures covered. State 0.3 Covers hospitalization expenses up to Rs200,000 for a family of five on a floater basis. page 22 of 77

23 Doctor engagement, standardization and capex are the key hurdles for serving Tier II cities. Need a new business model Indian hospitals trade at par or at a premium to regional peers despite lower returns profile, due to the structural growth story led by unmet demand. The current target market of most private hospitals in India is, however, only the premium segment (Tier I cities and high income) which is maturing. Larger growth opportunities are now outside these markets. This, along with increased government focus on increasing affordability, necessitates a change in business model going forward. The key hurdles for companies in targeting the affordable segment and Tier II cities are doctor engagement, standardization and capex. Some hospitals have started working on these aspects but to get true scale benefit and become more efficient, this needs to be standardized across whole system. Premium valuations driven by growth potential The Indian hospital sector is currently trading at 16.4x FY19 EV/EBITDA, in line with the regional (18.5x) and EM (17.7x) peers. This is despite lower margin and return ratios. The valuations for Indian hospital segment are driven largely by the growth potential of the market. Exhibit 52: Indian hospitals trading at par with regional peers Source: Bloomberg, Jefferies estimates Exhibit 53: Margin profile of Indian hospitals is the lowest among peers Exhibit 54: ROIC (%) also below regional peers Source: Bloomberg, Jefferies estimates Source: Bloomberg, Jefferies estimates page 23 of 77

24 Growth in mature hospitals has been sluggish, necessitating foray into Tier II cities Growth in mature though stagnating However, growth for the sector though has slowed over the past couple of years, led by increased competition and maturing industry. This is visible in the inpatient volume growth in existing clusters for most hospitals which is now in low, single digits. Management commentary also suggests this. We believe companies need to restructure their focus towards affordable segments and Tier II cities to sustain growth momentum. Exhibit 55: Mature hospital growth has come down Source: Jefferies, company data <check source> Exhibit 56: as has the inpatient volume growth Exhibit 57: which has led to margin reduction Source: Jefferies, company data <check source> Current model geared towards premium segment Doctor driven model leading to lower standardization Operating model for most corporate hospitals in India is currently geared towards the premium segment and Tier I hospitals. It is a doctor-driven model where the patient pull is driven largely by doctor reputation than hospital brands. This implies lower standardization across the chain. Additionally, most of the hospitals are under the ownand-operate model, which implies higher infrastructure cost and also long time to build. Exhibit 58: Comparable pricing of key cardiac surgeries/procedures (Rs) Mumbai - 1 Chennai -1 Hyderabad -1 Hyderabad -2 Mumbai - 2 Public hospital Bangalore -1 Angiogram K 15K 18K 10K 12-20K 8.6K 14-18K Narayana Angioplasty K 80-90K 75K K 25.3K 110K 54K-118K Coronary bypass 350K K 250K K 107K 350K 110K - 250K Source: Jefferies page 24 of 77

25 The focus is reflected in the fact that most hospitals do not participate in the welfare schemes of government. These schemes are usually at low price points and hospitals due to large overheads and cost structures do not find these hospitals remunerative. Exhibit 59: Medical tourism is seeing an uptick Source: Jefferies estimates, Company Data Exhibit 60: Hospitals not focused on government scheme patients Hospital Comments HCG NARH Reduced participation in certain government schemes like EHS, ESI etc. in Bangalore. Face some issues in recovery of funds Yield from a scheme patient typically 10-20% lower than a regular patient at the lower end of price band. Payment cycles from scheme patients have been quite bad. Also seeing a lot of misuse of these schemes Conscious decision to rationalize the subsidized scheme patients from the payor mix to improve profitability. APHS Not subscribed to Aarogyasri scheme in Telangana reducing addressable market size to 10%. Rush to fill beds by a few new patients by focusing on government scheme patients Source: Jefferies, company data Doctor engagement model A significant number of private hospitals in India work on star-doctor model. Under this, the hospital engages renowned doctors on an assured salary and a revenue share agreement. With this, hospitals engage in a revenue share agreement with doctors with a minimum guarantee, where the doctors get a share of the revenues generated by them. There are two components to these: Revenue share with in-house doctors. Referral fees in addition to revenue share to in-house doctors, many hospitals also give referral fees to the referring general physicians (GPs). The Star-Doctor model leading to margin pressures Additionally, the key patient driver is the doctor and not the hospital. Consequently, the doctors have the higher bargaining power, which results in increased costs for the hospitals, driven by two factors: High revenue share given the increased competition in the hospital space, hospitals have been forced to pay substantial amount to star doctors to retain them. Lack of standardization With the key decision maker and revenue pull being doctors, forcing standardization across hospitals becomes very difficult. This leads to higher overheads. The impact of this is reflected in Exhibit 61. Narayana, which has lower price points for procedures, has a significantly lower consumable and doctor fee compared to peers due to the high level of standardization. page 25 of 77

26 Exhibit 61: Cost structure across hospitals Narayana Apollo Fortis Kovai HCG Hospital Revenue Inpatient revenue Outpatient revenue Other Op Income Expenses Consumable Doctors + Consultants Doctor's payments Consultant Charges Other Employee Expenses Business Trust Costs Other Expenses EBITDA Depreciation EBIT Note: P&L for each hospital is Indexed with Revenues at 100; Source: Company data, Jefferies estimates Own and Operate is inefficient due high capex and long lead times Largely owned and operated The current structure for most corporate hospitals is Own and Operate. Under this, the corporates own all the infrastructure. This has two implications: Higher capex cost This leads to significant capex cost, especially on land acquisitions. Land cost for most hospitals is c40% of the overall hospital cost. Long lead time it also increases the time to operationalize as land acquisition and getting permissions is becoming challenging. Need to change model With Tier I cities and premium segment seeing increased competition and becoming well served, the industry is maturing. For companies to meet the long-term growth expectation to justify the valuations, they need to adjust their business model to cater to the affordable segment, which has most of the latent demand. This will require significant changes in the business model to bring down overall costs, which then can translate into affordable pricing. The key structural changes needed, in our view, are: Lower star-doctor dependence Standardization across chains PPP model to reduce investments Doctor dependency The key change in the business model, in our view, needs to be in terms of doctor engagement. This will need to move away from a revenue share to fixed salary model. This will allow scale advantage to flow to the hospital, allowing for increased operating leverage and serving lower category patients. Scale advantage The other key driver for reducing cost of services is the need to standardization procedures and consumables. Standardized buying across the chain can help significantly reduce costs. This is reflected in NH case where the consumables cost is much lower compared to peers due to standardisation. PPP model The other change which is needed is on the investment model. For companies to scale up in smaller cities, the capex costs needs to reduce and we believe PPP model will be the key page 26 of 77

27 going forward. This will allow lower investment cost and also reduce the time to operationalize by reducing land acquisition and approval times. Who is best placed to succeed? Given the changing dynamics and policies, we believe that there are headwinds to growth expectations. The companies that are positioned to target affordable segment can benefit significantly while those focussed largely on premium segment will see growth remaining below trend. We believe that in determining which of the companies are best placed, consider three factors: 1) positioning for the medium-term growth and profitability; 2) near-term financials; and 3) valuations. Exhibit 62: Mature hospital growth has come down Source: Jefferies estimates, Company Data NARH and HCG are best placed to tackle the changing landscape in the healthcare services space Medium-term outlook non-premium segment the key We believe that there are three key factors that will determine growth and profitability trends going forward and Exhibit 65 ranks hospitals on these. The factors are: Location hospitals in Tier II and also in north/central belt can see faster growth than those in south given competitive intensity. Exhibit 63: HCG has the max exposure Tier I Source: Jefferies estimates, Company Data Doctor engagement hospitals with higher FTE model and star doctors will find it difficult to cater to the affordable segment limiting growth. Additionally, with competitive intensity, increasing margins will remain under pressure. page 27 of 77

28 Capex model Hospitals relying on owned greenfield model should see delays in operationalization and also lower return ratios. It will also limit the amount of expansion without external funding. Exhibit 64: Average Capital Cost per bed lowest for NARH Source: Jefferies estimates, company Data Exhibit 65: Narayana and HCG better placed than peers over medium term Target market Doctor engagement Capex Model Execution track-record Overall Narayana HCG Apollo Fortis Note: Size of red pie indicates our score Source: Jefferies estimates Near-term financials location and capex cycle The near-term earnings trajectory is dependent on the growth in the clusters and also where in the capex cycle companies are. All listed companies are nearing the end of large capex cycle and thus margins should see improvement going forward. The other factor is the location, which in turn will determine competitive pressure and inherent growth. Exhibit 66: HCG and NARH have the best Exhibit 67: near-term growth expectation Source: Jefferies Estimates, Company Data Source: Jefferies Estimates, Company Data page 28 of 77

29 Exhibit 68: Return Ratios for the two are also Exhibit 69: expected to be better Source: Jefferies Estimates, Company Data Source: Jefferies Estimates, Company Data Narayana best placed followed by HCG Exhibit 70 combines the three factors medium term, near term and valuations. Narayana, in our view, is the best placed, considering the three despite premium valuations. HCG is our other preferred pick. While Apollo has strong near-term growth, we have concerns on its medium term growth prospects given rising competition in its home clusters and also its positioning. Exhibit 70: Narayana and HCG also better placed overall Medium term outlook Near term growth Valuations Overall Narayana HCG Apollo Fortis Note: Size of red pie indicates our score Source: Jefferies estimates Exhibit 71: NARH and HCG; valuation premium justified given better growth potential Source: Jefferies estimates, Company Data, Bloomberg page 29 of 77

30 Exhibit 72: Valuation regional and domestic hospitals (1) Mkt Cap EV/sales EV/EBITDA Company Name BB Code Rating Price (US $m) Fortis Healthcare FORH IN NC Rs , Apollo Hospitals APHS IN Hold Rs , Healthcare Global HCG IN Buy Rs Narayana Hrudayalaya NARH IN Buy Rs Raffles Medical Group RFMD SP NC SGD , IHH Healthcare* IHH MK Hold MYR , Bumrungrad Hospital BH TB NC THB 216 4, Bangkok Dusit BDMS TB NC THB , Bangkok Chain Hospitals BCH TB NC THB , Asia Hospitals Av Note: Closing Price as of 29 th Aug, 2017 Source: Jefferies Estimates, Company Data, NC data from Bloomberg; covered by co-brand research partner KAF-Seagroatt & Campbell Securities Sdn Bhd Exhibit 73: Regional and domestic hospitals valuations Mkt Cap P/E P/B Company Name BB Code (US $m) Fortis Healthcare* FORH IN 1, Apollo Hospitals APHS IN 2, Healthcare Global HCG IN Narayana Hrudayalaya NARH IN Raffles Medical Group* RFMD SP 1, IHH Healthcare IHH MK 11, Bumrungrad Hospital* BH TB 4, Bangkok Dusit* BDMS TB 9, Bangkok Chain Hospitals* BCH TB 1, Asia Hospitals Av. 3, Note: Closing Price as of 29 Aug, 2017 Note: * indicates non covered companies, NC data from Bloomberg page 30 of 77

31 Narayana Hrudayalaya Looks best placed Asset Right model and affordability focus key positives for NARH Narayana Hrudayalaya (NH) is, in our view, looks the best placed hospital player to tackle the challenges in the healthcare segment. Its affordable focus allows it to target the large growth segment, leading to stronger growth. It is a beneficiary of any move by the government to increase access and is also least impacted due to pricing caps. Further, the partnership model allows it grow profitably beyond Tier I cities. We expect the improving hospital maturity profile to drive 25% EBITDA growth, led by 196bps margin improvement over FY17-19E, and RoEs to improve to 15.7%. Retain Buy. Only large player in the affordable segment Narayana is the one of the few corporate hospital chains focussed on the affordable segment. NH s target segment is the low- to mid-income patients, and it has built a strong brand around affordable pricing (ARPOB 40-50% below peers). Exhibit 74: NH ARPOB is 40-50% lower than peers despite high cardiac focus NARH focused on low/mid income patients as indicated by the patient profile in Exhibit 75 The affordable target is also reflected in the fact that c20% of the company s revenues are from scheme patients vs <10% for peers. In fact, while most peers actively refrain from subscribing to government schemes, this is not the case for Narayana. Exhibit 75: Patient Profile FY13 FY14 FY15 FY16 FY17 Schemes 23% 25% 22% 18% 18% Insurance-covered patients, corporate patients and international patients 16% 17% 19% 22% 27% Walk-In patients 62% 59% 59% 60% 55% Source: Company data, Jefferies Affordable but for profit Although it is affordable, the company has recorded margins similar to peers with better returns. This is result of focus on innovation, standardisation and doctor engagement model. Surgeons at NH are full-time employees with no revenue sharing. No referral fees to doctors as it relies on NH brand to attract patients. page 31 of 77

32 NH lays great emphasis on maximising efficiencies through greater integration and better supply chain management. The standardization across networks has allowed the company to gain benefits of scale, which has helped reduce costs. Mature hospitals margins at 20% is at similar to best-in-class hospitals While the reported margins for NH are at 13%, this is not the true reflection of the hospital profitability of the company. As Exhibit 76 shows, despite the low cost and the fact that more than half of the beds are in hospitals with less than five-year maturity, margins for the company are at the industry average. Further, the mature hospitals margins stand at 25%, which is at a level similar to the best-in-class hospitals. Exhibit 76: Margins for NH in line with peers... Exhibit 77: with mature hospital margins better than most Source: Company Data, Jefferies estimates, Bloomberg Source: Company Data, Jefferies estimates, Bloomberg Exhibit 78: RoCEs for NH model higher than peers NH - New hospital (stable state) NH reported NH - Mature Industry average ARPOB (Rs / day) 20,685 20,820 23,034 29,572 EBIT Margins (%) Occupancy Cost per bed (Rs mn) WC days RoCE Source: Jefferies estimates Asset-right model allows expansion without balance sheet constraints Narayana s infrastructure model PPP partnership with government and trusts/charities reduces its capex cost and allows it to expand without balance sheet constraints. A key concern around NH has been the scalability and sustenance of its partnership model. We believe with government focus on PPP there would be an abundance of these deals. The asset-right model also allows expansion without balance sheet constraints. Strong mature segment growth validates potential The growth potential for Narayana is reflected in the growth trends witnessed over the past two years, at both the company level and also in its mature hospitals. Most hospitals reported FY17 mature hospital revenue growth and FY18 guidance of 4-8%, with only low single, digit volume increase. The key exception is Narayana, which reported 13% revenue growth in mature hospitals and 10%+ volume growth, and guided for sustained growth momentum. This has been led by focus on non-premium pricing. page 32 of 77

33 Exhibit 79: Sales growth for mature hospital ahead of peers Additionally, the increased inpatient growth has allowed the company to expand its mature hospital margin by c100bps vs the bps decline witnessed by peers. Exhibit 80: Narayana has shown one of the highest inpatient growth Exhibit 81:... along with one of the highest ARPOB improvement page 33 of 77

34 Exhibit 82: Mature hospital revenue growth has also been the strongest Exhibit 83: Narayana has also seen a 100bps margin expansion in mature hospital NARH is expanding into renal, oncology, neurology, orthopaedics and gastro Not just a cardiac hospital One of the concerns for NH has been whether it will be able to deliver the same success as in other therapies as it did in cardiac. Over the past three years, the company has focused on expanding into five other key therapies renal, oncology, neurology, orthopaedics and gastro. We believe that the company will be able to successfully expand in other therapies, which has been seen over the past year. Cardiac share in revenues was below 48% in FY17 vs 54% in FY15. Both oncology and renal have seen significant ramp-up and now contribute c10% of revenue each. Exhibit 84: Cardiac share in revenues is going down Improving mix to drive margin improvement We expect the improving hospital maturity profile to drive 25% EBITDA growth, led by 196bps margin improvement over FY17-20E, and RoEs to improve to 15.7%. While FY18 margins will be impacted due to stent pricing and Mumbai hospital, FY19 should see margin back to their uptrend led by normalization of stent pricing, improvement in Mumbai offset by Delhi hospital and ramp-up of other hospitals. The key growth drivers will be Karnataka and West and North cluster. We expect 19% revenue growth over FY17-20, led by 16% growth in Karnataka and Eastern. page 34 of 77

35 Exhibit 85: We expect revenue to grow c19% over the next three years Exhibit 86: with marginal improvement in the gross profit margin led by Karnataka and Eastern clusters Lower capex intensity to drive RoE improvement We expect the improvement in margins to drive improvement in return ratios. We expect RoEs to improve to 15.7% and pre-tax RoCE to improve to 18.2%. However, these do not factor any new hospital addition outside Delhi in the near term. NH aims to become a pan-india player. Given the low debt on balance sheet and lower capex intensity, we expect the company to enter additional partnerships over the medium term. We expect NH to add c400 beds every year going forward in the near term. Over the medium term, we expect NH to add beds annually funded through internal cashflows. Exhibit 87: Number of operating beds to increase over the coming years page 35 of 77

36 Exhibit 88: RoE to improve to c16% Exhibit 89: RoCE (pre-tax) to improve to best in class Exhibit 90: Capex muted in near term Exhibit 91: Net Debt to Equity to moderate Expect 25% EBITDA CAGR over FY17-20E Best placed hospital play; retain Buy NH remains our preferred picks in the hospital sector. We expect the improving hospital maturity profile to drive 25% EBITDA growth, led by 196bps margin improvement over FY17-20E, and RoEs to improve to 15.7%. Also, its medium term-growth drivers are much stronger with a model that profitably addresses tertiary care demand at lower cost and in non-metropolitan areas and allows expansion without B/S constraints. We retain our Buy rating and PT of Rs390, implying FY19E EV/EBITDA of 22x, a slight premium to peers. Trading at premium to peers NH is trading at 17.5x FY19 EV/EBITDA, a 5% premium to peers and sector. The premium, in our view, is justified given Stronger near-term growth we expect NH to report 25% EBITDA CAGR over FY17-20E. Strong medium-term growth led by affordable healthcare model unlike peers, NH targets the affordable pricing segment. This segment has the largest demand in the healthcare industry and it is also the least serviced. Thus, growth opportunities in this segment are quite high. Replicable model NH s asset-right model allows it to expand without balance sheet constraint and also reduces the time for approval. page 36 of 77

37 Exhibit 92: Valuation premium for NH led by its growth potential Exhibit 93: Indian hospitals are expected to experience higher EBITDA CAGR (FY17-20), Bloomberg page 37 of 77

38 Financials Exhibit 94: Profit and Loss Statement Rs mn E 2019E 2020E Net Sales 16,138 18,782 22,002 26,148 31,634 Change (%) Material Cost 3,871 4,359 5,348 6,144 7,429 Employee Cost 3,338 3,752 4,341 5,035 6,011 SG&A 7,183 8,382 9,714 11,332 13,719 EBITDA 1,746 2,289 2,598 3,637 4,475 % of net sales Depreciation ,111 1,245 Interest Other Income EO Income / (Exp) PBT 837 1,446 1,481 2,417 3,230 Tax Rate (%) PAT ,596 2,261 Share in (loss)/profit of associate (217) (79) (20) Minority Interest Adj. PAT ,635 2,271 change (%) (224.2) Exhibit 95: Balance Sheet Statement Rs mn E 2019E 2020E Share Capital 2,044 2,044 2,044 2,044 2,044 Minority Interest Reserves 6,716 7,587 8,545 10,180 12,451 Net Worth 8,763 9,633 10,591 12,226 14,497 Deferred Tax Liabilities Loans 2,321 1,888 3,088 3,588 4,088 Capital Employed 11,316 11,769 13,927 16,062 18,833 Gross Fixed Assets 13,580 14,637 18,537 20,773 24,018 Less: Depreciation 3,625 4,400 5,278 6,389 7,634 Net Fixed Assets 9,955 10,236 13,259 14,384 16,383 Capital WIP 728 1,112 1,112 1,112 1,112 Investments Deferred Tax Asset Current Assets 3,867 4,159 3,617 5,043 6,365 Inventory Debtors 1,518 1,569 1,838 2,185 2,643 Cash & Bank Balance (560) 405 1,116 Loans & Advances 1,611 1,725 1,725 1,725 1,725 Current Liabilities 4,248 4,698 5,021 5,438 5,988 Creditors 1,610 1,885 2,209 2,625 3,176 Other Liabiliteis 2,390 2,540 2,540 2,540 2,540 Provisions Net Current Assets (381) (539) (1,405) (394) 377 Appl. Of fund 11,174 11,770 13,927 16,062 18,833 page 38 of 77

39 Exhibit 96: Cash Flow Statement (Rs mn) E 2019E 2020E PAT ,596 2,261 Depreciation ,111 1,245 Interest Exp Other Income Change in Wkg Capital 2, (36) (46) (61) Change in Sundry Debtors Other Receivables Inventories (15) Creditors and other payables 2, Cash Flow from Operating Activities 3,345 2,027 2,059 2,769 3,445 Change in Fixed Assets 2,108 1,464 3,900 2,236 3,245 Change in Investments (349) (89) Other Income CF from Investing Activities (2,311) (1,379) (3,813) (2,017) (2,917) Change in equity 646 (38) (20) Changes in debt (1,299) (433) 1, Interest Exp (294) (218) (327) (327) (327) Dividend paid Others CF from Financing Activities (947) (690) Net change in Cash 87 (42) (900) Exhibit 97: Key ratios Basic (Rs) E 2019E 2020E EPS BPS Valuation (X) P/E P/B EV/EBITDA EV/Sales Profit Ratios (%) RoE RoCE Turnover Ratios Debtor Days Inventory Days Creditor Days Net Debt to Equity page 39 of 77

40 Apollo Hospitals Need to readjust; initiate at Hold Apollo Hospitals (APHS) is the largest private healthcare provider addressing the premium care segment. It also has a strong pharmacy business and early stage investment in the retail healthcare segment. With no significant capex in near term, we expect EBITDA to grow at 19% CAGR over FY17-20E, led by improvement in the new hospitals (29% revenue CAGR), strong growth in pharmacy (19% CAGR) and turnaround in AHLL. While APHS has expanded to cover Tier II cities, its target market is still the affluent class, which is a mature segment with slower growth. Hospital business is also seeing increased competition, driving the need for satellite hospitals, in turn putting pressure on margins and RoCEs. We expect the company to see further capex from FY19, led by competition. The government pricing moves remain an overhang in the near term, both for hospitals and pharmacy. The stock is trading at 17.5x FY19 EV/EBITDA, in line with peers despite slower growth and outlook. We initiate with a Hold rating and SOTP based PT of Rs1,150, implying FY19 EV/EBITDA of 19x. Key risks: better-than-expected ramp-up in Mumbai and Chennai clusters; faster turnaround in AHLL. APHS diversified healthcare service player Apollo is a diversified healthcare player and owns the largest private hospital chain with 71 hospitals comprising 8,189 operational beds (10,107 capacity beds) spread over 27 cities. It also has large pharmacy chain with 2,556 pharmacies. It has ventured into related healthcare services like birthing centres, day surgery facilities through its subsidiary AHLL. The company has strong foothold in south India, especially around Chennai and Hyderabad. Exhibit 98: Apollo at a glance Segment Revenue Contributions No. of Units Details Existing Hospitals 46.7% 30 A pan India network of hospitals with centre of excellence across cardiology, oncology, neurology etc. New Hospitals 10.3% 13 A host of hospitals opened recently to fuel growth Pharmacies 39.6% 2556 India's first and largest branded pharmacy network AHLL 3.4% 259 Source: Jefferies, company data The core idea is to take healthcare services purely from a hospital setting to closer home. Consists of Apollo Clinic, Apollo Sugar, Apollo Diagnostics, Apollo White Dental, Apollo Dialysis, Apollo Spectra and Apollo Cradle The hospital segment is the key for the company and contributes 57% of the revenues but 97% of the EBITDA. The pharmacy segment is a key growth driver and its share in EBITDA (and revenues) has increased from 8% (34%) to 17% (40%) between FY AHLL is still in investment mode and contributes only 3% of revenue and its losses are 14% of the company s consolidated EBITDA. page 40 of 77

41 Exhibit 99: Existing hospitals and Standalone Pharmacies major contributors to revenue Exhibit 100: but EBITDA contributed almost exclusively by existing hospitals Strong expansion over the past three years to fend off Increasing competition Hospitals rising competition putting pressure on growth APHS recently completed a large expansion in its hospital segment, adding 1,300 beds and 13 new hospitals. In our view, the company is well positioned in the premium segment and south India. It has started foraying into Tier II cities, which should aid in growth over the medium term. The target market remains the affluent class where rising competitive intensity is impacting growth and margins. Given this, we expect the growth to be weak and pressure on margins to continue. Additionally, competition should also drive further capex. Largest private hospital with strong foothold in South India Apollo is the largest private hospital chain in India with established presence in south India. 28% of its consolidated beds are in the Chennai and Hyderabad clusters. Additionally, it has c25% market share in the target segment in these clusters, highlighting the dominance. Exhibit 101: Apollo has a significant market share in major cities of the south Source: Company data, Jefferies page 41 of 77

42 Exhibit 102: Chennai and Hyderabad are the major clusters for Apollo Exhibit 103: with c28% operating beds present in these two clusters, Bloomberg REACH hospitals to act as spokes for their hubs in Chennai/Hyderabad. Forays into Tier II cities Over the past few years, Apollo has entered Tier II cities through its REACH hospital initiative. It now has 10 hospitals under this brand. The REACH hospitals are largely secondary care hospitals acting as spokes and feeders for the main hospitals in Chennai and Hyderabad. The forays, in our view, are positive, providing an entry point for further expansion over the medium term to target the affordable segment in these areas. Exhibit 104: List of Apollo REACH hospitals Nearest Big Hospital Location State Location Distance from nearest large hospital (km) Kakinada Andhra Pradesh Vizag 155 Karaikudi Tamil Nadu Chennai 418 Karimnagar Telangana Hyderabad 163 Bhubaneswar Odisha Kolkata 441 Karur Tamil Nadu Bangalore 297 Madurai Tamil Nadu Bangalore 436 Trichy Tamil Nadu Chennai 330 Vanagaram Tamil Nadu Chennai 15 Nellore Tamil Nadu Chennai 177 Nashik Maharashtra Mumbai 166 Source: Jefferies, company data Focus on affluent segment reducing the addressable market size significantly Target still affluent class, though Despite the expansion into Tier II cities, Apollo s target market continues to be the affluent class and the medical tourism segments. It has been recalibrating its hospitals and moving away from the government schemes and low paying corporates. This, in our view, limits the target market and consequently the growth prospects for the company. Some of the management comments on this are as follows: In Hyderabad, it does not cater to the Aarogyasri, as it is a low paying scheme which limits its target market to only 10% of the population. Management stays on course on improving the case mix despite rush to fill beds by a few new players by focusing on low profitability segments and government schemes. page 42 of 77

43 Higher capex led by competition In its hospital segment, Apollo is exiting a large expansion phase. Over the past four years, it added 20 hospitals. This has resulted in its operational beds increasing by 23% to 8,189. The capacity beds for APHS now stand at 10,107. The capex was expected to drive strong growth in the business ahead. The commentary and performance over the past 18 months has raised concerns on the same, though. We believe that given the increased competition in the space and government pressure, margins and RoCEs have seen a structural decline. Additionally, capex is required not only for growth but also for retaining market share, and we expect capex cycle to restart in 2HFY19. Our concerns are visible in three key factors: Slow growth in Chennai Chennai has added 25% additional beds over the past three years. Despite these new beds, inpatient volume growth has been muted at c1% over the past five quarters. While management has alluded to one-off issues in various quarters, even quarters without any of the factors growth has been slower. Exhibit 105: Slow growth in the number of operating beds in Chennai due to Exhibit 106: sluggish growth in the inpatient volume over the past 5 quarters Management indicated that volume growth likely to remain muted despite significant capacity expansion. Management commentary on market share and competition recently, management indicated that they expect volume growth to be in mid- to high, single digit going forward. This is also visible in the growth over the past eight quarters, where growth has been in single digits despite a 25% bed addition and 13 new hospitals. Management focus is also on improving mix and hence Average Revenue per Operating Bed (ARPOB). While the company has talked about focusing on new target segments, this is very selective and key focus remains improving mix and pricing. This indicates that growth will largely be driven by pricing and improving mix. However, this limits the growth potential due to rising competition in the space. Some of the management comments on volume growth and additions are: Slow inpatient volume growth of c1% seen in the Chennai cluster. Expect volume growth to be in single digits going forward. Added capacity despite sluggish volume growth in order to maintain market share and stave off competition. Inpatient growth for the overall company. page 43 of 77

44 Exhibit 107: Improvement in case mix driving revenue growth; volume growth in low single digits Regulatory pressures, the stardoctor model and increasing competition to hinder margin expansion Rising competition and government moves to keep margin improvement limited While hospital margins are depressed due to the losses in new hospital, especially Mumbai, we expect existing hospitals margins also to be under pressure due to competition and government moves on affordability. 1Q18 results reflect this, where existing hospital margins declined 314bps. We expect margins to recover only to 21% (consolidated level) vs the 22-23% in FY15/16. This is due to three factors: Government price caps while management has indicated that it will be able to offset the impact of price caps on stents and knee over the next 12 months, we do not believe that all of the losses could be recouped. Further, we expect additional measures over the next 12 months. Higher doctor fees with rising competition, especially in the key markets of Chennai/Bangalore and Hyderabad, doctor fees should remain elevated. This was visible in 1Q18, where margins were impacted by c60bps due to guarantee money. While APHS has been able to retain doctors, this would come at an additional cost Pricing pressure The increased competitive intensity would result in reduced pricing capacity for APHS. Given the recent capacity addition, we believe that APHS pricing capacity is low and this should limit margin improvement, especially given the rising wage costs. Pause and not a halt to the capex cycle We believe that the capex cycle is on a pause and APHS will revert to new hospital additions by 2HFY19. This is due to two factors: Slower growth in existing hospitals: We expect trend growth in existing hospital is expected to be slow at mid, single digits, largely led by mix. However, there is a limit to improvement from this and we expect growth to taper in FY19 as Hyderabad ARPOB improvement peaks. Competitive pressure The premium hospital segment is seeing significant competitive intensity both from existing players and also forays from international players. We believe that APHS may be forced to expand into feeder areas of its existing regions to stave off competition and retain the market share that it currently enjoys. page 44 of 77

45 The return of capex cycle along with lower margin trajectory implies that return ratios should also be lower going forward. Pharmacy key growth driver Strong growth opportunity in the largely unorganized market Apollo Pharmacies is India s first and largest branded pharmacy network with 2,556 outlets in key locations. The company is also looking at adding online presence once the appropriate government regulations and guidelines are announced. Currently, the company has a strong presence in south India and aims to develop a pan-indian presence. It also acquired Hetero Pharmacy two years ago and is looking at adding c250 stores per annum to increase its reach and widen its network. Exhibit 108: Revenues growing steadily on the back on increasing number of stores Exhibit 109: but EBITDA margins are stuck in low single digits GST will help but potential margin cap can act as a headwind for margin expansion. The capex required in expansion of network here is relatively low with capex of Rs482 mn done in FY17 for a net increase of 230 stores. The RoCE for the business was 14.9% in FY17. Going forward, we see some upside once the GST benefits start to accrue for the organized sector. However, the potential margin cap mentioned in the draft pharma policy can act as a headwind. Apollo Health and Lifestyle (AHLL) In early stage The core strategy behind AHLL is to increase patient engagement through multiple touchpoints AHLL consists of the largest chain of standardized primary healthcare centres and is one of the largest players in the retail healthcare segment in India. The core idea behind AHLL is to take healthcare services purely from a hospital setting closer to home and to serve the community through multiple touchpoints. It consists of Apollo Clinic, Apollo Sugar, Apollo Diagnostics, Apollo White Dental, Apollo Dialysis, Apollo Spectra and Apollo Cradle. Each of these formats is aimed at addressing a consumer trend seen in the market. Exhibit 110: AHLL at a glance Segment Care Type Network Revenue (Rs mn) Details Apollo Clinic Primary Care Providing patients primary care closer to home Apollo Sugar Primary Care Holistic Specialized care for diabetes Apollo Diagnostics Primary Care Diagnostics for brand conscious customers Apollo White Dental Primary Care Holistic specialized care for dental patients Apollo Dialysis Primary Care 5 55 Holistic specialized care for patients requiring dialysis Apollo Spectra Specialty Care Short stay surgical centres Apollo Cradle Specialty Care Differentiated Personalized experience for mothers-to-be Source: Jefferies, company data page 45 of 77

46 Exhibit 111: Apollo Spectra and Clinics are the major revenue contributors Exhibit 112: but Apollo Cradle is the major growth driver for revenue Apollo Spectra, Apollo Clinic and Apollo Cradle constitute c75% of the revenues in the company. AHLL has seen a stable growth over the past two years, mainly driven by Apollo Cradle. The company is still in the investment stage, as seen from the EBITDA margins, and aims to breakeven at the EBITDA level in the next 24 months. The target steady state EBITDA margin is c18-20%. Exhibit 113: Stable revenue growth over the past two years owing to increasing network Exhibit 114: but breakeven at the EBITDA level still some time away Each of the seven formats is treated as a separate business unit. This enables the company to get very specialized in their ability to handle customers and appreciate their requirements. Apollo Spectra: Apollo Spectra is AHLL s foray into short-stay or day surgery format. This model is relatively nascent in India but with the changing lifestyles in the country, time is at a premium and this segment is set to see significant growth in the near future. Nova Specialty Hospitals was acquired to build the network. The focus on is on driving profitability by refining the network and rationalizing the cost structure. Apollo Clinic: The goal of Apollo Clinics is to become the first point of care for communities for preventive and primary care treatment. The growth strategy for this format is by increasing penetration in the states where the company is already present. This is the most mature segment of AHLL and is very close to the breakeven point. page 46 of 77

47 Exhibit 115: Apollo Spectra Exhibit 116: Apollo Clinic Apollo Cradle: Through this format, the company is targeting the premium maternity segment and aims to provide a differentiated personalized experience to the mothers to be. It is a relatively young format but is already a market leader in terms of network size which positions it well to be a leader in terms of revenues fairly quickly. The growth for this format will be driven by expanding into the Top 30 towns and gaining the first mover advantage. Apollo Sugar: Apollo Sugar aims at providing a differentiated 360-degree offering to the diabetic patients. This operates as a fairly asset-light model because it operates as shop-in-shop i.e. Sugar clinics are set up either insider larger Apollo hospitals or inside an Apollo clinic etc. We expect this segment to be profitable over the next 24 months. Exhibit 117: Apollo Cradle Exhibit 118: Apollo Sugar Apollo Diagnostics: AHLL aims to create a pin-india B2C focused pathology business though this segment. This format operates as a hub and spoke model with company owned labs operating as hubs and patient service centres (operating through the franchise model) as spokes. Apollo White Dental: The core idea behind Apollo White Dental is to provide holistic specialized care to dental patients. FY17 was a tough year for this business but after numerous corrective actions taken by the management, this format is seeing a turnaround. page 47 of 77

48 Exhibit 119: Apollo Diagnostics Exhibit 120: Apollo White Dental Low capex near term to drive 19% EBITDA growth We expect APHS to report 19% EBITDA CAGR over FY17-20, led by AHLL turning EBITDA positive and sustained growth in pharmacy business. We expect hospital business EBITDA to grow at only 11% CAGR, largely led by ramp-up of new hospitals. We expect mature hospital EBITDA growth to be only 6% as price caps and increased manpower cost (competition and inflation) offset mix and pricing benefit. We expect margins and return ratios to normalize at lower levels versus history due to the higher capex intensity and structural challenges. We expect pre-tax RoCEs to be at 12% by FY20. Hospital business ramp-up in new hospital to drive 11% EBITDA CAGR We expect hospital business revenues to grow at 11% CAGR over FY17-20 and margins to improve 12bps, driving 11% EBITDA CAGR. The growth would be led largely by new hospitals and we expect existing hospital revenue and EBITDA growth at 6%. Exhibit 121: Existing hospitals expected to grow in single digits Exhibit 122: but new hospitals expected to drive growth for the company Revenue growth led by other cluster We expect revenue growth in the key clusters of Hyderabad and Chennai to be muted at just 8%, led largely by improving mix and 4% volume growth. The growth would be impacted by two factors: Recalibration in Chennai with corporates APHS is renegotiating its contract with PSUs in Chennai hospital which contribute 3% of inpatient volumes. page 48 of 77

49 Increasing competition The key clusters have seen increased competition over the past two years and this is likely to remain. This will impact inpatient volume growth especially as APHS has been moving away from low paying patients We expect the other clusters though to see strong growth of 22%, led by ramp-up in new hospitals and market share gains. JV growth would likely be impacted due to Kolkata hospital which could remain impacted for another couple of quarters. Exhibit 123: Growth in Chennai/Hyderabad clusters to remain muted Exhibit 124: due to increasing competition Exhibit 125: Other clusters to drive growth Exhibit 126: Single digit growth in associates Margin improvement limited due to headwinds We expect the hospital margins to improve by 12bps, led largely by ramp-up in new hospital. We expect existing hospital margins to be flat over FY This is despite improved case mix as we expect cost headwinds to offset gains in pricing. The key headwinds, in our view, are: Price cap on key commodities Rising doctor charges Higher wage inflation We expect the new hospital margins to improve to 8% by FY20, including the impact of the new addition in Chennai and Lucknow, and expansion in Mumbai. page 49 of 77

50 Pharmacy and AHLL the key for company EBITDA The key growth driver for APHS, in our view, is the pharmacy business and the turnaround in AHLL. We expect hospital contribution to EBITDA to decline from 97% to 81% as these two businesses improve. Expect pharmacies and AHLL to drive margin expansion We expect pharmacy business revenues to grow at c19% CAGR and margins to improve 20bps, driving 20% EBITDA CAGR. This should be led by 9% CAGR in number of pharmacy and 9% growth in same store growth, with GST providing further support. The key risk, though, is capping of trade margins on all prescription drugs. This could have impact on margins. Exhibit 127: Revenue for pharmacies to grow at c19% CAGR Exhibit 128: leading to EBITDA growth of c20% In AHLL, we expect revenues to grow at 20% CAGR and expect the business to turn EBITDA-positive in FY20 with 4% margins. Exhibit 129: Revenue for AHLL to grow at c20% CAGR Exhibit 130: with EBITDA turning positive in FY20 Return ratios to remain well below trends Despite the improvement in the currently loss-making business (new hospital and AHLL), we do not expect APHS to revert to the historical margins or return profile. We expect RoCEs to be at 12% in FY20 vs 14% in FY13. This would be due to three factors: Decline in hospital RoCEs due to competition, as highlighted earlier. Higher contribution of pharmacy. page 50 of 77

51 Sub-par performance of AHLL. Exhibit 131: Return ratios to remain below historical levels due to Exhibit 132: increasing competition and changing revenue mix Exhibit 133: Capital Employed across the various business verticals Exhibit 134: c82% of capital employed by the company is in hospitals Given the slower growth in mature hospital, rising cost pressure and need to add feeder hospital, margins and RoCEs will be lower going forward. We do not expect APHS hospital business to return to the previous margin peaks. Leverage to moderate We expect APHS leverage to moderate over FY17-20 as it remains in the consolidation phase. We expect net debt to equity to reduce from current 0.66x to 0.43x by FY20. Apollo is currently one of the most levered hospitals in the region along with HCG. page 51 of 77

52 Exhibit 135: Net debt to equity expected to improve Exhibit 136: Apollo one of the most levered amongst its peers, Bloomberg Exhibit 137 lists the stated capex plan for the company. In addition it also has 2 oncology centres planned over FY Additionally, we believe that in FY19 it will start announcing plans for additional capex to sustain growth. Exhibit 137: CapEx plan going forward Location CoD* Type of Hospital Addition in FY No. Of Beds Total Estimated Project Cost (INR mn) Navi Mumbai FY Oncology 620 Sub Total 620 Addition in FY 19 Indore FY19 Expansion South Chennai FY19 Proton Therapy 200 7,500 Sub Total 265 7,780 Addition in FY Byculla, Mumbai FY Super Specialty 500 3,500 Sub Total 500 3,500 Total ,900 Note: CoD stands for expected date of completion Source: Company Data page 52 of 77

53 Exhibit 138: CapEx expected to go down after the major expansion over the last 3 years, Bloomberg Initiate at Hold While we expect 19% near-term growth for Apollo, it does not have strong medium-term drivers. While it has expanded to cover a wider range of services and expanded in smaller cities, its target market is still affluent class where competition is increasing. Its key markets in hospital business (Chennai and Hyderabad) have matured and are seeing increased competition which will impact margins. Government pricing moves remain overhang in near term on both hospital and pharmacy. The stock is trading at 17.5x FY19 EV/EBITDA, in line with peers despite slower growth and outlook. We initiate with Hold rating and SOTP based PT of Rs1,150 implying FY19 EV/EBITDA of 19x. Key risks: Better than expected ramp-up in Mumbai and Chennai clusters; faster turnaround in AHLL. Rising competition limits profitable growth APHS has strong growth potential in near term, led by the rapid expansion over the past three years and uptick in pharmacy and turnaround in AHLL business. The growth trend in the hospital business, however, indicates slower potential over the medium term. This is as despite a 30% bed addition, we expect hospital business revenue growth of only 11% CAGR and even best consensus expectation is of only 15% CAGR. We believe the key hurdles for APHS going forward are Non-addressability of lower price patients Over the past few years, APHS has moved away from the lower priced patients indicating that they are not remunerative. This limits the target market for Apollo especially in South India with large government insurance schemes Rising competition implies slower growth increased competition in key clusters should impact both volume and pricing. And impact on margins Increased competition should also lead to higher cost as the star doctor costs go up. Further, the nursing staff could also see uptick due to same RoCEs to remain subdued With rising competition, APHS will need to increase its footprint to sustain growth. Additionally, there is increasing demand for local presence for attracting patients from Tier II cities to metros, which increases the capital requirement page 53 of 77

54 Government affordability the moves key headwind any incremental move by government to push affordable healthcare will have impact on APHS profitability and growth We believe that APHS needs to innovate its model to sustain growth. It needs to target the affordable segment atleast in the satellite hospitals more aggressively. This though would require change in business model which will take time. Additionally, while the company has talked about the same, the larger push in the near term remains on improving mix and pricing. Valuations at par APHS is trading at 17.5x FY19 EV/EBITDA in line with peers and premium to its historical valuations. This is despite lower return ratios and growth expectation ahead. We believe that valuations could see further moderation as growth in core hospital business flatters and cost pressures keep margins subdued. Exhibit 139: EV/EBITDA vs growth looks fairly valued, Bloomberg Exhibit 140: APHS is trading at premium to historical multiples Exhibit 141: P/B valuations it is at historical average though return ratios have deteriorated Source: Factset Source: Factset While APHS is expected to see 19% EBITDA CAGR over FY17-20, this is inferior to peers. Further medium-term outlook is weak. The next phase of growth in Indian hospital segment will be led by Tier II cities and affordable care. While Apollo has entered Tier II cities, its target market remains the affluent class. It has struggled to address the affordable segment in most of its hospitals, due to: page 54 of 77

55 Low cost requirement most of the incremental demand in these markets is at much lower cost than in metro markets, which APHS has found difficult to achieve. High capex and long approval timelines with land acquisition cost and approval timeline increasing expansions have taken longer than expected. Apollo, in our view, needs to quickly address the cost issue to be able to cater to this large market. This is especially important, as most hospitals are under-utilized and with slow inpatient growth will likely remain so over the medium term. Exhibit 142: Sales CAGR (FY17-20) Exhibit 143: EBITDA CAGR (FY17-20), Bloomberg, Bloomberg Initiate at Hold with PT of Rs1,150 We expect APHS to report 19% EBITDA CAGR over FY The growth prospects post FY20 though are not clear as the maturing premium care segments limit growth potential. We initiate with Hold rating and SOTP based PT of Rs1,150 implying 19x FY19 EV/EBITDA, in line with peers but discount to its recent valuations history. Risks We value the hospital business at 17x EV/EBITDA a discount to sector valuations due to the slower growth and risk to earnings. The valuations though are at premium to historical valuations for the company. We value pharmacy business at 25x EV/EBITDA (1.1x sales) We value Gleneagles at 10x FY19 EBITDA and a 35% holding company discount We value AMHI at 1x Sales and a 35% holding company discount The key risk for Apollo s PT and estimates is the increasing competition in its core clusters impacting both the doctor fees on the cost front and the patient flow on the revenue front. Government regulations in the sector in terms of price caps on various transplants as well as trade margin caps could pose a challenge to the company as well. Other than these, a delay in the ramp-up in new hospitals or AHLL could prove to be a headwind. Management profiles Dr. Prathap C. Reddy Founder, Chairman Dr. Prathap C Reddy, the visionary Founder-Chairman of Apollo Hospitals is widely acknowledged as the architect of modern Indian healthcare. Dr. Reddy has also been the Chairman of the Confederation of Indian Industry's National Health Council and advisor to its committees on Healthcare, Health Insurance, Public Health and Pharma. He was pivotal in the genesis of NATHEALTH - the Healthcare Federation of India. Dr. Prathap C page 55 of 77

56 Reddy was conferred the 'Padma Vibhushan' the second highest civilian award by the Government of India. Dr. Preetha Reddy Vice Chairperson Dr. Preetha Reddy is the Vice Chairperson of the Apollo Hospitals Group. Preetha works closely with the organization's clinicians in introducing contemporary protocols to continuously enhance clinical outcomes. Dr. Preetha Reddy holds a Bachelor's degree in Science and a Masters in Public Administration. She was conferred the degree of Doctor of Science (Honoris Causa) by the Dr. MGR Medical University, Tamil Nadu. Ms. Shobana Kamineni Executive Vice Chairperson Shobana Kamineni is the Executive Vice Chairperson of Apollo Hospitals Enterprise Limited. She helms Apollo Global Projects Consultancy and the Research & Innovation divisions of the organization. She also heads Apollo Pharmacy. She is the founder and a Whole Time Director on the Board of Apollo Munich Health Insurance. She was conferred an Honorary Doctorate Degree of Science by the prestigious Bryant University, USA. Ms. Suneeta Reddy Managing Director Suneeta Reddy is the Managing Director of Apollo Hospitals. Spearheading the finance and strategy functions, Suneeta Reddy was instrumental in bringing the first FDI into healthcare in India. She is a Director on the Board of Apollo Munich Re-Health Insurance Company Ltd. She also serves on the Board of several Apollo Hospitals' Group companies. She holds a Diploma in Financial Management from the Institute of Financial Management and Research, Chennai and has completed the Owner / President Management Program at Harvard Business School (HBS), Boston, USA. Ms. Sangita Reddy Joint Managing Director She joined Apollo in 1983 and has held a number of responsible positions including Executive Assistant to Chairman, CEO, Apollo Hospitals, Chennai etc. Sangita had promoted and currently helms Apollo Health and Lifestyle Ltd. Sangita Reddy is the Chairperson of FICCI (Federation of Indian Chambers of Commerce & Industries) for the states of Telangana and Andhra Pradesh, and she is also its National Head of Healthcare. Sangita Reddy graduated in Science with Honours from the Women's Christian College in Chennai, India. She has done executive courses in Hospital Administration from Rutgers University, Harvard University and the NUS. page 56 of 77

57 Financials Exhibit 144: Profit and Loss Statement Rs mn E 2019E 2020E Net Sales 62,147 72,549 83,532 96, ,300 Revenue growth (%) 20.0% 16.7% 15.1% 15.0% 13.8% Material Cost 30,547 35,954 41,313 47,301 53,620 Employee Cost 10,236 11,965 14,119 16,942 20,331 Other Expenses 14,486 17,344 19,939 22,005 23,156 EBITDA 6,878 7,286 8,161 9,778 12,193 EBITDA Margin (%) 11.1% 10.0% 9.8% 10.2% 11.2% Depreciation 2,638 3,140 3,642 3,724 4,098 Other Income EBIT 4,690 4,370 4,867 6,395 8,399 EBIT Margin (%) 7.5% 6.0% 5.8% 6.7% 7.7% Interest 1,800 2,574 2,574 2,626 2,711 EO Income / (Exp) PBT 3,049 1,797 2,293 3,769 5,689 Tax ,093 1,593 Rate (%) 31.8% 50.6% 30.0% 29.0% 28.0% PAT 2, ,605 2,676 4,096 Minority Interest Share in Associates Adjusted PAT 2,364 2,210 2,660 3,664 4,678 change (%) -30.5% -6.5% 20.4% 37.7% 27.7% Exhibit 145: Balance Sheet Statement Rs mn E 2019E 2020E Share Capital 34,537 36,679 38,335 40,900 44,175 Minority Interest 1,303 2,164 2,996 3,552 3,701 Share application money pending allotment Net Worth 35,840 38,878 41,366 44,487 47,910 Deferred Tax Liabilities 4,977 2,269 2,269 2,269 2,269 Loans 26,867 30,598 31,222 32,232 32,952 Capital Employed 67,684 71,744 74,857 78,987 83,131 Net Fixed Assets 36,127 44,233 43,711 44,987 43,389 Capital WIP 5,956 3,467 3,467 3,517 4,617 Goodwill 2,120 2,267 2,267 2,267 2,267 Investments 2,697 4,357 4,357 4,357 4,357 Deferred Tax Asset 134 1,340 1,340 1,340 1,340 Current Assets 29,837 25,711 30,104 33,770 39,327 Inventory 4,433 4,669 5,375 6,180 7,034 Debtors 7,020 7,482 8,615 9,904 11,273 Cash & Bank Balance 3,976 5,264 7,817 9,391 12,725 Other Current Assets Loans & Advances 13,923 7,406 7,406 7,406 7,406 Current Liabilities 9,188 9,632 10,389 11,251 12,167 Creditors 4,636 5,005 5,762 6,624 7,540 Other Liabilities 3,906 3,825 3,825 3,825 3,825 Provisions Net Current Assets 20,650 16,080 19,714 22,519 27,160 Appl. Of fund 67,684 71,744 74,857 78,987 83,131 page 57 of 77

58 Exhibit 146: Cash Flow Statement Rs mn E 2019E 2020E PAT 2,364 2,210 2,660 3,664 4,678 Depreciation 2,638 3,140 3,642 3,724 4,098 Interest Exp 1,800 2,574 2,574 2,626 2,711 Other Income Change in Wkg Capital -4,112 1,944-1,082-1,231-1,307 Change in Sundry Debtors ,133 1,289 1,369 Other Receivables 3,992-4, Inventories Creditors and other payables 1,737-2, CF from Op Acitivities 2,240 9,643 7,446 8,443 9,875 Change in Fixed Assets 9,073 8,906 3,120 5,050 3,600 Change in Investments , Other Income CF from Investing Activities -8,214-10,340-2,772-4,709-3,296 Change in equity 1,996 1, Changes in debt 6,944 3, , Interest Exp 1,800 2,574 2,574 2,626 2,711 Dividend paid 964 1,004 1,004 1,004 1,099 Others CF from Financing Activities 6,177 1,985-2,121-2,160-3,245 Net change in Cash 202 1,288 2,553 1,574 3,334 Cash at beginning of year 3,773 3,976 5,264 7,817 9,391 Cast at end of year 3,976 5,264 7,817 9,391 12,725 Exhibit 147: Key ratios E 2019E 2020E Basic (Rs) EPS BPS DPS Valuation (X) P/E P/B EV/EBITDA EV/Sales Profit Ratios (%) RoE 6.8% 6.0% 6.9% 9.0% 10.6% RoCE 8.1% 6.9% 7.7% 9.7% 12.5% Turnover Ratios Debtor Days Inventory Days Creditor Days Net Debt to Equity page 58 of 77

59 Significant presence in Tier II/III cities and strong execution is a key positive for HCG HCG IN Niche player; initiate at Buy HealthCare Global, in our view, with its hub and spoke model and doctor engagement model is well positioned to succeed in the oncology space. It has showcased ability to profitably expand in Tier II cities, which provides strong medium-term growth drivers. Additionally, we expect it to report 27% EBITDA CAGR over FY The stock is trading at 15.7x FY19E EV/EBITDA, a discount to sector and peers. We believe that the discount will narrow as growth overshadows peers and it ramp-ups in new centres. We initiate with Buy rating and SOTP based PT of Rs325, valuing it at 18.5x FY19 EV/EBITDA. Niche focus HCG is a niche healthcare provider specializing in oncology which contributes c75% of its revenues. It also has two multi-speciality hospitals in Gujarat and a growing fertility business under Milann brand. The company is in an expansion mode and is operationalizing right centres between FY17 and FY18. We expect HCG to be in consolidation mode from 4QFY18. Positively, of the 26 centres by end-fy18, 18 will be outside the metros and in Tier II cities. The company s execution track-record shows that it is able to profitably expand in these geographies, a key positive. Additionally, its existing centres have seen one of the highest growth among peers. Centred around onco and fertility Healthcare Global is a niche healthcare provider with a focus on oncology and fertility segments. The company operates 20 comprehensive oncology centres and is the leading oncology chain in India. Its main hospital is in Bangalore which houses the latest technology. Karnataka, Gujarat and East India are the key clusters for the company though it has now expanded to new geographies which are seeing fast ramp-up. Exhibit 148: HCG centers contribute c71% revenue Exhibit 149: Karnataka and Gujarat - the key clusters It also has 50% stake in Fertility clinic business Milann run by Dr Kamini Rao. As Exhibit 148 shows, it derives c71% of its revenues from Oncology and 8% from Fertility centres. It also operates two mutlispeciality hospitals both based out of Gujarat. Hub and Spoke with reach in Tier II cities The key positive for HCG in our view is the large presence in Tier II cities. Unlike peers, c60% of the company s beds is outside major cities and in fact c40% is outside the top 40 cities. This is led by the company s Hub and Spoke model where the centre s outside major cities provide diagnostic, medical and follow-up care. While complex cases get referred to the metros. Additionally, the company s centralized diagnostic, medical and radiation aids is reducing overheads. This is led by 1) centralization and standardization of page 59 of 77

60 consumables, 2) centralised treatment planning and tele-radiology services, and 3) standardised clinical protocols for diagnosis and treatment. The centres of excellence act as the hub for other centres present in the Tier II cities. These centres of excellence provide other centres: access to quality control and assurance services; establish treatment protocols that are adhered to across HCG network; provide centralized treatment planning and tele-radiology services to help with diagnosis and treatment conduct weekly central tumour meetings to review complex cases; give the network access to advanced technologies such as WBRRS and specialised procedures such as liver transplants and stem cell therapies. Exhibit 150: Sizable presence in Tier II cities Existing Metros Under Development No. of beds No. of centers No. of beds No. of centers Delhi 85 1 Mumbai Kolkata 80 1 Bangalore Chennai 35 1 Tier I (non metro) Ahmedabad 78 1 Vishkhapatnam 88 1 Kanpur 90 1 Nagpur Jaipur 93 1 Kochi Baroda 60 1 Tier II Cities Shimoga 60 1 Hubli 70 1 Gulbarga 85 1 Bhavnagar Ranchi 56 1 Cuttack Nashik Vijaywada 30 1 Ongole 19 1 Source: Jefferies, company data Asset light model as well as better doctor engagement leading to shorter lead times Partnership and doctor engagement allows better ramp-up In addition to expansion into smaller cities, the company has also differentiated in terms of the doctor engagement and expansion model. It has two key features in its expansion plan Partner with local doctors In most of its expansion, HCG partners with local doctors, preferably oncologists, to get local brand and also an initial patient pool. This allows for better occupancy. The partners own a minority stake Asset light model In a number of its centres, the company does not own the land but leases it from the partner or third party. This reduces the capex cost though increases the breakeven period from 12 months to 18 months page 60 of 77

61 In addition to partnership, most of the doctors in HCG centres are full time employees and exclusive to HCG. Additionally, majority of them are on a fixed salary basis. Superior execution HCG has shown superior execution over the past two years. In most of the centres which it has expanded over the past three years it has achieved break-even in less than 18 months. In fact, in three of the most recent expansions it has break-even in less than 12 months, as shown in Exhibit 151. It also expects all of the additions over next 6m to breakeven in FY19. This has been led by its strategy of partnering with key doctors and fixed salary to doctors. Additionally, centralization and standardization of process and radiology have aided costs. Exhibit 151: Efficient execution leading to faster breakeven Location Launch Quarter Break-even Quarter Time to Breakeven (months) Baroda Q1FY17 Q1FY18 12 Gulbarga Q4FY16 Q2FY17 6 Bhavnagar Q3FY16 Q2FY17 9 Kanpur Q1FY18 <12 Source: Jefferies, company data Strong growth even in existing hospital HCG existing centres have grown at 10% over the past six6 quarters despite the challenges from pricing on oncology drugs and demonetization. The growth is ahead of most peers who have seen low, single-digit growth. Additionally, margins have also see improvement for these centres over the period. Exhibit 152: FY17 mature hospital growth Source: Company Data, Jefferies estimates Nearing end of large capex cycle HCG is nearing the end of a large capex cycle. Over FY14-18, it has doubled its gross block and moved from 15 to 25 comprehensive cancer centres. Six of the centres will get operationalised in FY18. We believe that post this expansion, the company will be in consolidation mode. Management has also indicated this. Post the expansion, the company will have significant presence across India. page 61 of 77

62 Fertility small scale currently In 2013, HCG bought a 50% stake in Milann fertility clinic. Milann is a leading fertility player with seven centres based out of Bangalore (4), Mumbai, Delhi and Chandigarh. It plans to open one centre in Ahmedabad in FY18. Milann clinics have a strong growth potential but likely to remain a small part of business in the near future The Milann centres are more out-patient clinic and capex requirement for setting up a centre is low. In FY17, the company spent Rs119 mn capex and added two centres. The margin profile for the business is similar to oncology at 20-22%. Fertility is a growing segment in India and largely unorganized. The government has been incrementally increasing the regulatory overview which should aid organized players like Milann. We believe that Milann has strong growth potential but is currently in early stages and will remain a small part of the overall revenues (c10%) even over the medium term. Africa not a necessity The company plans to establish a network of specialty cancer centers in Africa in order to cater to the increasing unmet demand for cancer patients in that part of the world. They have partnered with CDC and are planning to do only the technology optimization piece in the centers. They have recently acquired Cancer Care Kenya, a leading Cancer Center in East Africa located in Nairobi. We think that this expansion may not be the most efficient use of resources by the management, as there is enough room for growth in India itself. Expect 27% EBITDA CAGR led by ramp-up We expect HCG to report 27% EBITDA CAGR over FY17-20, led by ramp-up in new HCG centres, increased occupancy in key centres and sustained growth in Milann. We expect existing centres EBITDA CAGR of 16%, led by Gujarat and other regions. We expect new centres to contribute c30% of revenue by FY20 and 18% of EBITDA. We expect Milann to grow at 21% CAGR. With a consolidation phase post FY18, we expect net debt to equity to stabilize at 0.56x in FY20 and RoEs to improve to 11.9% vs 5.1% currently. Revenue growth of 23% led by new hospital We expect HCG to report 23% revenue CAGR over FY17-20, led by six new centres in FY18. We expect existing centres to grow at 12% CAGR ahead of most peers. We expect new centres share of revenues to increase to 30% from 8% currently. We expect Milann to grow at 21% CAGR over the period led by ramp-up in recent centres and also new centres over the next the three years. Exhibit 153: Revenues to grow by c23% over FY17-20 Exhibit 154: driven by the growth in new centers page 62 of 77

63 Margins to improve 161bps We expect margins to improve 161bps over FY17-20, led by improvement at both exiting centres and also new centres turning profitable. We expect FY18 to see a dip in margins of 18bps due to losses from six new centres. However, this should normalize over FY19/20. In the existing centres, we expect margins to improve c200bps, led by increased occupancy and mix. Exhibit 155: 150 bps margin improvement expected Exhibit 156: driven by new centers breaking even Return ratios to improve from current lows as capex reduces Post the large capex in FY18, we expect HCG to be in a consolidation phase over FY This will be driven both by the BS constraints and also bandwidth, in our view. With the company adding 10 centres in three years, we believe that it needs to consolidate and improve EBITDA margins and cash flow before moving to next round of expansion. Given the consolidation phase, we expect RoEs to improve post FY18 to 11.9% by FY20 and RoCEs to improve to 13.8%. Exhibit 157: Return ratios to improve Exhibit 158: post FY18 page 63 of 77

64 Leverage to also improve We expect leverage to increase in FY18 due to the Rs 2bn capex and net debt to equity to increase to 0.94x. However, post FY18, we expect net debt to equity to moderate to 0.56x by FY20. Exhibit 159: Net Debt to Equity expected to increase in FY18 before moderating to 0.58x in FY20 Source: Company Data, Jefferies estimates Exhibit 160: HCG the most levered amongst the peers currently Source: Company Data, Jefferies estimates Initiate at Buy HCG, in our view, with its hub and spoke model, partnership and doctor engagement model is well positioned to succeed in the oncology space. It has showcased ability to profitably expand in Tier II cities which provides strong medium term growth drivers. Additionally, its partnership model reduces doctor churn and doctor engagement does not relies on star doctor. The stock is trading at 15.7x FY19 EV/EBITDA a discount to sector and peers. We believe that the discount will narrow as growth overshadows peers and it ramp-ups in new centres. We initiate with Buy rating and SOTP based PT of Rs325, implying 18.5x FY19E EV/EBITDA. Unique business model HCG, in addition to strong near-term growth, also is well positioned to cater to the unmet demand in the oncology segment. Its hub and spoke model and partnership with doctors allows for profitable expansion outside metros. The key features in HCG are: Strong execution and presence in Tier II cities HCG has one of the strongest presence in Tier II cities which allows it to cater to the large market. It has also page 64 of 77