APOLLO HOSPITALS On track

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1 RESULT UPDATE APOLLO HOSPITALS On track India Equity Research Pharmaceuticals Apollo Hospitals (APHS) Q1FY14 standalone results were in line with revenue growth of 15% YoY, led by 11% growth in hospitals and 23%, in pharmacies. While there has been moderate growth of 3-4% in IP volumes for Chennai and Hyderabad clusters, price increases and improved case mix along with stronger OP volumes aided momentum. APHS has commenced Ayanabakkam and the Bangalore facility (400 bed additions over last quarter) which would render higher growth in the ensuing quarters. We remain positive on structural growth drivers; however, owing to clustering of new projects, including new formats such as Cradle, we expect margins to dip 50bps over FY14E. We, thus, revise downward our earnings by 6% each for FY14-15E and maintain HOLD recommendation. Our revised TP, based on 16x EV/EBITDA, is INR985. Price increases, strong OP volumes sustained margins The price increases of 4-6% across existing hospitals, along with higher case mix and better OP volumes (17-18%YoY in mature clusters and 31% YoY in Tier-II hospitals) resulted in strong EBITDA margins of 24.5% in existing hospitals (up from 23.7% in Q1FY13). Retail pharmacies also saw improved margins of 3% (50bps YoY); however, addition of new hospitals resulted in an overall decline in margins by 47bps YoY. Improved case mix to cushion margin impact from new projects The management indicated that focus on higher case mix and lower ALOS would render stability to existing hospitals and would cushion impact from upfront overheads in the new facilities. Apollo plans to add four new hospitals including Trichy, Lifeline, Nashik and Nellore over Q2-Q4FY14 that would add ~700 beds to existing capacity. Outlook and Valuations: Near term margin pressure; HOLD We estimate earnings CAGR of 30% over FY13-15E. The planned 1,000 beds additions in FY14 30% are in Chennai, 50% in Reach and balance in Bangalore is estimated to contribute ~30% of growth over FY However, owing to near term pressure on margins, we maintain HOLD recommendation on the stock. EDELWEISS 4D RATINGS Absolute Rating Rating Relative to Sector HOLD None Risk Rating Relative to Sector None Sector Relative to Market None MARKET DATA (R: APLH.BO, B: APHS IN) CMP : INR 939 Target Price : INR week range (INR) : 1,098 / 608 Share in issue (mn) : M cap (INR bn/usd mn) : 131 / 2,148 Avg. Daily Vol.BSE/NSE( 000) : SHARE HOLDING PATTERN (%) Current Q4FY13 Q3FY13 Promoters * MF's, FI's & BK s FII's Others * Promoters pledged shares (% of share in issue) PRICE PERFORMANCE (%) Stock Nifty : NIL EW Pharma Index 1 month (4.6) (5.2) months 4.4 (4.7) months Financials (Consolidated) IP: Inpatient volumes; OP: Outpatient volumes; ALOS: Average length of stay Edelweiss Research is also available on Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. Year to March Q1FY14 Q1FY13 % chg Q4FY13 % chg FY13 FY14E FY15E Net revenue 10,218 8, , ,687 46,009 55,598 EBITDA 1,608 1, , ,083 7,239 8,885 EBITDA margin (%) Net profit (2.6) ,044 3,666 4,633 Adj. dil. EPS (INR) (8.7) Diluted P/E (x) EV/EBITDA (x) ROACE (%) Perin Ali perin.ali@edelweissfin.com August 13, 2013 Edelweiss Securities Limited

2 Pharmaceuticals Table 1: Actual vs. estimates (Standalone) Year to March Actual Q4FY13 Y-o-Y Growth (%) Estimates Q4FY13 Y-o-Y Growth (%) Deviation from Actual (%) Comments Net Revenue 8, , Strong growth in OP revenues (16%YoY) and higher price realization aided growth Raw material costs 4, , Gross profit 4, , Gross margin(%) Employee costs 1, , (4.7) Other expenses 1, , Addition of new capaicties Total operating expenses 2, , EBITDA 1, , (0.5) EBITDA margin (%) % margins in existing hospitals and 3% in retail pharmacies offset by overheads from new facitilites (8% EBITDA negative) Net finance expense (income) (7.0) Management has guided increase in D/E to 0.6x from current level 0.3x which would result in higher interest costs over FY14-16E Depreciation Depreciation higher from new hospital additions Other income PBT 1,009 (8.8) 1,002 (32.8) 0.7 Income tax expense 220 (15.3) 240 (7.3) (8.6) Benefit from 150% weighted deduction due from commissioning of new facilities PAT Extraordinaries (loss)/gain 0 0 PAT Adjusted PAT Source: Company, Edelweiss research Table 2: Revenue mix by segment - Standalone Year to March Q1FY14 Q1FY13 % chg Q4FY13 % chg FY13 FY12 % chg Hospitals and consulting 5,867 5, , ,164 19, Inpatient revenue 3,957 3, , ,721 12, Chennai 2,028 1, , ,619 6, Hyderabad ,405 3, Others 1, ,697 2, Outpatient revenue 1, ,714 3, Chennai ,368 2, Hyderabad Others Consulting and others (3.2) 959 (7.3) 3,729 3, Stand alone pharmacies 3,042 2, , ,017 8, No of Stores 1,526 1, , ,503 1, Revenue per pharmacy Total revenues 8,909 7, , ,181 28, Source: Company, Edelweiss research 2 Edelweiss Securities Limited

3 Apollo Hospitals Enterprise Table 3: Operational highlights Chennai Q1FY14 Q1FY13 % chg Inpatient (IP) revenues 2,028 1, Operational beds 1,229 1, Occupancy (%) Revenue per bed day (IP) 25,458 22, ALOS (6.0) IP volumes 18,328 17, Outpatient (OP) Revenues Total revenues 2,665 2, Comments Hyderabad Q1FY14 Q1FY13 % chg Inpatient (IP) revenues Operational beds Occupancy (%) Revenue per bed day (IP) 16,411 15, ALOS IP volumes 12,119 11, Outpatient (OP) Revenues Total revenues 1, Comments Continued focus on improved case mix resulted in better realizations Other Tier-II cities Q1FY14 Q1FY13 % chg Inpatient (IP) revenues 1, Operational beds 1,494 1, Occupancy (%) Revenue per bed day (IP) 11,033 9, ALOS (1.2) IP volumes 18,346 16, Outpatient (OP) Revenues Total revenues 1, Comments Lower ALOS from commencement if day care surgeries, while lower occupancy was from addition of ayanabakkam during the quarter Improved case mix and price increases resulted in 12% growth in revenue per bed day Plan to add Tricy, Nellore and Nashik in FY14; Incremental focus on more Tier II and reach set-ups would sustains strong growth to this cluster Source: Company, Edelweiss research 3 Edelweiss Securities Limited

4 Pharmaceuticals Financial snapshot - Standalone Year to March Q1FY14 Q1FY13 % change Q4FY13 % change Net sales 8,950 7, , Healthcare services 5,909 5, , Pharmacies 3,042 2, , Raw material costs 4,637 3, , Gross profit 4,313 3, , Employee costs 1,391 1, , Other expenses 1,463 1, , Total operating expenses 2,854 2, , EBITDA 1,459 1, , EBITDA margin (%) Net finance expense (income) (1.5) Depreciation Other income PBT 1, PBT (excl other income) Income tax expense (15.3) PAT Extraordinary Net profit Adj. PAT as % of revenues COGS Employee costs Other expenses Total operating expenses Gross profit EBITDA Net profit Tax rate Financials (Consolidated) Year to March Q1FY14 Q1FY13 % chg Q4FY13 % chg FY13 FY14E FY15E Net revenue 10,218 8, , ,687 46,009 55,598 Sales (Excl JVs) 9,581 8, , ,394 43,381 52,507 Share of JVs ,293 2,627 3,091 EBITDA 1,608 1, , ,083 7,239 8,885 EBITDA margin (%) Net profit (2.6) ,044 3,666 4,633 Adj. dil. EPS (INR) (8.7) Diluted P/E (x) EV/EBITDA (x) ROACE (%) Edelweiss Securities Limited

5 Apollo Hospitals Enterprise Change in estimates FY14E FY15E New Old % change New Old % change Comments Net revenue 46,008 46,320 (0.7) 55,598 55,913 (0.6) EBITDA 7,239 7,526 (3.8) 8,885 9,274 (4.2) EBITDA margin Revising down margins to factor in higher fixed overheads from new capacities Core profit 3,648 3,886 (6.1) 4,631 4,963 (6.7) Lower other income and increase PAT margin Capex 5,266 5, ,331 5, debt to result in higher interest costs 5 Edelweiss Securities Limited

6 Pharmaceuticals Company description Apollo Hospital (APHS) is India s largest private healthcare service provider, with an integrated business model providing an umbrella of healthcare services spanning from primary healthcare like doctor consultation, pathology, preventive health checks to specialty care treatments like cardiology. The company operates through a network of 36 hospitals and 27 clinics (~70% of revenues) and has 5,949 beds spread across metros and tier I towns through owned hospitals, subsidiaries, JVs and associates. Apart from hospitals, APHS has the largest organized pharmacy retail chain with ~1,400 stores, accounting for ~30% of total revenues. The company expects to spin-off the pharmacy chain by roping in a strategic partner over long term. Investment theme We expect APHS to sustain strong growth on back of significant expansion in Tier-I/II cities (2,687 beds to be added over FY13-16) and rising demand for complex diseases driving base business growth. We believe ROCEs could expand from current level led by improvement in pharmacy business and scale-up of new hospitals. Unlocking of value from divestments of retail pharmacies would improve return profile of business. Key risks Shortage of doctors and nurses Rising infrastructure costs could restrict investments 6 Edelweiss Securities Limited

7 Apollo Hospitals Enterprise Financial Statements Key Assumptions Macro GDP(Y-o-Y %) Inflation (Avg) Repo rate (exit rate) USD/INR (Avg) Company Bed capacity 5,925 6,250 7,260 8,195 Operational bed additions (YoY) 5, , , ,229.0 Occupancy (%) ALOS (no of days) Revenue per bed day (INR) 22, , , ,327.1 Retail pharmacy additions (YoY) Tax rate (%) Income statement Income from operations 31,475 37,687 46,009 55,598 Materials costs 15,623 18,558 22,544 27,243 Employee costs 5,029 6,231 8,033 9,903 R&D Cost 879 1,197 1,497 1,721 Total SG&A expenses 4,813 5,617 6,696 7,846 EBITDA 5,131 6,083 7,239 8,885 Depreciation & Amortization 1,239 1,423 1,697 1,945 EBIT 3,892 4,660 5,542 6,940 Other income Interest expenses 891 1,033 1,257 1,516 Profit before tax 3,260 3,928 4,677 5,937 Provision for tax 1,150 1,050 1,029 1,306 Net profit 2,110 2,877 3,648 4,631 Extraordinary income/ (loss) Minority interest (83) (103) (112) (121) Profit after minority interest 2,193 3,044 3,759 4,752 Basic EPS (INR) Diluted EPS (INR) CEPS (INR) Dividend per share (INR) Dividend payout (%) Common size metrics Operating expenses R & D cost EBITDA margins Net profit margins Growth ratios (%) Revenues EBITDA Net profit EPS Edelweiss Securities Limited

8 Pharmaceuticals Balance sheet As on 31st March FY12 FY13 FY14E FY15E Equity capital Reserves & surplus 24,396 26,772 29,880 33,982 Shareholders funds 25,068 27,468 30,576 34,677 Minority interest (BS) Short term debt 2,423 1,225 1,225 1,225 Long term debt 5,744 10,907 10,907 15,907 Borrowings 8,167 12,132 12,132 17,132 Deferred tax liability 1,551 2,294 2,622 3,037 Sources of funds 34,911 42,068 45,504 55,020 Tangible assets 18,566 21,767 24,493 28,928 Intangible assets 1,547 1,639 1,453 1,453 CWIP (incl. intangible) 2,093 4,034 5,063 4,013 Total net fixed assets 22,205 27,440 31,009 34,395 Non current investments 4,422 1,480 1,480 1,480 Cash and equivalents 2,368 6,988 6,968 11,794 Inventories 1,915 2,187 2,303 2,801 Sundry debtors 3,867 4,733 4,920 6,105 Loans and advances 6,259 5,075 4,927 5,240 Other current assets Total current assets (ex cash) 13,533 12,232 12,386 14,383 Trade payable 2,490 2,687 2,848 3,422 Others current liabilities 5,127 3,384 3,491 3,608 Total current liabilities & 7,617 6,071 6,339 7,031 Net current assets (ex cash) 5,916 6,160 6,047 7,352 Uses of funds 34,911 42,068 45,504 55,020 Book value per share (INR) Free cash flow Net profit 2,193 3,044 3,759 4,752 Depreciation 1,239 1,423 1,697 1,945 Others Gross cash flow 4,056 5,044 5,784 7,113 Less: Changes in WC (113) 1,305 Operating cash flow 3,466 4,462 5,897 5,808 Less: Capex 3,865 6,555 5,266 5,331 Free cash flow (399) (2,093) Cash flow metrics Operating cash flow 3,466 4,462 5,897 5,808 Investing cash flow (5,100) (3,716) (5,266) (5,331) Financing cash flow 2,066 5,821 (651) 4,349 Net cash flow 433 6,567 (20) 4,826 Capex (3,865) (6,555) (5,266) (5,331) Dividends paid (610) (895) (651) (651) Profitability & efficiency ratios ROAE (%) ROACE (%) Inventory day Debtors days Payable days Cash conversion cycle (days) Current ratio Debt/EBITDA Debt/Equity Adjusted debt/equity Operating ratios Total asset turnover Fixed asset turnover Equity turnover Valuation parameters Diluted EPS (INR) Y-o-Y growth (%) CEPS (INR) Diluted PE (x) Price/BV (x) EV/Sales (x) EV/EBITDA (x) Dividend yield (%) Peer comparison valuation Market cap Diluted PE (X) EV/EBITDA (X) ROAE (%) Name (USD mn) FY14E FY15E FY14E FY15E FY14E FY15E Apollo Hospitals Enterprise 2, Fortis Healthcare Ltd Median AVERAGE Source: Bloomberg, Edelweiss research 8 Edelweiss Securities Limited

9 Additional Data Apollo Hospitals Enterprise Directors Data Prathap C Reddy Executive Chairman Preetha Reddy Managing Director Suneeta Reddy Joint Managing Director Sangita Reddy Executive Director (Operation) Rajkumar Menon Director Rafeeque Ahamed Director N Vaghul Director Deepak Vaidya Director T K Balaji Director Khairil Anuar Abdullah Director G Venkatraman Director Habibullah Badsha Director Shobana Kamineni Executive Dir. (Special Init.) Shashank Singh Additional Director Auditors - S Viswanathan *as per last annual report Holding Top10 Perc. Holding Perc. Holding Integrated healthcar 21.7 Pcr investments ltd Oppenheimerfunds inc 7.64 Fmr llc 5.12 Apax mauritius fii l 5.08 Reddy prathap c 5.06 Reddy suneeta 2.16 Schroder investment 1.96 Reddy sangita 1.77 Ashmore emm llc 1.76 *in last one year Bulk Deals Data Acquired / Seller B/S Qty Traded Price No Data Available *in last one year Insider Trades Reporting Data Acquired / Seller B/S Qty Traded 03 Dec 2012 Mrs. Preetha Reddy Sell Dec 2012 Mr. P Vijayakumar Reddy Buy *in last one year 9 Edelweiss Securities Limited

10 RATING & INTERPRETATION Company Absolute reco Relative reco Relative risk Company Absolute reco Relative reco Relative Risk Apollo Hospitals Enterprise HOLD None None Aurobindo Pharma BUY SP H Cadila Healthcare BUY SP L Cipla HOLD SP L Divi's Laboratories HOLD SP M Dr.Reddys Laboratories BUY SO M Glenmark Pharmaceuticals BUY SO H Ipca Laboratories BUY SO L Jubilant Life Sciences BUY SP M Lupin BUY SO M Ranbaxy Laboratories BUY SO H Sun Pharmaceuticals Industries HOLD SP L Torrent Pharmaceuticals BUY SO H ABSOLUTE RATING Ratings Expected absolute returns over 12 months Buy More than 15% Hold Between 15% and - 5% Reduce Less than -5% RELATIVE RETURNS RATING Ratings Sector Outperformer (SO) Sector Performer (SP) Criteria Stock return > 1.25 x Sector return Stock return > 0.75 x Sector return Stock return < 1.25 x Sector return Sector Underperformer (SU) Stock return < 0.75 x Sector return Sector return is market cap weighted average return for the coverage universe within the sector RELATIVE RISK RATING Ratings Low (L) Medium (M) High (H) Criteria Bottom 1/3rd percentile in the sector Middle 1/3rd percentile in the sector Top 1/3rd percentile in the sector Risk ratings are based on Edelweiss risk model SECTOR RATING Ratings Overweight (OW) Equalweight (EW) Criteria Sector return > 1.25 x Nifty return Sector return > 0.75 x Nifty return Sector return < 1.25 x Nifty return Underweight (UW) Sector return < 0.75 x Nifty return 10 Edelweiss Securities Limited

11 Apollo Hospitals Enterprise Edelweiss Securities Limited, Edelweiss House, off C.S.T. Road, Kalina, Mumbai Board: (91-22) , Vikas Khemani Head Institutional Equities Nischal Maheshwari Co-Head Institutional Equities & Head Research Nirav Sheth Head Sales Coverage group(s) of stocks by primary analyst(s): Apollo Hospitals Enterprise, Aurobindo Pharma, Cadila Healthcare, Cipla, Divi's Laboratories, Dr.Reddys Laboratories, Glenmark Pharmaceuticals, Ipca Laboratories, Jubilant Life Sciences, Lupin, Ranbaxy Laboratories, Sun Pharmaceuticals Industries, Torrent Pharmaceuticals Recent Research Date Company Title Price (INR) Recos 12-Aug-13 Aurobindo Pharma 12-Aug Aug-13 Lupin Pharma Cadila Healthcare Upbeat quarter; Result Update Margins intact; Result Update Waiting in the wings; Result Update 181 Buy 801 Buy 708 Buy Distribution of Ratings / Market Cap Edelweiss Research Coverage Universe Buy Hold Reduce Total Rating Interpretation Rating Expected to Rating Distribution* * 1 stocks under review > 50bn Between 10bn and 50 bn < 10bn Market Cap (INR) Buy Hold Reduce appreciate more than 15% over a 12-month period appreciate up to 15% over a 12-month period depreciate more than 5% over a 12-month period 11 Edelweiss Securities Limited

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