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Strong revenue and margin recovery

Fortis Healthcare (FHL) reported Q3FY21 performance better than estimates driven by business recovery across hospitals & diagnostics and continued focus on cost optimization. We expect the performance to continue to improve in coming quarters and estimate positive revenue from Q4FY21 onwards. Revenue grew 0.7% YoY to Rs11.8bn (I-sec: Rs11.3bn) with hospitals declining 4.9% and SRL (diagnostics) growing 25.9%. EBITDA margin improved 280/410bps YoY/QoQ driven by revenue recovery and cost optimisation. Management has taken steps to reduce personnel and S,G&A costs and the benefits are visible from last two quarters. We remain positive on growth recovery, cost optimisation efforts and potential operating leverage outlook. Maintain ADD.

* Revenue recovery to continue: Revenue grew 0.7% YoY with a decline of 4.9% in hospitals revenue during the quarter. This decline is primarily attributed to lower occupancy of 64% in Q3FY12 vs 68% YoY but improved from 57% QoQ. The recovery has begun and we expect the occupancy to remain above 65% in coming quarters. Fortis has reduced bed allocation for COVID-19 patients from 1,300 to 600 as occupancy has come down significantly. SRL business grew 25.9% driven by 24.1% contribution from COVID-19 tests and non-COVID business declined 4.5%. We estimate positive growth in non-COVID diagnostics business from Q4FY21 and strong 27.4% growth in FY22E.

* Cost optimisation is the key margin driver: EBITDA margin in Q3FY21 was at 16.2%, up 280/410bps YoY/QoQ driven by visible benefits of cost optimisation efforts and revenue recovery and was above our estimate of 15.5%. Personnel cost and S,G&A expenses were down 4% and 12% YoY respectively. We believe these cost control measures along with gradual revenue growth recovery would help in improving EBITDA margin by 410bps over FY20-FY23E.

* Acquires remaining 50% stake in DDRC-SRL JV: SRL will acquire the remaining 50% stake in DDRC-SRL (50:50) JV for a cash consideration of Rs3.5bn and would be funded by mix of internal accruals and debt. This has been valued at 4.2x sales and 22.6x EBITDA on normalized (ex-COVID impact) FY20 numbers which is quite reasonable. This would help in strengthening leadership position in Kerala and synergies are expected to accrue on revenue and margin fronts.

* Outlook: We raise revenue/EBITDA estimates by 6-8%/5-8% for FY22E-FY22E to factor in consolidation of DDRC-SRL JV. We expect business to normalise in Q4FY21 and estimate revenue, EBITDA and PAT CAGRs at 8.1%, 18.4% and 72.9% respectively over FY20-FY23E. Supreme Court judgement on the pending open offer by IHH is still awaited.

* Valuations and risks: Maintain ADD with revised target of Rs190/share based on EV/EBITDA of 16x hospital and 22x SRL on FY23E EBITDA (earlier Rs163/share based on Sep’22E). Key downside risk: ongoing regulatory concerns and delay in margin recovery.