The fast growing healthcare sector has poor representation in the domestic equity market. Only a handful of companies from the sector are listed on the bourses currently, limiting the choice for investors. With rising economic prosperity, the tertiary care segment is growing steadily. Midsized player Fortis Healthcare is a promising pick from this space.

The Delhi-based company reported its maiden profit in the June ’08 quarter. With the company’s hospital network reaching a critical mass, its financials are expected to improve further in the forthcoming quarters. Aggressive expansion plans, a differentiated business model and improving efficiencies make Fortis a good longterm bet for investors. Besides, the healthcare segment is expected to outperform in a bearish phase.

BUSINESS:

Incorporated in 1996, Ranbaxy-promoted Fortis Healthcare started its business in ’01. With a dominant presence in North India, the company currently operates a network of 14 hospitals and eight satellite/heart command centres, including one heart command centre in Afghanistan. These hospitals include multi-specialty hospitals, as well as super-specialty centres providing tertiary and quaternary healthcare to patients in areas such as orthopaedics, neurosciences, oncology, renal care, gastroenterology and mother & child care with expertise in cardiac care.

Among the 14 hospitals, four are run under management contract, while Fortis owns the remaining. Barring the hospital located at Jaipur, all the nine hospitals under Fortis are back in the black. The company also runs two other hospitals under the publicprivate partnership arrangement. It has an average occupancy rate of 60-70% across its various facilities. Fortis acquired the Escorts group of hospitals in ’05, which added five hospitals to its kitty, including the famous Escorts Heart Institute in Delhi.

GROWTH STRATEGY:

Fortis has primarily grown through acquisitions. Unlike other players in the field who are building a national presence without being dominant players in any region, Fortis believes in regional consolidation. First, it built a considerable presence in North India and it now plans to do the same in West and South India.

Fortis’ immediate priority is to extend its market share and it aims to grab the share of the unorganised healthcare market to achieve a national footprint. The company acquired Chennai-based Malar Hospital last September. In the short run, the company is looking at inorganic growth to increase the quantum of its facilities, while relying on organic expansion in the long run.

Given its brand equity, the company views Escorts as an underperforming asset and hence, intends to grow the Escorts network of hospitals. Escorts’ incremental growth will further beef up Fortis’ margins.

The company has two hospitals under construction in the National Capital Region (NCR) and a hospital at Vashi in Navi Mumbai (Maharashtra) is being commissioned under the public-private partnership model. With a planned expenditure of nearly Rs 2,250 crore, Fortis aims to increase its hospitals network to 40 by ’11, taking its total capacity to 6,000-7,000 beds. It is looking at greenfield projects, management contracts and acquisitions to expand.

Fortis intends to raise funds via internal accruals and debt, while remaining open to further fund infusion by investors, including promoters. Raising funds will not be a constraint, as the promoters are expected to receive nearly Rs 10,000 crore from the sale of Ranbaxy Labs.

FINANCIALS:

The healthcare sector is a capital-intensive service sector with a long gestation period. In the case of Fortis, new acquisitions and greenfield projects have been eating into the company’s profits from existing
facilities. However, as the proportion of old facilities rises in the company’s portfolio, Fortis is expected to become profitable on a sustained basis.

It reported its maiden profit in the June ’08 quarter. The turnaround was aided by various cost-cutting measures and improvement in efficiencies by standardisation of operating systems, procedures and sourcing across the chain. The company’s net sales have increased at a compound annual growth rate (CAGR) of 67% since ’03 to Rs 507 crore in FY08, while losses have grown at a slower pace and touched Rs 55.5 crore in FY08.

During FY08, the company’s net sales suffered due to a decline in revenues posted by Escorts Hospital on account of the loss of business due to the exit of well-known cardiologist Naresh Trehan.

Fortis’ older facilities have the highest operating margins of 27% in the industry vis-a-vis 18% for Apollo Hospital. While each specialty hospital division has differ ent gross margins, the company has registered a 10-15% growth in revenue per occupied bed over the past year.

Rising occupancy and a lower length of stay have contributed to higher asset turnover, which has led to better operating margins. As the company ramps up occupancies across hospitals and simultaneously reduces the average length of a patient’s stay, its operating margin and net profit will improve. Currently, in the growth phase, the company intends to plough in its profits to further the growth momentum. So, investors looking for dividend income will have to wait for a while.

VALUATIONS:

Having been a loss-making company in the past, Fortis is now looking at a positive turnaround during this fiscal year. Taking a conservative estimate of 25% increase in revenues, it is likely to achieve a turnover of Rs 634 crore by ’09 and its operating profit is estimated to be around Rs 90 crore.

Accordingly, the stock is currently trading at around 19 times its forward EBITDA (earnings before interest, depreciation, tax and amortisation or operating margins). In comparison, it is trading at around 25 times its trailing EBITDA. This provides a good upside potential for long-term investors.

BOOSTER SHOT

Ranbaxy-promoted Fortis Healthcare is one of the largest private hospital chains operating in the tertiary care segment.

It has a dominant presence in North India. Fortis currently operates a network of 14 hospitals and eight satellite/heart command centres, including one heart command centre in Afghanistan.

Fortis’ older facilities have the highest operating margins of 27% in the industry. Its peer Apollo Hospitals’ operating margins stand at 18%.

The company’s net sales have increased at a CAGR of 67% since ’03 to Rs 507 crore in FY08, while losses have grown at a slower pace and touched Rs 55.5 crore in FY08.

Unlike other players in the field which are building a national presence without being dominant players in any region, Fortis believes in regional consolidation.

With a planned expenditure of nearly Rs 2,250 crore, Fortis aims to increase its hospitals network to 40 by ’11, taking its total capacity to 6,000-7,000 beds.

Raising funds will not be a constraint, as promoters are expected to receive nearly Rs 10,000 crore from the sale of Ranbaxy Labs.

The company intends to plough in its profits to further the growth momentum. So, investors looking for dividend income will have to wait for a while

Solar Explosives (SEL) is a Nagpur-based manufacturer of industrial explosives, which are mainly used for mining and infrastructure projects. SEL, which is the market leader in India, is likely to benefit from growth in the country’s mining sector and several new infrastructure projects. In light of SEL’s expansion plans and forward integration into the coal mining business, long-term investors can consider this stock.

BUSINESS:

Established in 1996 with a capacity of 6,000 tonnes cartridge explosives, SEL has become one of the leaders in the domestic explosives industry and a major exporter. Its current capacity stands at 80,000 tonnes cartridge explosives, 94,450 tonnes bulk explosives and 140 million detonators. SEL controls nearly 20% of India’s explosives market, currently valued at $400 million.

The company has successfully commissioned 12 bulk plants at various locations supported by one plant each for manufacturing cartridges, detonators and detonator components. It has a bulk explosives plant in the vicinity of every subsidiary company of Coal India, as well as in Singareni Collieries. The company has now started operations with Tata Steel in Jharkhand. Last year, SEL acquired 74% stake in Navbharat Coalfields, which owns a mining lease on a coal block in Chhattisgarh with reserves of 36 million tonnes (mt).

Recently, it obtained permission to pick up 24% stake in a joint venture with Chhattisgarh Mineral Development Corporation (CMDC) for development, mining and marketing of coal with estimated reserves of 80 mt at Shankarpur in Chhattisgarh. The commercial operations at these mining projects are expected to start in FY10.

GROWTH DRIVERS:

India’s mining and infrastructure industries are growing rapidly and the pace of growth is not likely to slacken in the near future. To meet the power
generation targets set in the 11th Five-Year Plan, India will need huge amounts of additional coal. This will increase the country’s coal output to 684 mt per annum (mtpa) from around 450 mtpa currently.

The Planning Commission estimates that 17,000 megawatts (mw) hydel power capacity will come up in the 11th Plan period, which will involve heavy excavation work, adding to the demand for explosives. During the same period, the domestic production of steel is expected to increase from around 55 mt currently to 80 mt. The same applies to most other metals and minerals. These initiatives will boost the demand for explosives, which is likely to grow at around 10% every year for the next 4-5 years.

SEL has already expanded its capacities in India to cater to the growing domestic market and it also exports its products. It is now spending around Rs 23 crore to set up a bulk explosives plant in Nigeria to be commissioned by March ’09, supported by another plant in Africa by June ’09. These plants will cater to the African demand for explosives, which are currently imported at high prices. This will enable the company to earn higher margins.

FINANCIALS :

SEL’s sales have grown at a cumulative annual rate (CAGR) of 51.7% over the past five years to reach Rs 281 crore in FY08. Its PBDIT grew 61.2% to Rs 71 crore, while net profit expanded at an even higher pace of 64.2% to reach Rs 36 crore during the same period.

The company’s return on capital employed (RoCE) improved to 22% in the year ended March ’08 after averaging around 16% in the past five years. SEL’s current debt-equity ratio is comfortably placed at 0.6 with no long-term debt. Since SEL is in a growth phase, it is a low dividendpaying company. Although it has consistently paid dividends in the past five years, the dividend payout has remained below 15% of its net profit. Considering the dividend for FY08, SEL’s dividend yield works out to around 0.7%.

VALUATIONS:

At the current market price of Rs 409, the scrip trades at 18 times its profit for the past 12 months. Going forward, we expect the company to report a profit of Rs 50 crore in FY09 and Rs 72 crore in FY10. Thus, the current price is 14.2 times its estimated FY09 earnings and 9.8 times its estimated FY10 earnings.

Among its competitors, Keltech Energies and Premier Explosives, which are smaller companies, are trading at P/E multiples of around 7.5 each. Gulf Oil, which is trading at a P/E of around 16.5, and has an explosives business comparable to that of SEL, derives over 65% of its turnover from lubricants and other businesses. Although SEL appears to be fairly valued at present, its leadership position, expansion plans and entry into coal mining justify the same. The company is likely to generate healthy returns for longterm investors.

Make no mistake: No investor can beat the business cycle. Thousands have discovered this fact the hard way. But the smarter ones have also spotted ways to soften the blow. Non-cyclical stocks can be less esoteric and academic than you think. Investors can, if they apply their minds, identify counters that will not give them sleepless nights. They just have to make sure that the stocks they pick up don’t miss out the bull run entirely, even as they cushion them from the batterings of a bear market.

Sectors whose fortunes are directly related to the performance of the broader economy — cyclical ones such as manufacturing — fall in the line of fire during an economic downturn. This limits the choice of investors to the fundamentally strong companies in the sectors, which are more or less non-cyclical in nature. The services segment in the economy, by and large, consists of such sectors that are not directly affected by a downturn.

Keeping this in mind, ET Intelligence Group this week brings you a first-cut analysis on the services space in the Indian economy, along with some investment ideas. Apart from its non-cyclical nature, another strong reason to evaluate the performance of the services sector is its prominent contribution to economic activity, represented by the gross domestic product (GDP).

Between Q1 ’04 and Q1 ’09, the share of services in the country’s GDP grew to 56% from 53%, while that of agriculture fell to 18% from 21%. The share of manufacturing, however, remained stagnant at 15% during the same period. The study selected only those aspects of the services space, which tend to show lesser coupling with the broader economy. These include healthcare, information technology (IT), telecom, logistics and recreation. Other sectors, including travel and tourism, retail, banking and financial services were not included due to their direct relationship with the changes in economic parameters. Further, the financial performance of this set of companies was compared with companies in the manufacturing sector. Here again, oil and gas was excluded on the ground that it is a tightly regulated sector.

The analysis reveals that the services sector has registered a stronger growth in sales and profit in each of the past four years until FY08 vis-à-vis the manufacturing sector (see table). While sales growth in manufacturing remained lower than 30% in each of the years during the said period, services almost always exceeded this mark. Further, even though sales growth in services tapered over time — 29% in FY08 compared with 79% in FY05 —it remained above the 18% recorded by manufacturing. A similar trend prevails in the case of net profit for both the sectors.

Another case in point is that higher growth in services has come on the back of higher profitability. This is in line with the common assumption that a component of services in a business offers greater profitability. During each of the past four years, the services sector has delivered better margins at operating and net levels.

While the services sector has outclassed manufacturing on various financial parameters, it lags behind the latter in terms of return on capital employed (RoCE). Manufacturing companies have delivered better RoCEs during the said period. A point to note is that in the case of services, RoCE has gradually increased over a period of time. During FY08, it was 22.7%, compared to 23.3% for manufacturing.

Given its stronger performance and noncyclical nature, investors can park their funds in select companies in this space (services) during an economic slowdown. ETIG has provided stock ideas on various service sector companies from time to time. It now presents a list of the best picks in this space along with the investment rationale.

The Chosen Ones

In logistics, the stocks of Container Corporation of India (Concor)and Gateway Distriparkslook promising. Concor is in the business of containerised movement of goods on rail. The stock trades at a priceto-earnings (P/E) multiple of 15.1 on a trailing 12-month (TTM) basis. It has historically traded at a P/E of less than 20. The company does not have any competitor in the strict sense. Concor appears to be trading at reasonable valuations, since the average P/E of stocks in the ET Logistics index is 18. The stock looks attractive at current levels, considering the growth potential in its domestic business, entry into cold chain logistics and reasonable valuations.

Gateway Distriparks trades at a TTM P/E of 13.4. This is lower than the average P/E of companies comprising the ET Logistics Index. As of now, only the container freight station (CFS) segment of the company is making profit as the remaining two businesses including cold chain logistics and container rail segments are yet to turn profitable. The stock looks attractive, given the future business potential of these segments.

The IT sector is battling with external economic pressures, including currency volatility and turmoil in the global credit business. So, investors can consider companies that provide niche solutions and have sizeable presence in the domestic market. One such company is Rolta India. The Rs 2,000-crore geo-spatial solutions provider is trading at a P/E of 20.4. It is the single biggest provider in its area of operations and has a significant presence in government and private sector projects. The company (through its international tie-us) is likely to benefit from the nuclear deal. In the IT services space, Infosys Technologiesand Tata Consultancy Services (TCS)look better placed to face macro-economic challenges. Both the companies are keen on inorganic growth to expand their service offerings.

In the healthcare space, Fortis Healthcare has shown a turnaround. With the company’s hospital network reaching a critical mass, its financials may improve in the coming quarters. (For a detailed analysis, refer to Fortis’ stock idea on page 2) .

The telecom space is another service sector, which continues to see buoyancy in subscriber addition despite slowing economic growth. Here, Bharti Airtel, Idea Cellular and Tulip Telecom are our top picks. Despite fierce competition, Bharti Airtel continues to hold the biggest market share in mobile telephony. The company has seen higher momentum in its net monthly subscriber additions. The company has chalked out plans to enter the direct to home (DTH) and internet protocol television (IPTV) services space.

Idea Cellular looks promising, given its recent acquisition of Spice Communications for Rs 2,720 crore. We expect the company’s operations to turn around in the next 2-3 quarters. This can improve Idea’s future performance.

Tulip Telecom provides solutions in the space of corporate data connectivity and network integration. The company has seen phenomenal growth in the past three years. It has undertaken capital expenditure (capex) to strengthen its presence in the virtual private network (VPN) space. Further, it has added two more services in its deliverables, including managed services and value-added services. These developments are expected to keep Tulip’s growth momentum intact.

There will be other such counters. You can spot them if the stock-picker in you plays a different role. Remember, it’s not a bull market; it’s life below 14K. Follow the news flow and policy drift, which can impact counters. There will be spin-offs. The only difference now is that identifying such stocks will require a little more hard work.

(Inputs by Joseph Pereira, Karan Sehgal and Kiran Kabtta)