Curious case of Fortis Healthcare

Fortis has been in the news for all the wrong reason. Promoter siphoning money from the listed entity, SFIO investigation in progress, overcharging patent at their hospital etc. This list of the negative news is quite lengthy and hence it's reflected in share price correction recently. But there remain few strength of the Fortis business which makes me believe it should give good return from here.

Here are few of the thoughts on Fortis Healthcare worth reading:

1. Promoter discount has to be adjusted: Fortis valuation has been hit in last few quarters as the company was taking burden of crooked promoter. Now since Singh Bros is no longer in picture, company should be valued normally in the lines of Apollo and other South Asian hospitals.

2. Loss report in Q2 and Q3 should be temporary: This is the same company which was alleged to charge 17lakhs for a dengue patient in Delhi. It was also mentioned how they are overcharging from their pharmacy. Ironical that company who milk their patient so badly is reporting losses. This has to do with their outgoing promoter who has been accused of swindling money. Over the course of next year, profitability should return to normalcy.

3. Strength of the Business (Diagnostic and 2nd largest chain of hospital): Fortis remain 2nd largest chain of hospital in India. Beside that, they also own SRL diagnostics which is much higher valuation business. It also has operation outside India. Combined valuation should be done on revenue per bed basis for hospital business and EV/EBITDA for the diagnostic chain.

4. Restructuring of RHT: RHT owns the hospital run by fortis, this help Fortis to run an assets light model. Fortis even have cross holding in RHT. Since RHT has raised money in Singapore, their cost of capital is lower. They can charge lower annuity for their assets and hence this was win-win situation. Just that it leaves complex structure in place. When promoter integrity is in question, complexity makes it difficult to find out if fund are siphoned. Once new promoter comes in, even if company continues with RHT structure, it will be appreciated by market.

5. SRL diagnostics spin off: Fortis has announced spin off and separate listing of SRL in 2016.  Diagnostics business will be valued much higher multiple compared to full healthcare business. SRL is crown jewel in Fortis business. If management tries to de-merge it now, it will make Fortis standalone bit unattractive to incoming investors. Hence they may want to delay this exercise till the new investor is on board.

6. Investment Banking like transaction without banker: Singh Bros owned ~70% stake in the company 4-5 quarters back, which is now almost zero. Of this 17% is held by Yes bank, rest all is well distributed among institution and general public. When Bajaj Finance wants to raise 4,500 cr they assign three bankers, do roadshow and meet scores of investors. It is amazing to see Fortis is able to do similar exercise with open market operations, such a credibility of exiting promoter. There has to be good intrinsic value in the assets, however that assets hasn't shown desired profitability to reflect fair value.

7. New Owner: Last year, TPG, IHH were rumoured to be interested in buying Fortis stake from Singh Bros. Back then, transaction was assumed will be done at 250 per share. Since then hospital business has been impacted by due to government intervention on stent, knee transplant and controlling drugs prices. However, this has coincided with general re-rating of capital market. Similar kind of bid should again come for Fortis this time.
http://www.livemint.com/Companies/bv3FHECoo9GFHjgPBRIKTO/Singh-brothers-said-to-seek-Rs250share-to-sell-off-Fortis-H.html

8. Healthcare has very very long run way for growth: This shouldn't be doubt in anyone mind that quality healthcare services in India is limited to metros and Tier-1 cities. Things need to improve significantly to put India anywhere near to global standards. As disposable income increases many people will be able to afford quality healthcare services. All small clinics in nearby locality run primarily by reference than by credibility.

9. Valuation: Story for any company is not complete without thinking about valuation. Given so much noise related to accounts it is difficult to assign Fortis value based to published information. However, instead of going wild assumption on valuation, lets make it a simple case. Apollo hospital business (exl pharmacy) revenue stands at INR 2952cr while Fortis hospital business was tad lower at INR 2815 cr in the nine month ending December 2017. Fortis EBITDA was INR 395 cr while Apollo makes INR 332 cr. However, Fortis incur BT cost post EBITDA as well. Beyond that Fortis own SRL with EBITDA run rate of INR 175 cr, which should trade at 25x multiple, should fetch INR 4 - 4.5K cr valuation. While Apollo has Pharmacy business which generated INR 85cr in 9M'FY18. Apollo trades at ~15k cr mcap.

10. Will Fortis be sold off cheaply: IHH & TPG have already shown interest to acquire substantial interest in Fortis. From Fortis side, there was talk to infuse INR 4,000cr for RHT payment. If the dilution is done at current price, current shareholder has to part significant portion of value at Fortis due to dilution at depressed price. hopefully, any fresh funding should go through majority of minority test rather than making preferential allotment to any bidder.

Disc. : All information shared in the article is for information purpose only. This is not to influence any investment decision. Please take advise of your financial advisor before any investment.

Private sector bank gaining market share may not be desired beyond a point

Ever since RBI took constructive view on private banks and started giving license to new age private banks since 1990s, they are gaining market share. RBI gave licensee to ~10 banks since 1990, most of them are running successfully. During the same time, public sector banks "PSB" have also experienced significant increase in their loan book, however their market share is consistently reducing as private banks are slowly taking morsel away from PSB platter.

As the banking structure stands today, private banks own 30% of market share while the public sector banks own 70%. One will come across numerous reports that will say private sector will soon swap market share with public sector. Hence all market participants will bet on the HDFCs and Kotaks of the world, that they will continue to gain market share and it is fair to value well run private banks at 3-4x book value.

However, gaining market share beyond a point may not be desirable for private banks and gaining market share in the current borrowing habits of Indian corporate may backfire to them. 

I would put my argument in two parts, one where private banks should be happy not to take larger market share from PSB. Second changes in borrowing habits where private sector will want higher market share.

Obviously changing borrowing habits is like moving a mountain, so we will discuss the easier part first.

Let's look at why PSB enjoy larger loan books. It is not because they are very efficient in lending, where lending is done much quicker than private banks. Not even that private banks doesn't have reach beyond metros.... They may not have reached to the remote locations and villages but there are very much present in the tier 2/3 towns catering MSME borrowers. One reason might be that PSB offers slightly cheaper loan to different sets of risky borrower and that is because they are wrong is understanding the underlying risks and not able to price the risks properly.

PSB have larger loan book as it acts big daddy of Indian corporate, and keep giving loan to undeserving candidates. About 10% of the PSB loan books is recognised bad loan, actual number will be much higher than currently recognized. Every alternate quarter results PSB management rhetoric would be "worst is behind and now we should see improvement in assets quality".

Private banks own smaller but healthier loan book. Their market share is at 30% because they restrained themselves hitting bad pockets of Indian corporate. It's better to have 30% share with less than 2% NPA than to enjoy 70% market share with over 10% bad loan.

Another reason for low market share is active account management. If the business of borrowers deteriorate private banks are quick to ask for extra collateral to cover the risk. They may also get out of certain accounts before situation gets ugly. PSB in general, once given the loan is married to borrower. Borrower, might leave for London, but banks will cling to their properties in India as if they are the remains of their departed spouse.

So, this reading loan book market share is wrong. One should look at share of profit among Indian banks. Since last two years has been particularly bad for public banks, one can look at profit share of 10 years. Private banks must be already hitting 60-70% even in the longer time frame.

Now, let's look at difficult aspect, changing borrowing habits. Public banks should enforce borrowers to provide extra collateral when business starts turning south. Currently many thinks borrowing is gambling with downside protected. If the business does well, profit is privatized, otherwise losses are nationalized. PSB also give top up loans to defaulting borrowers just to keep the banks away from recognizing as NPA. However, it seems that certain Indian corporate, who are addicted to free loan from PSB, will be unwilling to bring extra equity/collateral to maintain their loan backed up by sufficient equity.

Private banks remains cognizant of the current situation and hence keeping smaller but healthy books. Investor are right that their market share will grow and but growing beyond a point where you start taking bad loan books from PSB will not be value accretive.

Just as RBI have been cautious in giving me licensee, there should be rationalising on number of PSB. But that can be a discussion material for another day.

Emerging economies excusing responsibility from carbon emission is self defeating

Ever since cognisance have risen in the global arena to be responsible towards environment and carbon emission, there is tug of war between developing and developed nations regarding how much hit each should take towards economic growth.

Developing markets like India argument have been broader economic shoulder should bear heavier burden. Rationale given towards that is during industrialization phase US, European countries have grown without giving any importance to environment. They have polluted their fair share of the environment. 21st century belongs to emerging markets, bringing environmental concern will slow down the dominance emerging market will get at world stage.

On the other side developed market, (Ok this is before Trump we will not get into what Trump says) is saying that world has reached a point of no return. This is a global crisis, it doesn't matter if the economy is not so strong or you didn't polluted earlier. Everyone is suppose to contribute when the crisis is global.

If you listen to media or hear citizen from both side of argument. Most of them believe is their side is righteous, which left someone like me to think where is the balance of economic growth and environmental sacrifice.

Let's divide the environmental degradation to two part. One is breaking of ozone layer, which most of us is not able to see beyond global warming and summer getting hotter and winter getting colder. Other is respiratory related death occurs in the country due to polluting industries or other form of terminal illness as the water bodies is contaminated when discharge is left to flow to main water bodies without treatment. This is done so that industry remain competitive. Apart from land, labour cheap in India, cost of life is also cheap right.

Severe pollution in Delhi leads to many deaths in winter or lack of clean water bring terminal illness there. I am not sure if that can impact my health in Mumbai, leave aside US, UK.

Everytime we come across that polluting industries find safe heaven in African countries. They are constantly ruining their environment especially the entire water bodies. My reaction has been their government is pushing its citizen to death for economic growth. How is it different for us.

Another point, we have very fragile medical supports beyond tier 2 cities. Disease is detected at an advanced stage and then also treatment is lousy. It is in our own interest that we take care of environment.

Developed nations might want to throttle down our growth, but we should give due consideration on quality of growth we want to bring in our country.

May be most polluting industries needs to move towards thinly populated area and then health parameter of that zone should be constantly monitored. My argument is not like developed nations or NGOs who wants slow down growth but to take more pragmatic approach to the problem which is as much our own as much it is a global problem.

Steel anti-dumping duties indirect mini bank recapitalisation

It will be funny to say two sets of words "anti dumping duties" and "bank recapitalisation" in the single sentence. But once anyone looks deeper into benefits of anti dumping duties, it might look like anti dumping duties is helping finance ministry within its capacity to reduce bank stress.

May be at the end of this article, I would be able to connect anti dumping to bank recap, atleast a symbiotic relationship should be established.

Pre-2016 all steel companies use to complain about the stress in the sector due to cheap Chinese imports. China has huge overcapacity and use to dump steel in India and around the world just to keep their factories running and GDP growing.

India along with other countries started complaining about unfair trade practice out of China. Countries realized that it is in the interest of indigenous steel companies to put a restriction on dumping of steel from China.

In India, Government responded to the request of the steel companies in 2016 and imposed provisional safeguard import duties on steel imported from China. Later on, ministry further improved the breath of protection and bring in anti dumping duty on China and other countries.

As a result of which India which has net import of 7.7 million tonnes of steel in FY2016 is now turned net exporter of steel and has clocked export of 0.844 million tonnes in 2017. This was further improved in FY2018, where India has net export of 1.8mt of steel till January.

http://www.thehindu.com/business/Industry/indias-steel-import-falls-36-to-74-mt-in-2016-17/article18133428.ece

https://economictimes.indiatimes.com/news/economy/foreign-trade/indias-finished-steel-export-slides-over-30-in-january/articleshow/62968377.cms

There is significant improvement in the health of steel sector with government intervention. All companies are reporting very strong EBITDA margin. Is it happening due to cost improvement? No, raw materials cost is high in India as well as overseas. Is it due to improvement of utilisation and fixed cost leverage? Mildly, steel consumption has improved only 3.0% in 2017, though production has improved by 8.5%, that's because of import substitution and this benefit is one time gain. From here, operation leverage will be equivalent to consumption growth.

http://www.financialexpress.com/market/commodities/steel-sectors-yearly-performance-good-but-yet-to-reach-potential/623312/

Now let's look at the banking side of the story. Steel companies is the largest contributor to the banks stress. Aggregate debt of top five stressed steel companies in India is close to 1.4 lakh crore.

Of the twelve stress accounts which are taken for resolution, major contribution is from steel sector (Bhushan Steel, Essar Steel, Bhushan Steel and Power, Electrosteel and Monnet Ispat) with amount of 1.4 lakh crore. Bid submitted for Bhushan steel is even higher than expected by the banks and now they are going for potential write back on the provisioning done earlier.

http://www.livemint.com/Industry/L3KX0hXzcSkUacALhNY6LN/Bad-loan-resolution-Banks-drag-Essar-Steel-Bhushan-Steel-t.html

Isn't it equivalent to bank recapitalisation. Few months ago, everyone was guessing for the quantum of hair cut banks have to take when these companies going for resolution and now we are saying taking about sector turnaround and write backs.

http://www.financialexpress.com/industry/banking-finance/resolution-will-happen-in-most-accounts-under-nclt-says-sbis-deputy-md-sunil-srivastava/1035521/

So far so good, banks have to be funded and industry has to be protected. But recent price hike by steel companies and raw material have gone far beyond. This might even kill the growth of the sector which it is trying to protect.

Current state of affairs is India is net exporter of steel. Price realised on exports is lesser than what they get from Indian consumer. Here is the link regarding milking of domestic consumer, what started as protectionism is moving towards profiteering. Article mention India has started exporting steel to China, this can happen only when exporting price is less than what they are selling to Indian consumer.

http://www.tribuneindia.com/mobi/news/business/steep-hike-in-steel-prices-hits-engg-industry/548085.html

May be some correction to steel prices will come once the process of resolution of steel companies is over, till then I would think anti dumping duty is a form of mini bank recapitalisation.

Wrong investment decision from incorrect reading of return ratios:

Return ratios are considered as one of the most important metrics in evaluating investment prospects. In our quest for finding ideal investment opportunities, everyone will enquire what is the return ratios of the prospect? Many globally renowned investment gurus have maintained, they look at their investment and ask if they can deliver higher return ratios for a long period of time. They connect this higher return capabilities as the moat of the business.

There should be no doubt in any one mind that the return ratios should always looked into before making investment decisions. However, there are some areas where return ratios are wrongly used to make the investment case and I would try to put my argument over cases where return ratios are blindly appreciated. Since, I am based out of India and most of the understanding  has been from Indian capital markets, I would restrict my argument for Indian markets.

Let’s understand in simple terms what return ratios mean for investment decision. Investopedia says "Return on equity (ROE) is the amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested." In simple terms suppose Rs 100 was invested as equity in a business (say a restaurant), may be some time ago, and today that restaurant is generating Rs 20 as profit after tax, one can simply say the business is making 20% RoE. Now investor would compare this restaurant with other restaurant/investment opportunities and see which business or owner is able to make maximum of the invested 100 buck.

This concept work well for western countries where the inflation is very low. US, UK and Japan central government are struggling to increase their inflation rate to mere 2%. while India has always witnessed high inflation, RBI will never dream of bringing down inflation to 2%. 

Indian companies follow conservative accounting policy which means showing assets in balance sheet at market value or original value whichever is lower, so assets will be shown at historical value. Plus, there will be depreciation for wear and tear, which brings down the value of assets further in balance sheet, even though the replacement value of the same assets in current condition might be 2x or 3x, it will be recorded in balance sheet as book value minus depreciation. This is one side of story where assets in countries with high inflation and conservative accounting policy will always recorded lower than fair as denominator for RoE.

Let’s look at the profit side, the numerator of the RoE ratio. Profit is driven by what prices are charged at the restaurant. A restaurant will not charge lower price just because that property was acquired few years ago and prices where low back then. It will not charge lower price even if the acquisition has done recently and owner got a cracker of a deal and bought the property at a bargain. Revenue is always marked to market, based on current economic conditions.

Now, Let’s compare two business, one/ which has assets recorded at lower than fair value and there is another restaurant which is newly opened and assets is current market price. Since India always had high inflation rate, replacement value will normally be much higher than recorded value in the books. Here, just comparing return ratios as reported by the company, doesn’t lead to proper investment decision. If company with lower reported assets is considered better investment decision, then decision is not relying on business ability to generate higher return ratios. Rationale for selecting the business is that promoter will keep on adding new restaurant at bargain value. If that is the reason this Promoter should be compared with DLFs of the world and not the CCDs. 

There are certain instances when it becomes completely wrong to consider return ratios for investment decision, mostly in capital intensive manufacturing units where assets have long history. Think that you are comparing SAIL return ratios based on assets built over life of the company and comparing it with Tata Steel Kalingnagar plant which is built recently.

Comparing return ratios for a bank is fine, as significant portion of assets in balance sheet will be loan and advances or investment which are regularly mark to market. Hence, no distortion there. Even for service companies, they generally don't own hard assets. Infosys might not own building and hard infrastructure to do business, they will be taking it on lease instead. So the rentals booked in P&L would be again as in banks, mark to market.

The level of distortion doesn't end there. I was comparing two companies return ratios and face difficulty is showcasing my investment case due to skewed return ratios. Distortion in my case was further aggravated as one company has done regular acquisition and when you do acquisition assets value will be bought to normal current price or you might have to pay goodwill if the assets is added to the balance sheet at historical value.

To address issue to distorted return ratios, when assets is recorded at low value. One should start looking at inverted PE ratios instead of only return ratios. It gives picture to investor what he is currently paying for the business and whether business is doing well enough to return the money is shortest possible time. However return ratios should continue to be critical factor for banks and financial sector.