Dr. Agarwal's Eye Hospital

Dr. Agarwal's started off as a one-off hospital in Chennai and is now a chain of 35 specialty eye clinics - 24 owned clinics and 11 partnerships.

During the last fiscal, Dr. Agarwal's had Rs88cr turnover (65% medical services, 25% optical sales, 10% pharmacy sales). The PAT figure was a measly Rs 50lacs. However, it is expected to close FY11 with sales of Rs100cr and PAT of ~Rs4cr.

Between 2006-2010, Dr. Agarwal's started on a debt-fueled expansion program that resulted in a 50% growth in sales and a cut in net margins to almost 0%. Doctor's salaries are 26% of medical services fees collected, while operating overheads are at 45%. Rents, and other administrative overheads at 22% of sales imply an under-utilization of facilities - quite understandable as a large chunk of clinics have come online in last four years.

Dr. Agarwal's has halted its expansion program a bit with just two more clinics coming online in YTD.With better facilities utilization, administrative overheads can come down to 10% of sales, while doctor's salaries can be brought down to 20%, even with better remuneration. An industry standard operating overhead of 35% can allow Dr. Agarwal to target 35% margins in medical services division (from current 5-10%). Opticals (50% of sales is job-work including wages) and Pharmacy are high operating margin activities. 

We expect Dr. Agarwal's to achieve Rs130cr in turnover in FY12 with a PAT of Rs10-15cr, that leads to a valuation of 3x-4x the current market cap. Over a three-four year horizon, Dr. Agarwal's can expect to achieve a PAT figure of Rs25-30cr. However, for the profitability to materialize, Dr. Agarwal's would need to sacrifice their pursuit of growth, which may not be likely.

Competition: Lotus Eye Care came with an IPO in June 2008. At the time of IPO, Lotus had four operating clinics with average sales per clinics (ARPC) to the tune of Rs2.5cr and a net profit of Rs2cr. Lotus valued itself at Rs41cr (pre-money) and sought to raise Rs39cr for a 48% stake dilution. Despite falling below issue price at listing, its market cap was in excess of Rs70cr. It was effectively valued at Rs10cr per clinics and 20x earnings. At present with 7 operational clinics, Lotus is valued at Rs24cr, (almost 70% down from its market cap at listing) at a per clinic valuation of Rs3.5cr (negligible debt). Ignoring Dr. Agarwal's partnership clinics, at current valuation, Dr. Agarwal's is valued at Rs1.73cr per clinic, but it also has a debt of Rs1.33cr per clinic. Dr. Agarwal's ARPC at  Rs4.1cr is 65% more than Lotus's ARPC of Rs 2.5cr. Fundamentally speaking, Dr. Agarwal's is a better stock, but Lotus is a better value pick considering that it is available at 0.4x book (probably prompted India Deep Value Fund to take a 1%+ stake in Lotus).

Both the stocks can have a tumultous future ahead, and we will see either an erosion in growth or in profitability. Lotus can't sacrifice on either front, as growth was the premise on which IPO funds were raised, while any erosion in profitability will put it in a hole from which it may be difficult to climb back. In that respect, Dr. Agarwal's is in a better position as it can choose to consolidate and improve its profitability and yet at Rs100cr+ sales, it will have a sizable presence in its market.  The total debt of Rs32cr is manageable, current capital structure is tax efficient for shareholders.