Detailed Rationale

CRISIL Ratings has reaffirmed its ‘CRISIL AA/Stable’ rating on the long-term bank facilities of Agilus Diagnostics Ltd (Agilus).

 

CRISIL Ratings has taken note of the company withdrawing its draft red herring prospectus (DRHP) on February 13, 2024. The company had filed the DRHP in September 2023, for a proposed initial public offer (IPO) by way of an Offer for Sale. As per the DRHP filed, only private equity (PE) investors having around 31.5% stake were likely to sell their shares partially, with no stake being diluted by Fortis Healthcare Limited (‘the parent Company or ‘FHL’). As per the management, the DRHP was withdrawn in consultation and mutual agreement with PE investors, with confirmation/ approval of the boards of FHL and Agilus.  While the same will have no impact on the business or financial risk profile of Agilus, as the proposed IPO was entirely to offer an partial exit to PE investors, and no money was supposed to come into the company , any material impact on the parent FHL’s credit profile in the process of giving partial exit to PE investors, shall remain a monitorable.

 

For the nine months ended December 31, 2023, Agilus recorded flattish revenue of Rs 1,034 crore and an operating margin of around 17%, against Rs 1,015 crore and around 21% for the corresponding period of the previous fiscal. The dip in operating margin includes the effect of one-time provisioning of around Rs 15.5 crore pertaining to one of the contract, from which dues are yet to be recovered.

 

In July 2023, the ratings were upgraded, following a similar rating action on the long-term rating of the parent, FHL to ‘CRISIL AA/Stable’. The rating action factored in sustained improvement in the business risk profile, driven by steady occupancy, better surgical mix, and greater share of international patients, leading to a higher average revenue per occupied bed (ARPOB). Despite growth plans, financial risk profile of FHL should be comfortable over the medium term, backed by strong capital structure and debt protection metrics. On a consolidated basis, debt to earnings before interest, tax, depreciation and amortisation (EBITDA) ratio is likely to be below one time; the ratio was around 0.8 time as on March 31, 2023, against around 1.2 times as on March 31, 2022.

 

Operating income of Agilus declined by 16% to Rs 1,347 crore in fiscal 2023 from Rs 1,605 crore in fiscal 2022. This was due to a drop in the number of reported Covid cases and Covid-related tests, which accounted for just 4% of topline, as against 28% earlier. Non-Covid revenue grew 12% year-on-year, led by rise in the number of collection centres, driving higher volume. Post acquisition of the entire stake in DDRC (a large diagnostics player in South India) in fiscal 2022, the southern market accounted for 28% of revenue in fiscal 2023, against around 10% in fiscal 2021.

 

Operating margin of Agilus normalised to pre-pandemic level of 17.7% in fiscal 2023, from a high of 25.7% in fiscal 2022. Furthermore, competition from new-age online players, especially in the wellness segment, can also adversely affect the margin. However, Agilus has a healthy B2B (business-to-business) share of 46% and greater presence in the complex test segment, compared with online players.

 

The strong financial risk profile continues to draw comfort from negligible bank borrowing as on March 31, 2023, in line with March 2022. Networth was over Rs 1,000 crore, while debt protection metrics were resilient. Agilus acquired the pathology business of RK Diagnostics (effective since July 2022) for Rs 11 crore (goodwill of Rs 10 crore), and Dr Ponkshe Path Lab (including care diagnostics) in Maharashtra (announced in January 2023) for Rs 11 crore (goodwill of Rs 8 crore). Internal accrual should suffice to fund these small acquisitions and the moderate organic capital expenditure (capex). Any large, debt-funded capex or acquisition or any adverse ruling in existing litigations under dispute of the Fortis group, necessitating significant payout, may impact the financial risk profile of Agilus and will remain a key monitorable.

 

The ratings had earlier been placed on watch due to pending legal issues. The Hon’ble Supreme Court of India had initiated suo moto contempt proceedings against FHL with regard to fund infusion by its promoter, IHH Healthcare Berhard (IHH), in the form of preferential allotment of fresh shares and purchase of assets of RHT Health Trust (RHT). CRISIL Ratings has undertaken a detailed discussion with the management subsequent to the Supreme Court judgement disposing off the suo moto contempt suits against FHL. The management does not anticipate any major implication on the day-to-day operations and future growth plans of the company on account of the remaining litigations. Furthermore, IHH has reiterated in multiple forums that FHL remains strategically important as India, along with Malaysia, Singapore and Turkey, remains its key market. The prospects for the healthcare sector in India remain strong over the medium term, and FHL is expected to be a key growth driver for IHH.

 

In its stock exchange announcement on September 23, 2022, FHL intimated that the Hon’ble Supreme Court, in its final judgement, held inter alia that the suo motu contempt petition and the connected proceedings (Special Leave Petition (Civil) No. 20417 of 2017 and the contempt petition No. 2120 of 2018 in SLP (C) No. 20417 of 2019) have been disposed of. The court has neither found nor indicated any wrongdoing by FHL related to the preferential allotment to Northern TK Ventures Pte Ltd (part of IHH) by FHL. The Hon’ble Supreme Court also observed that acquisition of the business portfolio of RHT by FHL appeared to be prima facie an acquisition of proprietary interest to subserve the business structure of FHL. However, the court has stated that the facts on record are not adequate to definitively evaluate issues concerning the acquisition and has issued certain directions including that the Hon’ble High Court of Delhi may consider issuing appropriate processes and appointing forensic auditor(s) to analyse the transactions entered into by FHL and RHT and other related transactions. The judgement further provides that it will be open to the Hon’ble Delhi High Court to pass such directions as the facts and circumstances presented before it, may justify.

 

The Securities and Exchange Board of India (SEBI) had, vide orders dated April 19, 2022, and May 5, 2022, imposed a penalty of Rs 1 crore each on Escorts Heart Institute and Research Centre Ltd (EHIRCL: rated ‘CRISIL AA/Stable/CRISIL A1+’) and FHL, and Rs 50 lakh on Fortis Hospitals Ltd (FHsL; rated ‘CRISIL AA/Stable/CRISIL A1+’) due to irregularities, inter alia, committed by the erstwhile promoters. FHL and FHsL have filed an appeal against the order of April 19, 2022, before the Securities Appellate Tribunal, Mumbai (SAT), which has directed SEBI to file its response and ordered that on deposit of 50% of the penalty amount, SEBI will not initiate recovery of further amounts. Against the order dated May 18, 2022, EHIRCL has filed an appeal before SAT, which has ordered that on deposit of 50% of penalty amount, SEBI will not initiate recovery of further amounts. The two appeals are sub judice, and a Serious Fraud Investigation Office investigation is underway.

 

The outcome of these proceedings before the Delhi High Court that may have a bearing on the financial risk profile of FHL, will remain a monitorable.

 

The rating reflects the established market position of Agilus, its improving operating performance and strong financial risk profile. These strengths are partially offset by exposure to intense competition and inherent regulatory risk. The rating also reflects the strong market position of the Fortis group, which has a pan-India presence through its network of 27 hospitals, sound operational efficiency, and healthy financial risk profile, including adequate liquidity. These strengths are partially offset by pending litigations, the impact of which may not be material; and exposure to regulatory risk associated with the hospital sector.

Analytical Approach

CRISIL Ratings has combined the business and financial risk profiles of Agilus and its subsidiaries, as they are engaged in the same business, and have strong operational and financial linkages, and a common management. Also, CRISIL Ratings has amortised goodwill arising from mergers or consolidation over a period of 10 years, given the strong brand of acquired entities and expectation of returns in the long term.

 

Please refer Annexure - List of Entities Consolidated, which captures the list of entities considered and their analytical treatment of consolidation.

Key Rating Drivers & Detailed Description

Strengths:

• Strong support from the parent: As a subsidiary, Agilus receives strong operational and managerial support from FHL. It represents the diagnostics arm of the Fortis group and therefore, remains strategically important to the parent, which has management control and may extend need-based support going forward too.

 

• Established position in the diagnostic services industry in India: Agilus is the second-largest diagnostics player in the domestic diagnostic services industry in terms of revenue. It has established a strong brand both in the retail (business-to-consumer) and B2B segments, and manages over 410 labs (including joint ventures), with over 3,700 customer touch points across India. It is also present via subsidiaries in the Middle East, which account for around 2% of overall revenue. The strong market position will sustain over the medium term, aided by a wide geographical footprint and diverse speciality mix. Transitioning to the new brand of Agilus in May 2023, while maintaining the market position. will be a key monitorable. While operating profitability peaked in fiscal 2022 during the pandemic, same normalised in fiscal 2023 to 17.7%and is expected at stable levels over the medium term.

 

• Strong financial risk profile: CRISIL Ratings-adjusted networth was healthy over Rs 1,000 crore, against negligible debt as on March 31, 2023. Debt protection metrics were comfortable, as reflected in adjusted interest coverage ratio of over 15 times in fiscal 2023. Liquid surplus was around Rs 331 crore in March 2023, supported by high cash accrual. Financial risk profile should remain stable over the medium term, aided by healthy cash accrual and absence of term debt. In absence of any debt funded capex going forward, financial risk profile shall remains strong over the medium term.

 

Weaknesses:

• Exposure to regulatory risks, market fragmentation and modest entry barriers: The cap on prices for diagnostic tests (for instance, testing for Covid-19), introduced by the government, has impacted players adversely. Limited capital requirement for setting a diagnostics laboratory has led to emergence of several diagnostic centres. Intense competition restricts the market share and pricing power of players such as Agilus.

 

• Continuing litigations involving the Fortis group: While theHon’ble Supreme Court directions have not had any adverse impact on operations of the Fortis group, the apex court has directed the Hon’ble Delhi High Court to look into matters involving purchase of RHT assets by FHL, which may include a forensic audit. While the FHL management does not envisage any significant financial liability, the timeframe by which the said legal issues may be resolved is uncertain. Furthermore, contingent liabilities of over Rs 2,400 crore as on March 31, 2023, include matters of income tax, medical negligence, among others. Any adverse development related to these will be a key monitorable. 

Liquidity: Strong

Liquidity (cash equivalent of around Rs 331 crore and undrawn working capital limit of Rs 52 crore) was around Rs 383 crore as on March 31, 2023, against negligible debt. Limited capex  of up to Rs 100 crore per annum will be funded internally. Going forward, accruals are expected to remain sufficient to fund incremental working capital and capex requirements.

Outlook: Stable

The credit risk profile  of Agilus will continue to benefit from its established market position, steady growth in revenue, and healthy operating profitability. The company is also expected to sustain its debt metrics and capital structure at comfortable levels, while pursuing organic and inorganic growth opportunities.

Rating Sensitivity Factors

Upward factors:

• Substantial increase in revenue with sustenance of operating margin at ~18-19%, benefitting cash generation
• Sustenance of strong financial risk profile
• Revision in the rating of the parent FHL by 1 or more notches

 

Downward factors:

• Lower utilisation of labs impacting revenue and operating margin sustaining below 15%
• Significant, debt-funded capex or investments or any unfavourable judgement in the ongoing litigations moderating financial risk profile
• Revision in the rating or outlook of the parent FHL by 1 or more notches, or reduction in FHL stake in Agilus

About the Group

Incorporated in February 1996, FHL’s first healthcare facility became operational at Mohali in Punjab in 2001. The company is an integrated healthcare services provider, present across hospitals, diagnostics, day care, and specialty facilities. It has both owned and managed hospitals. The diagnostics brand, Agilus, is among the leading chains in the country. FHL has entered the women and child health and well-being segments through the La Femme brand. It has a facility each in Jaipur; Greater Kailash and Shalimar Bagh (both in New Delhi); and Bengaluru. The company has four hospitals accredited to the Joint Commission International (JCI), 21 accredited to the National Accreditation Board for Hospitals (NABH), 18 with NABH-accredited nursing programmes under its umbrella, and 9 NABH-accredited blood banks.

 

On February 15, 2018, shareholding of the erstwhile promoters, Mr Malvinder Mohan Singh and Mr Shivinder Mohan Singh, came down to less than 1% after the Hon’ble Supreme Court allowed lenders to invoke the pledge against shares of FHL held as security. Thereafter, the search for a new promoter began and bids were invited from investors. IHH was the winning bidder and became the new promoter, having invested around Rs 4,000 crore against fresh issuance of around 31.1% stake.

 

The board has provided the in-principle approval for change of names, brands and logos of Fortis and its diagnostic subsidiary, whose license agreements expired in April and May 2021, respectively. Subsequently, the diagnostics subsidiary has been renamed as Agilus Diagnostics Ltd since May 2023. The proposal to change the name, brand and logo of Fortis remains subject to various deliberations and requisite corporate and regulatory approvals.

 

For fiscal 2023, FHL reported net profit of Rs 633 crore (including an exceptional gain of Rs 74 crore pertaining to reversal of impairment in an associate company) and an operating revenue of around Rs 6,298 crore. This compares with operating revenue of around Rs 5,718 crore and net profit of Rs 790 crore in fiscal 2022. This includes an exceptional gain of Rs 315 crore, pertaining to remeasurement of the previously held equity interest held by Agilus in its JV with DDRC, at its fair value, post-acquisition of the balance 50% stake in April 2021).

Key Financial Indicators

As on/for the period ended March 31	Unit	2023	2022
Reported operating income	Rs.Crore	1,347	1,605
Reported profit after tax (PAT)	Rs.Crore	117	555
Adjusted PAT margin	%	8.7	34.6
Adjusted debt/adjusted networth*	Times	--	--
Interest coverage*	Times	15.43	25.68

*CRISIL Ratings-adjusted numbers; networth has been adjusted for intangible assets such as goodwill

Any other information: Not Applicable