Investment Highlights

• We reiterate our NEUTRAL call on the private healthcare sector for 2H19. The growth prospects for the sector globally are positive over the long term, underpinned by an aging population, rising affluence and increasing life expectancy. The local private healthcare sector has an added catalyst, i.e. medical tourism backed by its highly competitive charges and hospitalization costs (vs. those in developed countries), a generally English-speaking population as well as various incentives provided by the government.
• Our house projection for the USD/MYR rate is RM4.16. Private healthcare operators in Malaysia may be negatively impacted by the weakening MYR vs. the USD as costs of key inputs such as drugs, medical supplies and medical equipment are denominated in USD. On the other hand, a cheaper MYR might boost Malaysia’s medical tourism volume. Malaysia’s medical tourists contribute close to 5% of IHH Healthcare and KPJ Healthcare’s revenue.
• We may upgrade our NEUTRAL call to OVERWEIGHT should there be: (1) a surge in patients due to outbreaks of pandemic diseases; (2) lower-than-expected start-up losses at new hospitals; (3) value-accretive M&As; and (4) a jump in medical tourists. In contrast, we may downgrade to UNDERWEIGHT should there be: (1) a significant dropout of patients from private hospitals due to economic reasons; (2) higher-than-expected and prolonged start-up losses from new hospitals.

• Average revenue per inpatient was high in 1Q2019. KPJ’s average revenue per inpatient grew 9.7% YoY while IHH’s average revenue per inpatient trended upwards YoY (+7.0% Singapore, +7.5% Malaysia, +27.2% Acibadem). We believe both groups enjoyed a better case mix while IHH benefitted from a higher occupancy rate and increased ASP in Turkey.

• KPJ has opened KPJ Bandar Dato’ Onn in Johor Bahru in February 2019 and is targeting to add another 670 beds in 2019 through new hospitals as well as expansion of existing hospitals. KPJ will be opening 4 new hospitals (Miri +96 beds; Kuching +150 beds; KPJ Batu Pahat +90 beds; Kluang Specialist +90 beds) as well as expanding 4 existing hospitals (KPJ Seremban +87 beds; KPJ Ampang +87 beds; KPJ Klang +40 beds; Sri Manjung +30 beds). Meanwhile, IHH plans to open one new hospital in Chengdu, China with a 350-bed capacity in 2019. It is also focusing on improving operations in its recently acquired Fortis.

• KPJ’s EBITDA margin improved 3.7ppts YoY to 16.7% in 1Q2019 on the back of cost optimization initiatives while IHH’s EBITDA margin rose 1.0ppt YoY to 22.3% with better operational performance across its segments. Although we expect continued improvement in cost optimization and operational performances, we think this will be offset by higher gestation costs from new hospitals and lower contribution by IHH’s Fortis (EBITDA margin 10.8% in 1QFY19). IHH’s Acibadem Holdings repaid US$250mil out of the outstanding US$670mil non-Turkish lira debt to deleverage its balance sheet and plans to reduce another US$360mil equivalent of non-lira debt. Hence, we can expect its interest expense to improve in 2H2019.

• Our top pick is KPJ Healthcare (BUY, FV: RM1.14). We continue to like KPJ for its vast network of hospitals in Malaysia and potential growth from capacity expansions.

• We like IHH Healthcare (HOLD, FV: RM5.58) for its position in the premium segment of the private healthcare sector, translating to high EBITDA margins of around 20%. However, we are cautious as we believe the group would face risks from its Turkish operations due to the volatile lira and deteriorating macroeconomic conditions which are reflected in a higher discount rate on our DCF valuation (WACC: 8.3%).

Source: AmInvest Research - 15 Jul 2019