• We reiterate our NEUTRAL call on the private healthcare sector for 2020. 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 hospitalisation costs (vs. those in developed countries), a generally English-speaking population as well as various incentives provided by the government. However, we anticipate new hospitals to be hit by gestational costs in the near term as well as the impending drug pricing control (DPC).
• According to the Pharmaceutical Association of Malaysia (Phama), the Ministry of Health (MoH) has announced that the ministry intends to use external reference pricing (ERP) to benchmark drug prices in Malaysia against 7–8 selected countries by choosing the average three lowest reference prices to determine the ceiling price sold to dispensing channels in Malaysia. One of the highlights is a phased implementation of the DPC whereby the first phase is to apply the mechanism on single-source products which are generally patent-protected medicine (instead of medicine with generic alternatives).
• We estimate sales of drugs to be circa 20–25% of revenue for the hospitals. Although there is still no any clear drug pricing guideline, we believe any impact on the selling price of drugs can be partially covered by other charges (such as hospital bed charges, consumables and medical devices), limiting the impact to its margins.
• Private healthcare operators in Malaysia may be negatively impacted by a weaker MYR vs. the USD as costs of key inputs such as drugs, medical supplies and medical equipment are affected by the USD. On the other hand, a cheaper MYR might boost Malaysia’s medical tourism volume. Malaysia’s medical tourists contribute around 5–6% 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.
• We expect the hospital’s operational metrics to continue to improve on the back of an increase in medical tourism. This is underpinned by the RM25mil allocated to the Malaysian Healthcare Tourism Council (MHTC) for the Malaysia Year of Healthcare Travel 2020 programme which is expected to strengthen Malaysia’s position as the preferred destination for medical tourism. However, we expect the hospitals’ net margin improvement to be limited (+/-1ppt) on the back of a continued drag from gestational costs of its newly opened hospitals as well as upcoming new hospitals.
• KPJ is targeting to add around 474 operating beds in 2020 through new hospitals as well as the expansion of existing hospitals. KPJ will be opening 3 new hospitals (Kuching +70 beds; Kluang Specialist +90 beds; KPJ Damansara +30 beds) as well as expanding 5 existing hospitals (KPJ Ampang Puteri +88 beds; Taiping +20 beds; Sri Manjung +30 beds; KPJ Puteri +101 beds; KPJ Perdana +45 beds). Meanwhile, IHH plans to open one new hospital in Shanghai, China with a 450-bed capacity in 2019. It is also focusing on improving operations in its recently acquired Fortis.
• Our top pick is KPJ Healthcare (BUY, FV: RM1.12). We continue to like KPJ for: (1) its bright prospects in the private healthcare sectors; (2) vast network of hospitals in Malaysia; and (3) positive earnings growth led by capacity expansions.
• We like IHH Healthcare (HOLD, FV: RM5.40) for: (1) its strong prospects in the private healthcare sector backed by rising affluence and the aging population; and (2) its position in the premium segment of the private healthcare sector, translating to high EBITDA margins of over 20%. However, we are wary of the geopolitical risks from its Turkish and China operations due to the volatile currency and political climate. We expect lower foreign exchange exposure for IHH.

Source: AmInvest Research - 26 Dec 2019