Investment Highlights

• We upgrade our call on the private healthcare sector to OVERWEIGHT from NEUTRAL. 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.

• We anticipate a contraction in earnings in 2020 in light of the Covid-19 pandemic which will significantly impact the healthcare sector in the short term. However, we expect recovery to kick in in 2021. We expect KPJ’s earnings in FY20F to slip by 7% but expecting recovery in FY21F with 11% growth in earnings. In terms of net margin, we believe it will slid by roughly 0.7ppt to 5.1% in FY20F. We expect IHH’s earnings in FY20F to decline by 13% but expecting recovery in FY21F with 45% growth in earnings. In terms of net margin, we believe it will contract by 1.0ppt in FY20F to 5.2%.

• We believe valuations for both KPJ and IHH are now attractive as their share prices have dropped around 8.3% and 9.7% YTD respectively. KPJ is now trading at a PE of 18.2x FY21F EPS while IHH is trading at a PE of 37.6x FY21F EPS.

• KPJ and IHH are offering private Covid-19 tests in Malaysia. KPJ offers Covid-19 tests through 12 of its hospitals as shown in Exhibit 2. KPJ has also made it compulsory for its patients to go through Covid-19 screening upon admission to 7 of its hospitals. The group has recently scaled up its testing capacity from 150 in the beginning to around 1K tests per day now. Its subsidiary, Lablink (M) Sdn Bhd (Lablink), now runs around the clock to speed up the process (results ready within 24-48 hours). As a result, the group was able to lower the price of the test kits to RM388 starting 3 April 2020 from roughly RM600 previously. Considering that Lablink only contributes less than 5% to the group’s revenue and the lower pricing of the test kits, we expect its impact to the group’s margins is minimal.

• IHH’s Covid-19 tests in Malaysia are offered at a higher price of around RM950. The group’s wholly-owned subsidiary, Pantai Premier Pathology, has the capacity to run 500 Covid-19 tests per day. Contribution from Pantai Premier Pathology is also less than 5% to the group’s revenue whereas the group’s diagnostic arm across all regions contribute around 15– 20% to IHH’s top line. We believe the Covid-19 testing which is offered in Malaysia, Singapore, Turkey and India will slightly alleviate the pressure on IHH’s margins given the higher price point and availability throughout different regions. In Singapore, the Covid-19 test charge is around S$160 per test. The price is controlled as Singapore’s Ministry of Health sets the price which is paid and reimbursed by the Singaporean government.

• The Covid-19 pandemic is expected to negatively impact the hospitals’ inpatient and outpatient volumes as medical tourists decline and non-essential cases are deferred. Medical tourists made up roughly 3% of KPJ’s revenue and 15% of IHH’s revenue (6% Malaysia, 26% Singapore, 16% Turkey, 10% India). We believe IHH’s bigger exposure to medical tourism means that it will face a bigger impact due to the travel bans compared with KPJ. We expect margins to be pressured for both groups as patients delay non-essential cases.

• Presently, the companies are not taking in Covid-19 patients in Malaysia. In the event that they have to take in Covid- 19 patients, we believe both groups’ operations will be scaled down as a precautionary measure which will limit the capacity per hospital. In Malaysia, KPJ runs roughly 3.1K beds in 28 hospitals while IHH runs 2.5K beds in 15 hospitals. According to Ministry of Health’s website, there are around 140 public hospitals in Malaysia running around 40.7K beds.

• We lower our earnings forecasts for KPJ and IHH as shown in Exhibit 1. We have assumed lower patient volumes as well as lower margins due to the impact of Covid-19 like the drop in medical tourism, deferment of non-essential cases and longer gestation period for new hospitals.

• We maintain our BUY call on KPJ Healthcare with a lower FV of RM1.15 (RM1.18 previously) based on 23x PE FY21F EPS. We continue to like KPJ Healthcare for: (1) its bright long-term prospects in the private healthcare sector; (2) vast network of hospitals in Malaysia; and (3) positive long-term earnings growth led by capacity expansions.

• We upgrade our recommendation for IHH Healthcare to BUY from HOLD with a lower FV of RM5.91 (from RM6.06). Our valuation is based on DCF with a WACC of 7.3%. We like IHH 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 around 20%. We have taken into account the geopolitical risks from its Turkey, China and India operations due to the volatile currency, political climate and legal battles which is reflected in its WACC of 7.3%.

Source: AmInvest Research - 7 Apr 2020