Investment Highlights

• We maintain Overweight stance on the healthcare sector. For hospital operator, we expect IHH Healthcare (IHH) to ride on its organic growth engine in 2023 and beyond, which includes the expansion of the group’s bed capacity in key regions – Malaysia, India and Turkiye. Furthermore, IHH is poised to benefit from continued recovery of domestic and foreign inpatient admissions (IA) amid continuous relaxation of lockdown measures and travel restrictions, especially in Malaysia and Singapore.

• For pharmaceuticals, Apex Healthcare (Apex) and Duopharma Biotech (Duopharma) in the near term are poised to benefit from recent strengthening of MYR against US$ since early Nov 2022, as well as initial moderation signs of active pharmaceutical ingredients (API) prices beginning in 3QCY22. Furthermore, Duopharma hold a better position to ride on the higher government allocation to Ministry of Health (MoH) in 2023 (+11% YoY) and the addition of 5 public and 19 private hospitals scheduled to be operational within next 3 years.

• Stronger bed capacity expansion ahead. Going into 2023 and beyond, IHH guided that its Malaysian operation will add 600- 700 beds over the next 2-3 years (or CAGR of 7.5-11.5% per annum) via the expansions of Pantai Hospital Penang, Gleneagles Hospital Penang and Pantai Hospital Klang. Separately, IHH’s Indian operation will add another 1,500 beds in 2023-25 (or CAGR of 8% per annum) via its 31.1%-owned Fortis Healthcare. For its Turkish operation, Acibadem in Aug 2022 acquired a Turkiye-based private healthcare operator, Ortopedia, currently operating with a 52-bedded hospital specifically for orthopedics. Furthermore, Acibadem opened Acibadem Atasehir Hospital in Turkiye in 3QCY22, which is now running with 280 beds. Going into 2023, a new Acibadem Kartal with 200+ beds will be opened and IHH will further expand into European regions to diversify from Turkiye. All in, we believe this will re-ignite IHH's organic growth engine and sustain its long-term development trajectory, rather than relying primarily on returns from overseas and domestic patient admissions.

• Continue to benefit from recovery of inpatient admissions... IHH is poised to benefit from the continued recovery in foreign and local IA, amid continuous relaxation of lockdown measures and travel restrictions, especially in Malaysian and Singaporean operations (both achieved 80% of pre-Covid levels in 3QFY22), whereas Indian and Turkish operations have recovered back to pre-Covid levels. Going forwards, IHH will continue to target more foreign patients from the second-tier cities ie. Indonesia, Indochina countries and Bangladesh, in addition to current markets.

• … but dragged by nursing shortages in Singaporean operation. For the Singaporean operation, a slower recovery of IA was mainly due to nurse shortages (Exhibit 2-5), which constrained the utilisation of bed capacity. Singapore is highly dependent on foreign nurses ie. >50% of the new nurses who entered the profession in 2020 were non-Singaporean. As a result of global shortages of nurses, some developed countries are paying foreign nurses twice as much as in Singapore and providing perks like permanent residency status, causing a mass exodus from Singapore. Separately, local nurses are also leaving owing to the stress of working longer shifts, and annual leaves are not permitted due to a dearth of foreign nurses. Based on The Straits Times, IHH requires 2,200 nurses to operate optimally but is now short of 300 (or 13.5%) across its hospitals and clinics. IHH guided that this could lead to a 10% revenue loss in FY22F. On a positive note, IHH guided that the staff shortages could be resolved within 6 months.

• … and impacted by Turkiye’s hyperinflation. Turkish Consumer Price Index (CPI) increased by 86% YoY in Oct 2022 (Exhibit 6) as compared to 11.1–19.4% over past 5 years. Given Turkiye’s elevated inflation rate, IHH has further increased its blended pricing structure in 2HFY22, after a 39% increase in Jan 2022. Management believes that this can be achieved without any consequential demand destruction, thanks to the group’s strong customer focus in high net worth market. This move is to offset inflationary pressures and elevated wages in Turkiye. Given rising electricity bills in European regions, which are revised with higher frequency, these cost escalations could lead to a timing mismatch vs Acibadem’s sales price revisions, which are implemented to protect margins. Nevertheless, IHH guided Acibadem’s EBITDA margin has bottomed at 19.3% in 3QFY22 and may be recovering to the range of 24-25% as inflation eases.

• Pharmaceuticals could exhibit some QoQ softness in 4QFY22F sales... Apex has been benefiting from strong demand for flu-related medications as a result of elevated flu cases in Malaysia and Singapore, as well as Omicron which has become a community respiratory illness. Similarly, Duopharma has gained from higher demand for ethical classic products as public and private medical institutions restocked inventories in view of the strong rebound in both domestic and foreign patients. However, Apex guided that the demand for flu-related medications could normalise from Dec 2022 to early FY23F, in view of declining flu cases in Malaysia and Singapore (Exhibit 7 & 8). Separately, Duopharma guided that its sales typically peak in the first 3 quarters of the calendar year and will gradually taper off in 4QFY22, mainly due to the historical weaker demand from MoH and the normalisation of Vitamin C sales.

• …while Duopharma could still resume its FY23F growth trajectory, underpinned by (I) higher government allocation to MoH in 2023 (+11% YoY) since public sector accounted for 44% of Duopharma’s 9MFY22 revenue (vs Apex’s <10%). While the allocation to MoH might be revised following the formation of a new unity government, we believe it will still be an upward trajectory; and (II) 5 new public and 19 new private hospitals (including Sunway Healthcare Group and Selgate Healthcare) are coming on stream over next 3 years.

• Strengthening RM is boon to pharmaceuticals. MYR has strengthened against US$ by 7%-8% since early Nov 2022. This will be beneficial to pharmaceuticals, as almost all of their API are imported and denominated in US$. Based on our estimates, for every 10% strengthening of MYR against US$, the impact on FY23F core earnings will be 15-16% for Apex and 18-20% for Duopharma. This is assuming 50% of Apex’s cost of goods sold (COGS) is denominated in US$, comparable to Duopharma’s mix of US$-denominated COGS, both companies have no hedging arrangements and will not pass on the lower costs to their customers.

• Moderation in API prices is another tailwind to pharmaceuticals. Indian-based IIFL Securities’ (IIFL) API/KSM pricing Index, which is composed of 16 key imported pharmaceutical products from China, indicates that API costs have moderated 4.5% QoQ in 3QCY22. This also marked the first quarter showing a QoQ decline in API import prices vs. a consistent 3-8% sequential increase in API prices over the last 6 quarters (since 1QCY21). Furthermore, with China's relaxation of pandemic restrictions, this could ease local supply chains and further reduce API prices. According to Optima Insights, China accounted for 40% of global API supply. The continuation of recent moderation in API cost pressures will be crucial to provide margin tailwinds to pharmaceuticals in CY23F, as we believe the majority of high-priced API inventories will be largely depleted by end-CY22, given Duopharma’s 5-year average inventory turnover ratio of 2.2x annually. We believe Apex’s manufacturing segment should have a comparable turnover ratio.

• Key downside risks: For hospital operators, risks include: (a) worsening nursing shortages in Singaporean operation; (b) reaccelerated inflation rate in Turkiye with IHH unable to offset the higher costs with increased blended pricing structure; (c) delay in its organic expansion plans; and (d) re-imposition of lockdowns amid another round of pandemic/contagious disease. The risks for pharmaceuticals include: (a) implementation of drug price control mechanism by the new unity government; (b) spike in API prices and freight costs, and (c) resumption of US$ uptrend against MYR.

• Hospitals and pharmaceuticals working towards sustainability. From environmental perspective, IHH, which is also our top ESG pick, set its target to cap carbon emissions by 2025 and achieve net zero by 2050. Besides, IHH has committed to reducing single-use virgin plastics by 90% in non-clinical areas by 2023, starting from 20 hospitals in Malaysia and Singapore. From the governance perspective, IHH also implements the Value-Driven Outcome (VDO) programme to increase the value of each clinical outcome to tackle inflation and so improve shareholder value. From social perspective, IHH is working with Malaysia’s MoH to fully sponsor radiotherapy and radiosurgery for 500 cancer patients in the B40 income group from government hospitals.

• Sector valuation still compelling. Duopharma currently trades at a compelling FY23F PE of 15x, an unjustified discount of 13% to its 5-year average of 17x while IHH trades at an undemanding FY23F P/BV of 2.0x vs. its 5-year mean of 2.3x. Separately, Apex is currently trading at FY23F PE of 21x vs its 3-year peaks of over 25x.

• Key considerations for downgrading the sector to Neutral: (a) spike in API prices; (b) strengthening of US$; and (c) implementation of drug price control mechanism by the new unity government.

• Top pick is Duopharma (FV: RM1.89/share). We continue to like Duopharma as the largest local pharmaceutical manufacturer which can leverage on: (a) the rising take-up of generic drugs in Malaysia, (b) upcoming industry’s patent cliff in 2022-2026 and booming biosimilars with the company’s strength in R&D and state-of-art manufacturing facilities; and (c) ever-growing Vitamin C market with its popular brands, Champs and Flavettes. In addition, the strengthening of MYR against US$ and the recent moderation of API prices provide a boost to near-term investment sentiment. In terms of valuation, Duopharma has the highest upside of 15% as compared to Apex (+5%) and IHH (+12%).

Source: AmInvest Research - 29 Dec 2022