Investment Highlights

• FY22 results mostly beat expectations. Out of 3 companies under coverage, 2 were above expectations, and 1 within (Exhibit 2). The FY22 core net profit of Apex Healthcare (Apex) and Duopharma Biotech (Duopharma) beat expectations. Apex’s results were boosted by continued strong demand for influenza (flu)-related medication and outstanding performance of 40%-owned Straits Apex while Duopharma benefited from lower effective tax rates of 17% (vs 21% in FY21). Separately, IHH Healthcare (IHH)’s FY22 result was broadly in line with our expectation but 8% below consensus estimates. The slight shortfall by IHH from consensus was mostly due to higher operating costs (ie. staff and energy costs), weaker Turkish lira (TRY) against MYR, higher post-MFRS 129 depreciation/amortisation and rising net finance costs.

• Reignition of IHH’s organic/inorganic growth trajectory. IHH guided that the primary growth drivers for 2023F and beyond will be expansions of the group’s bed capacity in the key regions of Malaysia, India and Turkiye. IHH will add 600- 700 beds over the next 2-3 years for Pantai Hospital Penang, Gleneagles Hospital Penang and Pantai Hospital Klang, representing a 2023F-25F CAGR of 7.5%-11.5% (vs 5-year CAGR of 4.5% for 2016-21) for Malaysian operations. IHH will expand additional 1,200-1,500 beds in 2023F-25F via its 31.1%-owned Fortis Healthcare, translating to a FY22-25F CAGR of 7.8%-9.6% (vs a flat 3-year CAGR for 2018-21) for Indian operations. Acibadem will experience both organic and inorganic expansions. With recent acquisitions of 52-bedded Ortopedia in Aug 2022 and 340-bedded Kent Health Group in Feb 2023, as well as the opening of 280-bedded Acibadem Atasehir in 3Q2022 and a new Acibadem Kartal with +200 beds expected to be operational by 2023F, Turkish bed capacity will increase by 6% in 2023F (vs 5-year CAGR of 4% for 2016- 21). We positively view these developments, which could assist in sustaining the group’s long-term revenue trajectory, as opposed to relying primarily on the recovery of overseas and domestic inpatient admissions (IA).

• Higher revenue/IA boosted by foreign patients. Notably, IHH’s foreign IA share of revenue in 4QFY22 has recovered and in some countries, exceeded pre-Covid levels with Singapore at 25% (at parity to pre-pandemic), Acibadem at 15% (vs 12%), India at 8-10% (at parity) and Malaysia at 6%-7% (vs 5%). Hence, IHH anticipates that the revenue share of foreign IA could surpass pre-Covid levels due to the continued strong influx of foreign patients. We view this positively since foreign IA typically generates a 20%-25% higher revenue/IA than domestic inpatients.

• Normalisation of Acibadem’s EBITDA margin. Notwithstanding Turkiye’s hyperinflationary environment (Exhibit 3), Acibadem’s 4QFY22 EBITDA margin improved to 25% (broadly in line with 23%-28% in FY19-21) from 19% in 3QFY22 and 18.5% in 2QFY22. This was mainly attributable to an increase in blended pricing structure, higher share of medical tourism and a decline in energy costs in 4QFY22 from the 2022 peak in 3QFY22. IHH guided that Acibadem's long-term EBITDA margin should be 24%-25%.

• Flu cases in Malaysia on the rise again amid drug shortages. According to World Health Organisation (WHO) data, the number of flu cases in Malaysia peaked in mid-Jul 2022, then steadily fell until mid-Oct 2022 and subsequently reversed to an uptrend again (Exhibit 4). Hence, we believe this development reignited demand for flu-related medications amid ongoing drug shortages (Exhibit 5). This could also increase the bargaining leverage of pharma manufacturers to pass on potentially higher costs.

• Decline in API prices is another tailwind to pharmaceuticals. India-based IIFL Securities’ (IIFL) API/KSM pricing Index, which is composed of 16 key imported pharmaceutical products from China, indicates that active pharmaceutical ingredients (API) costs have decreased consistently over the past 2 quarters ie. -4.5% QoQ in 3Q2022 and -12% QoQ in 4Q2022. To recap, API import prices registered a consistent 3%-8% sequential increase in API prices over the last 6 quarters (1Q2021 to 2Q2022). The continuation of recent declines in API costs will be crucial to provide margin tailwinds to Apex and Duopharma in 2023F. On average, APIs contribute 40% of medicine costs.

• Pharmaniaga quagmire could benefit Apex and Duopharma. On 27 Feb 2023, Pharmaniaga was classified as a PN17 company following the recognition of RM552mil provision of losses in 4QFY22 for slow-moving Sinovac Covid-19 vaccine inventories, plunging its shareholders’ equity into negative territory. Since Pharmaniaga’s problem is mainly related to company-specific risk (ie. Sinovac vaccine inventory write-offs) rather than fundamental systemic risk (eg. weakening drug demand), investors may gradually switch from Pharmaniaga to other pharmaceutical companies. This might potentially raise the investment profiles of Apex and Duopharma and mitigate their valuation discounts amid better-than-expected FY22 results.

• We maintain Overweight stance on the healthcare sector. For hospital operators, we expect IHH to ride on its organic/inorganic growth strategy and higher revenue/IA prospects. Furthermore, Acibadem’s strong EBITDA margin could be maintained at 24%-25% in the coming quarters.
  For pharmaceuticals, Apex and Duopharma are poised to benefit from the prevalence of Covid-19 and elevated flu cases amid drug shortages in Malaysia in the near term together with continued declines of API prices since 3Q2022 and the return of patients to Malaysian hospitals (Exhibit 6). Lastly, Apex and Duopharma could potentially benefit from the exit of Pharmaniaga investors to alternative stocks in the sector.

• Top pick is Duopharma (FV: RM2.06/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. Furthermore, Duopharma holds a better position to leverage on the increased government allocation to Ministry of Health (MoH) in 2023F, amounting to RM36.3bil (+12% YoY) (Exhibit 7) and the addition of 5 public and 19 private hospitals scheduled to be operational over the next 3 years. In terms of valuation, Duopharma has a higher fair value upside of 32% vs IHH’s (FV: RM6.49/share) 9% and Apex’s (FV: RM4.21/share) 10%.

Source: AmInvest Research - 8 Mar 2023