Investment Highlights

• 1QFY23 results were largely within expectations. Out of 3 companies under our coverage, 2 were within expectations, while 1 underperformed (Exhibit 3). The 1QFY23 core net profit of Apex Healthcare (Apex) and Duopharma Biotech (Duopharma) came in within our expectations. However, IHH Healthcare (IHH)’s 1QFY23 results were below expectations, accounting for 18% of our earlier FY23F earnings and 20% of street’s estimate. As a comparison, historically IHH’s 1Q earnings made up 21%-23% of its FY18-22 core net profit. The deviation was attributable to higher income tax expenses from the increased restated profit before tax after recognising RM165mil of net monetary gain from the adoption of MFRS 129 in Turkish operations.

• On a QoQ basis, 1QFY23 core net profit for healthcare sector declined by 4%, driven largely by the 3% decline in IHH's core net profit despite a revenue growth of 6%. The stronger revenue growth for IHH was primarily supported by higher inpatient admissions (IA) (+2%) and hospital charges/IA (+12%) for Acibadem (Turkish operations). However, the sequential decline in IHH’s 1QFY23 core net profit was primarily attributable to higher income tax expenses.

• Increase in hospital bed capacity of IHH. IHH guided that the primary growth drivers for FY23F and beyond will be expansions of the group’s bed capacity in the key regions ie. Malaysia, India and Turkiye. For Malaysian operations, IHH will add 600 beds in FY23F-25F to Pantai Hospital Penang, Gleneagles Hospital Penang, and Pantai Hospital Klang, bringing the total bed capacity in Malaysia to 3,331 beds, representing a FY22-25F CAGR of 7% (vs 5-year CAGR of 5% in FY17-22).
  For Indian operations, IHH will expand additional 1,500 beds in FY23F-24F to 6,380 beds via its 31.1%-owned Fortis Healthcare, translating to a FY22-24F CAGR of 14% (vs a flat 4-year CAGR in FY18-22).
  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 3QFY22 and a new Acibadem Kartal with +200 beds expected to be operational by FY23F, Turkish operations’ bed capacity will increase by 11% to 5,320 in FY23F (vs a 5-year CAGR of 5% in FY17-22). With the recovery of overseas and domestic IA, we view the additional bed capacity as positive to support the group’s long-term revenue growth.

• Higher hospital charges/IA boosted by foreign patients. IHH anticipates that revenue contribution from foreign IA could surpass pre-Covid levels in FY23F given the continued strong influx of foreign patients. Notably, foreign IA share of revenue in 1QFY23 has recovered to pre-Covid levels for Singapore, Malaysia, India, and Turkiye. Based on our channel checks, we gather that foreign IA typically generates a higher hospital charges/IA of 20%-25% compared to domestic patients.

• Potential EBITDA margin upside in India. For the Indian operations, IHH has outlined their plans to enhance EBITDA margin from 15% in 1QFY23 to >20% within 12-18 months by disposing non-performing assets (e.g., unprofitable hospitals). The group guided that margin improvement can be seen from 2QFY23F onwards. For now, we maintain our FY23F-25F EBITDA margin assumption of 17% pending disclosure of further details.

• Flu cases are normalising, drug shortages eased in Malaysia. According to data from the World Health Organisation (WHO), the number of influenza (flu) cases in Malaysia peaked in mid-Jan 2023 (Exhibit 4). Notably, the flu cases have been volatile since late 2021. As for now, we believe that the declining flu cases could dampen the demand for flu-related medications (e.g., cough syrups, analgesics, and throat lozenges) from Apex in the near term. Hence, after the restocking activities by Apex’s customers in 2QFY23F, demand for flu-related medications is expected to moderate in 2HFY23F. 
  In contrast, demand for prescriptions (unrelated to flu) remains robust. Duopharma’s core earnings in FY22 and 1QFY23 were primarily driven by continued robust demand for ethical classic products (mainly non-flu-related prescriptions) as both public and private sectors restocked inventories in response to Malaysians returning to hospitals for elective treatments and check-ups (Exhibit 5). This reflects that Duopharma is less impacted by the normalisation of flu cases in Malaysia, but to continue benefiting from the patients returning to hospitals.

• Rising utilities and labour costs could be passed through an increase in selling prices. Increases in (a) electricity surcharge from 3.7 sen/kwh to 20 sen/kwh for the period of Jan-Jun 2023, and (b) entitlement threshold for overtime work from ≤RM2K/month to ≤RM4K/month effective Jan 2023 have increased the full year operating expenses for Apex by RM2.1-2.7mil (or 2.2%-2.9% of our FY23F net profit) and Duopharma by RM12mil-14mil (or 11%-13% of our FY23F profit). Consequently, we observed margin erosion in 1QFY23, with Duopharma’s GPM decreased by 4.4ppt QoQ and Apex’s manufacturing PBT margin dropped by 1.8ppt QoQ. We believe the larger impact on Duopharma was primarily due to its greater exposure to drug manufacturing activities (>90% of FY22 revenue), compared to Apex’s (<25%). In order to preserve margin from further erosion, Apex reaffirmed that the group would pass on the higher operating costs by increasing product prices, whereas Duopharma will mitigate the higher expenses with the moderating active pharmaceutical ingredients’ (APIs) prices as well as by raising product prices.
  Notably, pharmaceutical players under our coverage have exhibited pricing power to pass on higher costs to customers (margin protection) by increasing product selling prices given Malaysia does not implement any drug price control mechanism. This is underpinned by their resilient GPM trajectory from 1Q2021 to 2Q2022 (Exhibit 6), despite API prices registering a consistent 3%-8% sequential increase amid 9% weakening in MYR against US$ over the same period. We attributed the increasing trend of GPM beginning in 1Q2022 to drug shortages happened in Malaysia back then.

• Decline in API prices is a boon to pharmaceuticals. Both Duopharma and Apex guided the prices of APIs are stabilising and should be gradually moderating in the coming quarters to pre-pandemic level. The India-based IIFL Securities’ (IIFL) API/KSM pricing Index, which composed of 16 key imported pharmaceutical products from China has shown the consistent decline in APIs costs over the past 3 quarters i.e., 2%-8% QoQ since 3Q2022 mainly due to the easing of supply chain disruptions and transportation costs. This was after a 3%-8% sequential increase in 1Q2021 to 2Q2022. The continuing moderating of APIs costs will be crucial to provide margin tailwinds for Apex and support Duopharma GPM’s to offset the higher operating cost for pharmaceuticals in 2023F. Typically, APIs account for 40% of medicinal cost.

• The opening of approved products purchase list (APPL) tender to Duopharma provides room for price revisions. To recap, the current APPL was awarded in Dec 2017 and will expire by 30 June 2023. We understand from Duopharma that in Apr 2023, the tender for 60%-80% of drug items under APPL have been opened by Ministry of Health (MoH). This allows the group to submit its tender based on new prices which will cover the increase in operating expenses and the recent weakened MYR against US$. Approval for the purchase of the drug items in July 2023 by MoH is likely to be granted to the group by end of Jun 2023. The remaining balance (20%-40%) under the APPL may be extended to Dec 2023. We estimate that APPL accounted for 20%-35% of the group’s FY22 revenue.

• We maintain Overweight stance on the healthcare sector with Duopharma as our top pick. For hospital operators, we expect IHH to ride on its organic/inorganic growth strategies, higher hospital charge/IA prospects, potential improvement in India’s EBITDA margin and strategies to improve ROE, which could lead to a revaluation for IHH.
  For pharmaceuticals, we prefer Duopharma as we believe that the group’s revenue growth will be driven by: (a) the return of patients to hospitals for elective surgeries and check-ups, (b) increased government allocation to MoH in 2023F, amounting to RM36.3bil (+12% YoY vs 10-year CAGR of 7%) (Exhibit 7) which focuses mainly on the procurement of medicines, reagents, vaccines and consumables, and (c) additional hospitals scheduled to be operational over the next 3 years. Furthermore, the recent open tender for APPL allows Duopharma’s product prices to be raised to cover the increase in operating expenses and fluctuations in currency. For Apex, we believe the market interest will be muted in the near term amid normalising flu cases which will reduce the demand for flu-related medications and the reduction of Apex’s effective equity stake in Straits Apex (an orthopaedics business) from 40% to 16%. These 2 factors will dampen the group’s earnings.
  In terms of valuation, Duopharma (BUY, FV: RM1.95/share) has a highest upside potential of 44% vs IHH’s (BUY, FV: RM6.28/share) 8% and Apex’s (HOLD, FV: RM2.62 /share) 6%.

Source: AmInvest Research - 13 Jun 2023