Investment Highlights

• We maintain Neutral on the healthcare sector with Duopharma Biotech (BUY, FV: RM1.52/share) as our top pick. We expect Duopharma to stage a robust 2024F EPS growth of 18%, underpinned by:
  
  (a) a recovery in discretionary consumer healthcare products (CHC) after a contraction of >5% YoY in 9MCY23. CHC accounted for a substantive 26% of Duopharma’s 9MCY23 revenue, and
  
  (b) stronger demand from government agencies, supported by a renewed approved product purchase list (APPL) and higher 2024F government budget allocation of RM41.2bil to the Ministry of Health (MoH) (+13% YoY vs. 5-year (2018-2023) CAGR of 6%).
  
  For Apex Healthcare (HOLD, FV: RM2.64/share), we expect a flattish 2024F net profit as demand for flu-related medication softens and lower earnings contribution from the group’s effective stake in Straits Apex, which decreased from 40% to 16% due to partial disposal of the orthopaedic business. On a positive note, we anticipate a 2024F recovery in discretionary CHC sales.
  
  For IHH Healthcare (HOLD, FV:RM6.34/share), we expect investor interest to be muted in the near term due to the group’s lackluster 2024F EPS growth of 8.5%. To drive revenue and ROE in the future, IHH announced the ACE Framework, which is supported by these 5 pillars:
  
  a) Organic growth: Expanding bed capacity from 12K existing operational beds to 16K (+33%), primarily in operations in India and Malaysia over the next 5 years (2024F-28F),
  
  b) Expansion across healthcare continuum: Growing ambulatory care offerings and primary care penetration in selective markets in Singapore and Hong Kong,
  
  c) Development of new growth engines: Growing laboratory business to become a distinct core business,
  
  d) Inorganic opportunities: Acquisition of value-accretive assets which are aligned to cluster strategy, and
  
  e) Turning around underperforming assets.

• Stronger IHH bed capacity expansion ahead. For 2024F-28F, IHH said that organic growth will be the primary growth driver. The expansion of the group’s bed capacity will focus on Malaysia and India. For Malaysia, IHH will add 1,275 beds, bringing total bed capacity to 4,123 beds, representing a 2023-28F CAGR of 8% (vs. 5-year CAGR of 5% in 2017-22). For India, IHH will add 1,827 beds to 6,856 beds, translating to a 2023-28F CAGR of 6% (vs. a flattish 4-year CAGR in 2018-22).

• Potential EBITDA margin upside in India from restructuring of non-performing assets. For Indian operations, IHH plans to improve EBITDA margin by disposing non-performing assets/unprofitable hospitals. In November 2023, IHH disposed Fortis Malar Hospital while the Vadapalani facility sale was completed in Jul 2023.

• Expect CHC market to improve in 2024F after declines in 3QCY23. Both Duopharma and Apex highlighted declining discretionary CHC sales in 3QCY23. Duopharma said that CHC experienced a double whammy in 9MCY23 from a decrease in price and sales volume. We believe this was due mainly to destocking activities by consumers after robust purchases in 2020- 2021, as well as softening consumer sentiments. Management expects the CHC segment to improve in 2024F as destocking activities end. CHC accounted for 20%-26% of the 9M2023 revenues of Duopharma and Apex.

• The award of APPL to Duopharma provides room for price revisions and volume growth. To recap, the current APPL was awarded in Dec 2017 and will expire by 31 Dec 2023. We understand from Duopharma that the tender started in Apr 2023. In its result briefing, the group affirmed that the new APPL would be awarded by 1QCY24. The number of drugs in the contract may be higher than the previous list awarded back in 2017. This would translate to about 80 drugs vs. 50 previously.
  
  In terms of overall pricing, we believe that it should be similar or slightly higher than the previous list. The US$/MYR exchange rate is expected to be US$1.00:RM4.60 vs. US$1.00: RM4.20 previously while the tenure of the renewed contract is expected to be 2-3 years. APPL accounted for 23%-25% of Duopharma’s 9MCY23 revenue.

• Overblown fears on credit risk from Pharmaniaga. Duopharma’s share price has been declining since late Feb 2023, coinciding with Pharmaniaga’s announcement of its PN17 status. We believe that the market was pricing in the credit risk of Pharmaniaga, which accounted for 23%-25% of Duopharma’s 9MCY23 sales. Based on checks with Duopharma, we understand that Pharmaniaga has fulfilled all payment obligations while Duopharma has increased the frequency of collection for receivables.

• Flu cases are normalising in Malaysia. According to World Health Organisation (WHO), the number of flu cases in Malaysia peaked in late Aug 2023. For now, we believe that declining flu cases would dampen demand for Apex’s flurelated medications (e.g., cough syrups, analgesics and throat lozenges) in the near term. Cough syrup accounted for a quarter of Apex’s manufacturing revenue, which commands a higher PBT margin of 28% in 9MCY23 compared to the distribution segment’s 4%.

• Boon to pharmaceuticals from decline in API prices. Duopharma and Apex said that prices of active pharmaceutical ingredients (APIs) in 3QCY23 are stabilising and will be moderating in the coming quarters. The India-based IIFL Securities’ (IIFL) API/KSM pricing Index, which compose of 16 key imported pharmaceutical products from China, has been consistently declining over the past 4 quarters mainly due to the easing of supply chain disruptions and transportation costs. The continuing moderation in APIs costs in 2024F will be crucial in supporting gross margins for Apex and Duopharma. Typically, APIs account for 40% of medicinal cost.

• Key downside risks:
  
  For hospital operators, the risks are:
  
  (a) worsening nursing shortages in IHH’s Singaporean operation,
  
  (b) accelerating inflation rates in Turkiye as IHH may be unable to offset higher costs with increased pricing,
  
  (c) delay in expansion plans in 2024F and beyond, and
  
  (d) re-imposition of lockdowns amid another round of pandemic/contagious disease.
  
  The risks for pharmaceuticals are:
  
  (a) implementation of drug price control mechanism by the government;
  
  (b) spike in API prices, freight costs or weakening of MYR against US$ which may not be fully offset by higher selling prices;
  
  (c) default by Pharmaniaga; and
  
  (d) continued deterioration of demand for CHC or delay of APPL awards.

• IHH is our top ESG pick in healthcare sector. From an environmental perspective, IHH sets its target to cap carbon emissions at the 2022 baseline while growing the business and achieving net zero by 2050. Additionally, IHH has committed to reduce single-use virgin plastics by 90% in non-clinical areas in Malaysia and Singapore in 2023. From a governance perspective, IHH has implemented the value-driven outcome (VDO) programme to increase the value of each clinical outcome to tackle inflation and improve shareholder value. From a social perspective, IHH is reviewing all human resource policies and processes to minimise bias, roll out total well-being framework to support employees and prevent burnout while aligning to internationally-recognised occupational health and safety management system standards.

• Sector valuation is mostly fair. Duopharma currently trades at a compelling 2024F PE of 13x, an unjustified discount of 24% to its 5-year average of 17x, while IHH trades at a fair 2024F P/BV of 1.7x – 13% discount to its 5-year average of 2.0x amid slowing global economic growth prospects. Separately, Apex is currently trading at fair 2024F PE of 18x, 10% discount from its 5-year average of 20x.

• Key considerations for upgrading the sector to Overweight:
  
  For hospital operators, we may upgrade on:
  
  (a) better-than-expected improvements in revenue intensity or inpatient admissions; and
  
  (b) higher-than-expected EBITDA margin.
  
  We may upgrade pharmaceuticals on:
  
  (a) material easing in API prices, freight costs or favourable MYR against US$;
  
  (b) stronger-than expected recovery in CHC market; and
  
  (c) a spike in flu cases in Malaysia.

Source: AmInvest Research - 18 Dec 2023