The sector still lacks concrete near-term positive re-rating catalysts. We unearth some potential winners and losers arising from Pakatan Harapan’s manifestos related to the healthcare space. Probable beneficiaries are DKSH, CCM Duopharma Biotech and Apex Healthcare while KPJ and IHH are seen to have mixed outlooks. A likely victim would be Pharmaniaga. The risk-reward profile of the sector sees positive secular trends offset by current uncompelling valuations. Maintain MARKET WEIGHT.

WHAT’S NEW

Good or bad prescriptions? Pakatan Harapan (PH) is walking the talk and held true to its pre-election manifesto commitments (although some are shelved temporarily due to financial constraints). In this report, we examine how a number of their promises that could affect the private medical sector like: a) transitioning back to the sales and services tax (SST) regime, b) potential increase in public healthcare spending, c) possible break-up of the drug supply cartel, and d) probable scrappage of Pharmaniaga’s Approved Product Purchase List (APPL) concession agreement with the Ministry of Health.

ACTION

Maintain MARKET WEIGHT on the sector as it is lacking any concrete form of near term positive re-rating catalysts. Also, we find the risk-reward profile of the sector is balanced by positive secular trends like: a) an ageing population, b) ‘lifestyle’ diseases, and c) rising affluence, but offset by uncompelling valuations. Below are the potential winners and losers arising from PH’s slew of manifestos related to the healthcare space:

a) The switchback to SST has a net positive impact to private healthcare providers as they no longer need to absorb the 6% input tax on drugs. Winners are KPJ and IHH as their profit margins could expand from lower medical costs and consumable expenses, holding other factors ceteris paribus.

b) If the drug supply cartel breaks up and the Pharmaniaga’s (a loser) concession agreement is scrapped, we believe hospital operators like KPJ and IHH are likely beneficiaries as medical costs may fall given a leaner supply chain structure. We identified DKSH as another potential winner from these initiatives seeing that it is already one of the preferred distributors for multinational pharmaceutical companies (MNC). We think they can easily fit into the role of being an agent at a lesser fee given their strong competency and vast experience in offering a full suite of market expansion services.

c) The potential higher budget allocation to the Ministry of Health may see a larger number of public hospitals being built in order to provide more affordable healthcare services to Malaysian citizens. However, there are negative repercussions to both KPJ and IHH due to the possible rise in competition. We reckon patients may opt for the cheaper alternative if constraints like accessibility and long waiting time when visiting a public hospital can be improved. Nevertheless, probable winners are CCM Duopharma Biotech and Apex Healthcare as more public hospital openings will then require more medical supplies (e.g. generic drugs).

ESSENTIALS

Transition back to SST has net positive impact. The new ruling government, PH, has kept its manifesto promise to switch back the SST system from the good and services tax (GST) regime. To recap, the GST partially led to a rise in medical cost as the 6% input tax on drugs under the non-National Essential Medicine List is absorbed by private healthcare providers. According to Willis Towers Watson, Malaysia's 2016-17 real healthcare inflation shot up by 8-9%. That said, medicines were not subjected to tax under the previous SST system. Hence, we believe the transition back to SST has a net positive impact to private healthcare providers.

Increase in public healthcare spending? PH's manifestos also include introducing Skim Peduli Sihat, which offers basic treatment (primary care at RM500 per year) for B40 households to visit private clinics. However, this was shelved temporarily due to financial constraints. Besides, the PH government has pledged to increase the budget allocation for the Health Ministry to 4% of GDP instead of the current spending level of 2%. If the first proposal comes to fruition, it should benefit private healthcare operators but the second initiative is a potential negative (depending on whether resources are directed to new public hospital openings or expansion, spurring competition in the process).

Breaking up drug supply cartel? The PH government is looking into the allegation of a drug supply cartel. Based on various news reports, there were 20 companies who acted as tendering agents that obtained RM3.7b worth of medical supply contracts in 2013-16; they are said to be politically-linked to the previous Barisan Nasional administration. This practice is customary for public sector procurement especially when a MNC bids for a tender called out by the Ministry of Health; the agents charge a fee between 2-3% for their services. That said, MNCs appoint their own distributors to handle logistics services (most of the time).

Making do without dominant middleman? In attempt by PH to disband industry monopolies, a potential company that may be put under the microscope would be Pharmaniaga. We note it is the largest Bumiputera agent with an exclusive concession to supply circa 700 medical items, under the APPL program, to government hospitals and clinics; all APPL items must traverse through Pharmaniaga. The Malaysia Competition Commission claims the company controls 75% of public drug procurement. We gathered the concession is due to expire in Nov 19 (it is 10-year agreement with the Health Ministry which began in late 2009).

Source: UOB Kay Hian Research - 3 Jul 2018