Although KPJ is embarking on a digitalisation drive, it is mindful to balance between the costs and benefits. A slew of initiatives has been taken over the past two years to ensure market readiness. However, market acceptance is still at its embryonic stage. Separately, KPJ is slated to release its 2Q18 results on either 15 or 16 August. We expect a soft quarter with core profit ranging from RM33m-38m (down by 10-23% qoq/up 1-18% yoy). Maintain HOLD with target price of RM1.07. Entry level: RM0.90.

WHAT’S NEW

Management update. We met up with management recently and this note highlights the key takeaways, which focused more on KPJ’s digitalisation transformation initiatives.

STOCK IMPACT

Modernising healthcare services. According to International Data Corporation (IDC), the Malaysian healthcare industry is considered a laggard in the digital space. Hence, there is a lot of catching up to do in terms of adoption. To stay ahead of the curve, KPJ is embarking on a digitalisation drive. The idea is to approach this on a gradual but cautious basis in order to juggle between market acceptance and readiness. Management is mindful not to spend too quickly (as this may drag short-term ROI in the process), so that they can be better align and monetise efforts accordingly.

What has been done so far? We gathered adoption will occur in stages, starting from clinical systems to mobile applications, and then only robotics. Among the digital initiatives taken by KPJ over the past two years include the implementation and roll-out of: a) patient appointment system, b) retail online shop, c) mobile application, d) IBM Watson for Oncology, e) 3D printing, f) Value Innovation Platform, and g) digital marketing.

a) Patient appointment system: Allows patients to book their own doctor appointments through website and mobile app.

b) Retail online shop: The brand of its E-shop is called KPJ Healthshoppe. So far, they are only selling supplements, OTC drugs, and personal care products online. Prescription drugs should be put on sale by end-18.

c) Mobile application: The name of the app is KPJ Connect. This is an aggregate of all its digital initiatives (so far) put into a small screen device. The app is regularly optimised to incorporate new service offerings.

d) IBM Watson for Oncology: It is a cognitive computing platform for the treatment of cancer patients (to help generate treatment proposals). So far 150 cases have been logged since inception in late Nov-17.

e) 3D printing: Gives patients precise modeling into their personalised treatment. So far in KPJ, only dental surgeons are using it. Actual 3D printing of the parts is done by Materialise NV but dimensions are provided by KPJ.

f) Value Innovation Platform: This is a government initiative to help corporations develop a structured plan to adopt digital strategies, in collaboration with Rainmaking Innovation UK.

g) Digital marketing: Enhancing its digital assets and accelerating the use of social media.

2Q18 results preview. KPJ is slated to release its 2Q18 results on either 15 or 16 August. We expect a softer performance with core profit coming in between RM33m-38m (down 10- 23% qoq/up 1-18% yoy) given the typical seasonal effect from Hari Raya festivity. Management shared that 1H18’s total patient visits improved 1% yoy. However, our back-ofthe-envelope calculation shows that 2Q18 volumes may have declined 2% yoy and 6% qoq. Still, KPJ is expecting 2018 to be a better year whereby it is keeping its bottom-line guidance of RM186m (+6% yoy), fuelled mainly by cost efficiencies.

Other updates. The hospital opening timelines at Bandar Dato’ Onn, Miri and Kuching are all intact for 3Q18, 2Q19 and 2Q19 respectively. Separately, Jeta Gardens (57%-owned aged-care business in Australia, which was acquired in 2010 for RM19m), is still up for sale. The disposal could free up KPJ’s capital to pare down debts or for reinvestment purposes. In 1Q18, group net gearing stood at 0.7x (1Q17: 0.8x). Management aims to complete the exercise by the end of this year.

EARNINGS REVISION/RISK

No change to our forecasts. Key downside risks include: a) market share losses, b) delay in hospital openings, and c) inability to pass on higher operating costs to customers.

VALUATION/RECOMMENDATION

Maintain HOLD and target price of RM1.07, based on 28x 2019F PE. This is in line with its five-year forward mean PE of 28x but below the sector's 36x. We believe the discount is fair as KPJ has a stretched balance sheet (net gearing of 0.7x vs sector’s 0.4x) and generates an anaemic ROE of 10% vs the sector's 15%. Similarly, our PE-ROE regression analysis suggests pegging the stock at 26-28x forward PE. Despite the HOLD call, we acknowledge KPJ still appeals to long-only investors, given it is blessed with positive structural trends such as: a) an ageing population, b) ‘lifestyle’ diseases, and c) rising affluence that will continue to support and drive organic growth. Entry level is RM0.90.

Source: UOB Kay Hian Research - 2 Aug 2018