- We upgrade KPJ Healthcare to a BUY, with a higher fair value of RM8.00/share vs. RM6.47/share previously, based on our DCF valuation, as we roll our valuation base year to FY14F. Our fair value implies a 28x PE of FY14F earnings.

- Our recent visit provided reassurance of KPJ’s strong expansion strategy ahead. We have now turned more positive, particularly on the gestation period, which have strengthened our upbeat view on KPJ.

- Potential upside is seen to stream into FY14F-FY15F earnings arising from faster-than-expected turnaround of new hospitals and better EBITDA margins at 11.9%-12.3% (vs. 11% previously). As such, we have raised our FY14F-FY15F earnings by 7%-13%. Having said that, there is no change to our FY13F earnings forecast.

- In light of the group’s solid expansion track record, the transparent and visible long term profile is compelled to further strengthen via the step-up of bed capacities by 65% from a fleet of 11 hospitals over FY15F. Beyond this, greenfield hospitals are believed to have been identified, mainly in East Malaysia given the lack of presence. We understand KPJ is keener on developing greenfield hospitals rather than M&As of small-scale hospitals due to accreditation and medical tourism standard purposes.

- Given its existing customer base, Sabah Medical Centre (SMC) is unlikely to undergo gestation period (expected to open in June). To our surprise, KPJ is prepared for the possibility of being approached by Ministry of Health (MOH) to acquire the former’s new SMC due to its close proximity to MOH’s public hospital. A land has been identified in Kota Kinabalu for acquisition to build a 250 bed hospital, pending regulatory approvals.

- The old Tawakkal Specialist will be converted (refurbishment to be completed in FY14) to provide assisted living by trained caregivers – short term accommodation for long-staying patients due to limitation of care of the old-aged. This positive move:- (1) Allows a more efficient level of operation, thanks to additional bed capacity; and (2) Can potentially turn into a long-term revenue generator as Malaysia’s aged care industry lacks proper attention from qualified nurses and doctors.

- Total asset value of hospitals worth c.RM300mil are expected to be injected into Al’Aqar Healthcare REIT (HOLD, FV: RM1.45/unit) in FY14F – in tandem with its asset-light business model to fuel future expansion.

- Supported by the booming medical tourism, defensive nature and growing healthcare sector in Malaysia, KPJ stands to be a beneficiary given its strong domestic foothold of 19%.

- At an EV/EBITDA of 13x on FY14F, KPJ is trading at a 8% discount to regional peers’ average of 14x currently. It now trades at 22x FY14F fully diluted PE, which below its historical peak of 26x and at a discount to IHH Healthcare’s (HOLD, FV: RM3.25/share) 45x.

Source: AmeSecurities