- We reaffirm our BUY recommendation on KPJ Healthcare with a lower fair value of RM7.90/share (vs. RM8.00/share), based on our DCF-derived valuation, following an earnings revision.

- KPJ reported 2QFY13 core earnings of RM25mil, bringing 1HFY13 core earnings to RM50mil. The results came below expectation, constituting 35% of ours and consensus estimates, as a result of longer-than-expected gestation losses contributed by the newly opened hospitals. Dividend of 2.0sen was declared.

- We have therefore tweaked downwards our FY13F-FY15F earnings by ~40% to incorporate a reduced EBITDA margin assumption to 10%-11% (vs. 12% previously). This is to reflect:- (1) longer-than-expected gestation losses; and (2) delayed in the opening of Sabah Medical Centre (SMC) in June, pending approval of license from the Ministry of Health. SMC is expected to open by the end of the year.

- Despite 1HFY13’s EBITDA margin compression to 10% (vs. 1HFY13’s 12%), revenue grew in tandem with the increased operational efficiency of existing and new hospitals.

- Pasir Gudang Specialist (120 beds) started operations in April, with initial bed capacity of 60. As operational efficiency improves, another 60 beds are expected to be added in FY15F. Acquisitions of Sri Manjung Hospital (30 beds) and Rawang Specialist Hospital (159 beds) were completed on 23 May and 18 July, respectively.

- In line with KPJ’s expansion plans, another two hospitals (SMC and Maharani Specialist) will be added by FY13 – bringing a total of five new hospitals in FY13.

- A notice of appeal has been filed against the judgement of the recent litigation case with Hospital Penawar. The actual appeal hearing is yet to be fixed. The judgement sum comprises of RM70mil in damages and a cost of RM150,000 (represent >50% of our FY13F earnings projections). Having said that, this oneoff item should not impact the group’s operations and expansion plans.

- Separately, the proposed bonus and rights issue exercise is envisaged to complete in 4QFY13F.

- KPJ’s share price corrected by ~7% over the past two weeks, in line with weaker sentiments pervading the broader market. We view the current weakness as a buying opportunity ahead of its healthy expansion (+65% bed capacities over next three years).

- KPJ remains our top BUY as we like its long-term earnings resilience and more importantly, aggressive hospital expansion plans to drive earnings growth. KPJ is trading at a forward PE of 32x, at a 44% discount to IHH Healthcare (HOLD, FV: RM3.80/share).

Source: AmeSecurities