-  We reaffirm our BUY recommendation on KPJ Healthcare with an unchanged fair value of  RM7.90/share, based on a DCF valuation.

-  KPJ’s wholly-owned unit, Kumpulan Perubatan Johor Sdn Bhd (KPJSB) (which is an investment holding company) is exercising its option to purchase Menara 238 for RM206mil.  Menara 238 is a 36 multi-storey office building located along Jalan Tun Razak. The proposed acquisition is expected to complete in 3QFY14F.

-  Presently, KPJ and its subsidiaries occupy 30% of the total lettable area with its corporate office occupying 15% of the total lettable area.

-  The acquisition will be funded by a combination of 80% debt (RM164.8mil) and 20% internally generated funds (RM41mil). Gearing is expected to increase to 0.7x from 0.5x currently. As at 2QFY13, KPJ’s cash pile stands at RM291mil.

-  Moving forward, all the non-revenue generating services that occupy KPJ hospitals will be moved to Menara 238. This is a positive as it frees up more space within KPJ network of hospitals that could be converted and utilised to generate more revenue (i.e. increase bed capacity).

-  Menara 238 is earmarked to be the headquarters. A wellness centre will also be established that will comprise aesthetic, alternative medicine, physiotherapy, rehabilitation, day care, laboratory and radiology services. Furthermore, the group is keen to utilise part of Menara 238 as the one-stop centre for its IT function.

-  KPJ views that it has the capacity to manage and turn Menara 238 into a revenue centre on its own by attracting the right tenants to maximise rental income (rental rate: RM3psf-RM5psf).

-  In line with its asset light business model, Menara 238 could potentially be injected into Al’-Aqar Healthcare REIT (HOLD, FV: RM1.45/unit) in the long run for better deployment of free cash flow to fuel its expansion.

-  Valuation wise, the stock is trading at a forward PE of 30x for FY114F, at a discount of 60% to IHH Healthcare (HOLD, FV: RM3.80/share). 

Source: AmeSecurities