- We downgrade KPJ Healthcare to HOLD (from BUY), with a lower fair value of RM6.00/share, based on a DCF valuation, following the weak 3Q earnings. KPJ’s 9MFY13 core net profit was below expectations. Dividend of 2sen/share was declared.

- We have revised our FY13F-FY15F earnings downwards to account for the near-term margin pressure from the largerthan-expected gestation losses of its new hospitals, and preoperating expenses (which were aggravated by the minimum wage policy and extension of minimum retirement age). This is our second earnings downgrade in this year; in total, we have trimmed our earnings forecast by c.52%. We expect material earnings to kick-in in FY2016.

- The group posted a weak 9MFY13 earnings growth (-31%), as the large gestation losses of its new hospitals were not compensated despite higher revenue (+7%) from ramp-up of beds capacity and in-patient volume. EBITDA margin shrank to 9.6% from 12.4% in 9MFY12. This suggests that near-term earnings growth remains a challenge and is likely to be flat, due to gestation losses from the opening of more new hospitals.

- The relatively flat 3Q revenue QoQ was due to lower inpatient volumes arising from a seasonally slower quarter (Ramadhan and Hungry Ghost month). We expect 4Q to pick up on the back of increased in-patient volumes and higher revenue.

- Despite the near-term margin pressure, we continue to remain positive on KPJ, supported by healthy expansion (+60% in beds or 10 new hospitals), and its position to leverage on growing private healthcare demand and ageing population.

- A rights issue exercise (up to RM123mil proceeds) and sukuk issuance (up to RM1.5bil) will be done to fund its aggressive expansion. We, however, do not rule out the possibility of an asset injection into Al’-Aqar Healthcare REIT (HOLD, RM1.45/unit) to potentially materialise in FY14, for the deployment of free cash flow.

- In addition to the opening of Muar Specialist (120 beds) in FY14, Sabah Medical Centre (250 bed) and Rawang Specialist (159 beds) have been delayed to 1QFY14, pending the required licenses from Ministry of Health.

- Appeal date for the Hospital Penawar lawsuit is fixed for 12 December 2013. Although no provisions were made, the group had set the required cash flow aside in event of a loss.

- The stock is currently trading at 36x PE for FY14F, above its 5-year historical peak of 33x.

Source: AmeSecurities