- We reaffirm our HOLD recommendation on KPJ Healthcare with a lower fair value of RM3.40/share (vs. RM3.85/share previously), based on a DCF-derived valuation, following adjustments to our WACC to reflect earnings risk of further margin compression due to its rapid expansion.

- KPJ’s 4Q13 core earnings came in above our expectations (at 108%) but were within consensus. The variance is largely due to our weaker-than-expected EBITDA margins assumption as a result of a larger-than-expected gestation losses given the earnings disappointment in the past few quarters.

- The group reported core earnings of RM34mil for its 4QFY13, which brought full-year core earnings to RM103mil. No dividends were declared during the quarter under review.

- FY13 EBITDA margins contracted to 9% vs. FY12’s 12%, despite a revenue growth of 10% YoY. This did not come as a surprise given the gestation losses arising from new hospital openings and pre-operating expenses.

- Margin pressure is likely to persist in FY14F-FY15F as expansion of new hospitals will continue. As such, we have assumed EBITDA margins of ~8.8% and expect a marginal recovery in margins to 9% in FY16F, in view of growing operational efficiency of its new hospitals. We introduce FY16F earnings at RM136mil.

- As at end-FY13, KPJ operated 2,750 beds. The opening of three new hospitals (+180 operational beds or +6.5%) that were delayed from last year are opening this year. These are:- (1) Sabah Medical Centre (220 beds), which opened in January. We expect a faster ramp-up of bed capacity underpinned by the relocation of the hospital and its existing customer base. (2) Rawang Specialist (159 beds) and Muar Specialist (120 beds), which are expected to open in the 1HFY14, pending approvals from MOH.

- In addition to that, a hospital in Bangladesh – which is under Hospital Management Agreement – is expected to open in the 1QFY14.

- Pahang Specialist (160 beds) and Perlis Specialist (90 beds) are earmarked to open in FY15F. In FY16, the groups expects to open another three hospitals, i.e. Bandar Dato Onn hospital (390 beds), Miri Specialist (120 beds) and Klang Bayuemas hospital (200 beds).

- While we like KPJ’s leverage on the growing private healthcare industry and its expansion plans, our HOLD call is premised on losses during the gestation periods, which will continue to drag near-term earnings.

Source: AmeSecurities