- We reaffirm our HOLD recommendation on KPJ Healthcare with an unchanged fair value of RM3.40/share, based on our DCF valuation.

- KPJ reported a net profit of RM30mil in 1QFY14. The results are largely within expectations, accounting for 27% of both our and consensus full-year estimates.

- A single-tier dividend of 1.45 sen/share was declared.

- Its 1Q earnings were up by 20% YoY mainly due to pricing revision, which was implemented in end-3QFY13. EBITDA margins contracted to 4.2% from 4QFY13’s 7.8% and 1QFY13’s 9.5%, due to gestation losses from new hospitals.

- Thus far, two new hospitals have opened, i.e. Sabah Medical Centre (SMC) in January, and Rawang Specialist in May.

- SMC’s current bed occupancy stands at 70% given its existing customer base. KPJ is looking to ramp up SMC’s bed capacity soon. Pending approvals from the Ministry of Health, Maharani Specialist is earmarked to start operations in June.

- KPJ hopes that Rawang Specialist and Maharani Specialist could break even faster, i.e. within 3 years, underpinned by their positions as the only private hospitals within their respective untapped areas.

- While we do not preclude the possibility of faster turnarounds of these two hospitals, we do not expect margins to increase given its continued expansion; there are four unprofitable hospitals at the moment with another six new hospitals in the pipeline by FY17.

- On a side note, the hearing date with the Federal Court for the appeal in its litigation with Hospital Penawar is set on 19 August.

- While we are positive on the outlook for the healthcare industry, our concern remains on its margins pressure as a result of its aggressive expansion plan. Bearing this in mind, it would take three to five years for its new hospitals to break even due to gestation losses.

- We believe that the key to outperformance lies in KPJ’s ability to turn around faster than expected, in order to significantly improve margins.

- The stock is currently trading at an FY14F PE of 33x, above its 5-year mean of 20x.

Source: AmeSecurities