Highlights

• A pure domestic Malaysian hospital play. With 25 private hospitals in Malaysia, KPJ is the leading domestic player with c.23% of the market share. With the exception of Melaka and Terengganu, its presence is felt nationwide.
• The group’s niche . KPJ has expanded into less densely populated tier-2 cities (Manjung, Muar, etc). This regional feeder network operates in a less competitive environment and serves as a pipeline to refer more complex cases to its specialist hospitals. This network affords KPJ almost uncontested brand loyalty in the second tier towns.
• Health insurance under penetration. Relative to our peers within the region, the level of insurance penetration is low. Singapore and Hong Kong have both achieved an insurance penetration rate of above 10% of GDP, whereas Malaysia as at 2016 stood at c.4.5% of GDP in 2016. We expect this gap to narrow as Malaysia marches towards developed status.
• Long term growth to be fuelled by expansion. Newly installed capacity from green field and brown field network expansions are expected to boost total capacity from c.3,000 beds currently to over 5,000 beds by 2020, representing an 87.0% growth in total capacity.
• Change in focus. To combat sluggish growth and earnings drag from greenfield hospitals, the group has steadily shifted its capacity expansion strategy towards brownfield hospitals which are less capital intensive and have a faster ramp up period. This strategy, in our view, is expected to be earnings accretive in the near term whilst allowing the group to manage its gearing levels.

Risks

• Risks to the stock includes lower than expected ramp up in patient revenue due to a laggard price revision, higher than expected drug costs due to the weak ringgit and longer than expected gestation period for its greenfield hospitals coupled with strong pricing competition from smaller niche hospitals.

Forecasts

• We project a modest FY17-20 earnings growth of 9%, 11% and 10%, driven by newly opened hospitals and higher revenue intensity. All-in-all, this implies 3-year earnings CAGR of 11%.

Rating

Initiate with HOLD, RM 1.18 (+9.3% upside)

• KPJ offers investors an exposure to a pure Malaysian hospital play. Its niche lies in its regional hospital network that feeds patient into its urban specialist centres. While its gearing is high relative to its peers, it is manageable and should taper off once assets are injected into the REIT or disposed. However, we initiate with a HOLD as we believe that at this juncture the stock is fully priced.

Valuation

• We initiate with SOP-derived TP of RM1.18 . Our TP implies an FY18F EV/EBITDA multiple of 14.3x, a 21% discount to the peers’ average of 18.1x, which is justified due to its relative illiquidity, lower ROE (peers ROE average 12.4% vs. 9.4%) and higher net gearing (peers net gearing average 0.5x vs. 0.75x).

Source: Hong Leong Investment Bank Research - 26 Sep 2017