2H18 outlook for the hospitals remain healthy, to be driven by the ramp up of new operations and organic growth. We are of the opinion that the reinstatement of the SST would at the very least result in prices not decreasing and as such positive to companies that had previously absorb the GST or parts of it. We qualify that the concession agreement remains intact for Pharmaniaga at this juncture, however the stocks concentration risk looms large given that the concession is to end by November 2019. Consequently on the above notion we are reviewing our TP to RM2.96 from RM3.97 as we reduce our PE from 15x to 11.2x (-1SD below 5 year historical average). We maintain our earnings forecasts and our NEUTRAL sector rating. We make no stock call changes.

Hospitals. The outlook remains healthy for private hospitals as we expect 2H18 to be driven by robust operating statistics as exhibited in the recent 1Q results. Revenue to namely be driven by higher inpatient and outpatient volumes on the back of the ramping up of operations in new hospitals as well as organic growth at matured hospitals (partially offset by losses from newly opened ones for both KPJ and IHH).

Healthcare pledge. The new PH government has promised to increase the financial allocation to the MOH to 4% of GDP from 2% currently (c.RM27bn) within its first term. Thus on the above notion, we are positive as we can expect the volumes of drugs demanded by the market to be higher as the government is the biggest procurer in Malaysia. The impact to the private hospitals remains to be seen as no affirmative measures have been spelt out at this juncture, but judging by the pledge to bring the “Peduli Sihat “scheme to the B40 en-masse we thus can expect more engagements between the public and private sectors moving forward.

0% GST. While some medicines were GST exempted, hospital services were standard rated (6% GST). For pharmaceuticals, only 25% of drugs on the National Essential Medicines List were zero rated. Under the now defunct GST regime, hospitals and pharmaceutical players have previously been absorbing the said tax and not raising prices. Thus it would be fair to assume that with the migration to SST, prices would too be maintained (i.e. not decrease). This would hence be positive for margins.

Pharmaniaga. We reiterate that Pharmaniaga’s drug distribution concession to public hospitals and clinics agreement remains intact for the remaining duration of its tenure (expiring Nov 2019). Looking beyond this, we feel there could be risks pertaining to its concession terms and/or structure given that the new government has promised to review all existing agreements and encourage more open tenders for public contracts. Nonetheless, we expect Pharmaniaga to experience a better 2018 on the back of lower input costs and slightly stronger RM vs USD YoY (2017 avg: 4.30 vs 2018 YTD avg: 3.94). The bulk of the active ingredients and raw mats for its manufacturing arm are denominated in USD and EUR.

Peduli Sihat. The government promised to implement a nationwide “Peduli Sihat” program targeting the B40 within its current term. We can expect demand for generics drugs to increase from clinics as outpatient traffic flows move towards participating clinics and hospitals away from government hospitals. This could be negative for Pharmaniaga as their penetration into the private sector is miniscule.

Maintain NEUTRAL. We maintain our NEUTRAL call on the sector as there are no overarching catalysts expected in the near term to warrant a significant re-rating at this juncture. Our Top pick for the sector is KPJ (BUY, TP: RM1.24).

Rating & Call Changes

IHH – Maintain HOLD Call. TP of RM6.33 Unchanged

Whilst we like IHH for its exposure to key gateway markets and astute management; earnings delivery in FY18 will be hampered by higher operational costs before a ramp up in operations in FY19. Our TP implies FY19-20 EV/EBITDA of 16.6x-14.4x.

KPJ – Maintain BUY Call. TP of RM1.24 Unchanged

We like KPJ as it offers investors exposure to a pure Malaysian hospital play. Its niche lies in its regional hospital network that feeds patient into its urban specialist centres. Our SOP based TP implies FY19-20 EV/EBITDA of 11.6x-10.6x.

Pharmaniaga – Maintain HOLD. TP Reduced to RM2.96

Whilst we maintain that in our view the concession agreement remains intact and that Pharmaniaga is the only domestic player with the track record and distribution network within the nation to be able to supply drugs to all government hospitals within the time frame and conditions as stipulated in the concession agreement, we do acknowledge that there is considerable risk to the concession terms and or its structure given that the new government has promised to review all existing agreements. As such we are downgrading our P/E multiple from 15x (inline with the peers average) to 11.2x (-1SD below 5 year historical mean). This reduces our TP from RM3.97 to RM2.96.

Source: Hong Leong Investment Bank Research - 3 Jul 2018