Adoption of MFRS 16 will see KPJ’s gross gearing increasing to 2x. There will be a non-cash charge of c.RM17m in FY19 to account for interest expense and depreciation (c.8.1% of our forecasted FY19 earnings). MFRS 16 will expedite asset monetization, the 7 hospitals available for monetization is expected to fetch c.RM800m-RM1bn. Maintain our forecast and SOP based TP of RM1.27. We expect the effects of MFRS 16 to be offset by higher patient volume growth and revenue per patient. Maintain BUY.

We Met With Management Recently and the Following Are Some of the Key Take-aways:

MFRS 16: Adoption of new leasing standards (MFRS 16) will see KPJ’s gearing increasing to 2x (gross gearing stood at 0.97x, whilst net gearing stood at 0.73x as at 9M18) upon “grossing up” its assets and lease liabilities, consequently resulting in KPJ recognising 18 hospitals on its balance sheet. There will also be a non-cash charge of c.RM17m in FY19 to account for interest expense and depreciation on the lease liabilities, which represents c. 8.1% of our forecasted FY19 earnings. To recap, MFRS 16 applies a “right-of-use” approach which requires a lessee to recognise assets and liabilities for the rights and obligations created by lease contracts. Most importantly, impact to borrowing costs will be negligible as lenders will exclude lease liabilities from gearing calculation on existing debt covenants.

Jetta sale. The sale of 57% owned Jetta gardens which is to be concluded soon, will result in a small gain on disposal having written down the investment previously. The sale would have no impact to earnings as it has been classified as asset for sale since 4Q17. The disposal is expected to give Al-Aqar some flexibility to acquire hospitals in the near term. We expect MFRS 16 will expedite the monetization of hospital assets (Bandar Maharani, Manjung, Pahang, Pasir Gudang, Perlis, Rawang, Sabah). We understand that these 7 hospitals are expected to fetch c.RM800m-RM1bn upon disposal to Al-Aqar. The last hospital injected into Al-Aqar was KPJ Klang in 2012.

Update on the B40HF. Discussions with the government have still to commence at this juncture. Management are positive on the schemes prospects as it fits well into their expansion strategy. We remain reserved on the prospects of the RM8k/annum allocation will be sufficient to cover major treatments and are of the opinion that outpatient and ancillary service volumes would shift to the private healthcare sector from the MOH instead. With only c.25% of Malaysians has access to private healthcare, thus even a small scale migration of the remaining 75% to the private sector could result in margin enhancement.

Network expansion. In 2019 KPJ will have 3 greenfield openings, BDO, Kuching and Miri. KPJ BDO (150 bed capacity) will open shortly post CNY. This will be followed by KPJ Kuching (150 bed capacity), essentially a brownfield – migration to a bigger hospital (existing capacity 60 beds). KPJ Kuching caters to a lot of Indonesian medical tourists from Western Kalimantan. KPJ Miri (96 bed capacity) will be the first full spectrum private hospital in Miri and only the second to set up shop (Colombia Asia operates a multi specialist hospital in Miri). Management expects above average ramp up period for both Sarawak hospitals on the back of pent up demand and solid Indonesian and Bruneian patient traffic.

Forecast. Unchanged as we expect the effects of MFRS 16 to be offset by higher patient volume growth and revenue per patient.

Maintain BUY, TP: RM1.27. Maintain our SOP based TP of RM1.27. We like KPJ as it offers investors exposure to a pure Malaysian hospital play. Expect a seasonally stronger 4Q18 in tandem with KPJ’s historical trend.

Source: Hong Leong Investment Bank Research - 23 Jan 2019