Although Covid-19 related revenue is expected to continue to be on a decline in 2H22, we believe the earnings shortfall will be offset by a recovery in patient volume, supported by strong pent-up demand from both local and foreign patients. As such, patient volume should continue its recovery trajectory, since patient footfall reported in 1Q22 is still 16-19% below pre-Covid levels. Strong pricing power is also key for hospital operators to better weather through this high inflationary period and we are not expecting the hike in costs to significantly impact profitability. All in, we continue to like the sector for its defensiveness and strong pricing power and our preferred pick for the sector is IHH Healthcare (BUY, TP: RM7.75). Maintain OVERWEIGHT.

Back to normalcy. As we transition into endemicity, Covid-19 related revenue (i.e. Covid-19 lab tests, border screening, Covid-19 patients treatment, etc.) will no doubt continue to be on a decline in 2H22. The shortfall in earnings is expected to be offset by a recovery in patient volumes, supported by strong pent-up demand from both local and foreign patients. In general, hospital operators experience an uptick in patient volume after the easing of every movement control (i.e. 3Q20, 2Q21 and 4Q21) and thus far, patient volumes have been on an overall uptrend (with the exception of 1Q22, due to a spike in Covid-19 cases from the Omicron variant). Looking at the quarterly patient volumes, we highlight that KPJ and IHH’s Malaysia inpatient volume is still 16- 19% lower than pre-pandemic level (1Q22 vs 4Q19), hence we reckon that there will be more room for patient footfall recovery in 2H22.

Medical tourism a boost. Healthcare traveller revenue has been charting steady growth every year since CY11, but suffered a 53% YoY decline to below RM800m in CY20 due to the pandemic (see Figure #4). The reopening of international borders, has however put Malaysia in a better position to revive the health tourism sector. According to the Healthcare Travel Industry Blueprint 2021-2025, Malaysia aims to generate RM1.7bn worth of healthcare tourism revenue by CY25, which also implies that Malaysia’s healthcare tourism sector will only rebound back to pre-Covid levels in CY25. Taking cue from the stronger-than-expected recovery in tourist numbers, whereby the tourist arrival numbers of 2.37m (from 1 Apr to 17 June) has far exceeded the earlier target of 2m tourists for CY22, we think the medical tourism sector could potentially return to pre-Covid levels ahead of Malaysia Healthcare Travel Council’s (MHTC) initial targeted timeline of CY25, ultimately leading to better patient recovery for both IHH and KPJ.

Inflation not too big of a concern. While there has been increasing concerns on cost inflation eroding profits, we think that hospital operators are likely to emerge from this unscathed, owing to the inelastic demand for healthcare which gives hospital operators substantial pricing power. We note IHH has revised its pricing to accommodate the hike in costs, while KPJ will remain cognisant of the situation and will pass on the incremental costs should its margins come under pressure. The ability to pass on cost increases is unlikely to significantly impact hospital operators’ profitability, in our view.

Pharmaniaga. Pharmaniaga has yet to see any impact on active pharmaceuticals ingredients’ (APIs) supplies and costs so far as the Group typically keeps 3-6 months’ worth of supplies. Currency movements are also not expected to have a huge impact on APIs cost due to the hedging positions that could help mitigate the impact. That said, we do caution that, should there be any increase in costs, it would be difficult for Pharmaniaga to pass it on to the government and the Group could only cushion the impact by improving its overall efficiency. On a separate note, with the economies now reopened, we do foresee an improved demand for pharmaceuticals, as (i) patients return to health facilities for treatment, as well as (ii) increased risk of common infections as people return to workplace and school.

Maintain OVERWEIGHT. We continue to like the sector for its defensiveness and strong pricing power (especially the hospital operators). Substantial pricing power is key in helping healthcare players better weather through this high inflationary period, in our view. Our referred pick for the sector is IHH Healthcare (BUY, TP: RM7.75), as we believe that the recovery in patient volume can help to mitigate the earnings shortfall arising from lower Covid-19 related revenue. We also like it for its strong market position in the geographies that it operates in.

Source: Hong Leong Investment Bank Research - 14 Jul 2022