Healthcare is expected to remain as a key focus for the country regardless of the political landscape, as evident by the larger allocation made in the previous Budget 2023, and also as outlined in the election manifestos of PH and BN to gradually raise health spending to 5% of GDP. The hospital operators under our coverage have seen a healthy recovery of patient volumes back to pre-pandemic levels, and we foresee the momentum to continue, underpinned by a shift in patient behaviour and growing bed counts. We maintain our OVERWEIGHT stance on the sector as we continue to like it for its defensive qualities and fairly inelastic demand. Top pick for the sector is IHH.

A larger pie. In the Budget 2023 unveiled by the previous administration, the Ministry of Health (MoH) was allocated a budget of RM36.1bn (+11% YoY). However, given the change of guards recently, a new budget is expected to be tabled earliest in Jan-23. We believe that healthcare will still remain as a key focus in the upcoming new budget, considering that both manifestos by PH and BN has pledged to gradually raise the public healthcare expenditure to 5% of GDP in the next 5 years. A growing budget for the MoH would be beneficial for all the healthcare counters under our coverage, especially Pharmaniaga (BUY, TP: RM0.63) (the existing sole concession holder to distribute drugs and consumables) and UEM Edgenta (BUY, TP: RM1.32) (via purchase and maintenance of biomedical equipment). Private hospital operators like IHH (BUY, TP: RM7.75) and KPJ (BUY, TP: RM1.27) could also benefit from the burgeoning budget indirectly, as higher allocation would mean more budget for MoH to decant patients to the private establishments. Separately, we note that some of the new public hospitals are expected to gradually come on stream from CY23f onwards. This poses as an opportunity to UMediC (HOLD, TP: RM0.78) to supply more medical equipment for these upcoming healthcare facilities.

Patient volume growth likely to sustain. Patient volumes for both IHH and KPJ have been rebounding steadily post lockdowns and reopening of borders. As at 3Q22, patient volumes recorded for both KPJ and IHH’s Malaysia operations have recovered back to pre-pandemic levels. We expect patient volumes to continue growing, as we note a shift in behaviour whereby patients are more receptive towards receiving treatment in hospitals for less acute cases. The growth in footfall will also be underpinned by (i) IHH’s additional bed opening in the pipeline, and (ii) additional capacity added by KPJ prior to pandemic that is ripe for ramping up currently. Potential decanting cases from the public healthcare system would also supplement this growth.

Medical tourism. The medical tourism industry in Malaysia has experienced a strong rebound post reopening of borders, so much so that the Malaysia Healthcare Travel Council (MHTC) has revised its CY22f healthcare travel revenue target upwards to RM1.0bn, versus its earlier target of RM800m. MHTC also expects its healthcare travel revenue to recover back to its pre-Covid high of RM1.7bn (in CY19) by CY24f, one year ahead of its previous target of CY25f. Recovery of medical travellers’ volume will lead to both stronger patient footfall and improved revenue intensity for hospital operators, as hospitals are allowed to charge foreign patients a 20% premium. We expect revenue contribution from foreign patients to continue growing going forward, as both the hospital operators are focused on deepening clinical capabilities, as well as targeting patients in foreign second-tier cities, to broaden their foreign patient base.

Pharmaniaga. As the existing concession agreement is set to expire by end-CY22f, we expect the renewal to be granted by MoH by the end of the year to ensure no disruption in terms of supplies to the medical facilities. Separately, API (active pharmaceutical ingredients) costs for Pharmaniaga might increase in CY23f, as some of its API procurement contracts will end by CY22f and prices will likely be revised upwards. Should the USD revert to c.RM4.70 level, costs are expected to increase by c.8% in CY23f. However, we think that the cost inflation situation might be more manageable now, considering that the ringgit has strengthened relative to USD to c.RM4.40 level. Additionally, a government tender for products under the Approved Product Purchase List (APPL) is also expected to take place by end-CY22, hence we think that part of the cost will be passed on to the government.

Reiterate OVERWEIGHT. We maintain our OVERWEIGHT stance on the healthcare sector, as we like it for its defensive qualities and the fairly inelastic demand. Our preferred pick for the sector is IHH (BUY, TP: RM7.75), premised on its (i) strong presence in the market it operates, and (ii) refreshed strategies that will support its sustainable growth.

Source: Hong Leong Investment Bank Research - 20 Dec 2022