Stemming the Bleeding

We view KPJ Healthcare as a potential consumer-laggard play with patient volume expected to recover in tandem with overall consumer affordability. Against the backdrop of improved domestic prospects and dissipating foreign risk factors, we believe this should catalyse KPJ’s sluggish valuations. Maintain BUY with a higher TP of RM1.30, as we raise our earnings assumption and roll forward our valuation horizon to FY19E.

Worst Is Over for Indonesia

KPJ’s Indonesia operations suffered the brunt of new healthcare policies, effectively capping prices for its healthcare services. 4Q17 losses alone dragged group 4Q17 operating earnings by -9%. However, with innovative and shrewd policies, we believe the worst is over for KPJ’s Indonesia operations. It should allay fears of further dragging.

Bidding Australia Farewell in 2H18

KPJ now expects the sale of its aged care centre in Australia, Jeta Gardens, to be sold in 2H18 instead of 1H18. The pushback was due to the counterparty’s inability to gain adequate financing. More importantly, the exercise would alleviate headline earnings by 4% and ease KPJ’s lofty net gearing level to below 0.65x from 0.70x.

Patient Volume Recovery Driven by Improved Prospects

Despite the necessity of healthcare, patient volume growth took a noticeably step-down post implementation of GST in Apr 2015. With improved consumer affordability and sentiment, we expect a recovery in overall prospects to positively translate into volume growth gradually reverting back to previous norms.

Maintain BUY With a Higher TP of RM1.30

We reaffirm our BUY rating on KPJ but lift our earnings to better reflect improved prospects underpinning the sector. We also take the opportunity to roll forward our valuation to FY19E, resulting in a 12-month SOTPderived TP of RM1.30. We like KPJ for its: (1) diminishing risk factors - Indonesia and Jeta Gardens, (2) improved industry prospects and (3) attractive valuation vs historical valuation (historical mean of 30x) and regional peers (56x FY18E PE) Downside risk: (1) spike in cost, (2) delayed corporate exercise and (3) slower-than-expected recovery in patient volume. This note marks a transfer of analyst coverage.

Worst Is Over for Indonesia

New Health Policy Behind Underperformance

To recap, the local health coverage scheme overseen by the Healthcare and Social Security Agency (BJPS), capped prices of healthcare treatment administered by local private hospitals. The impact was more pronounced especially among the hospitals situated in neighborhoods with lower socioeconomic status. As a result, KPJ’s Rumah Sakit Medica Bumi Serpong Damai (RSMBSD) was a drag on operating margins, with Indonesia posting an operating loss of –RM7.1m for 4Q17 (9% of KPJ’s 4Q17 group operating earnings). It effectively reversed headway made in the preceding quarters of improved patient traffic.

Shrewd and Innovate Policies Steadies Ship

Positively, it saw minimal losses in 1Q18 and management expects for the trend to persist going forward. The losses were stemmed by lowering the admission of negative margin patients, which were largely inpatient treatment. KPJ resorted to offering potential inpatients to lower priced outpatient treatment and referrals to other specialist hospitals. Therefore, we believe the worst is over for KPJ’s Indonesia operations and it should allay fears of further dragging.

Bidding Australia Farewell in 2H18

Little Glitch to Jeta Garden Sale

KPJ previously expected for the sale of its 57% stake in Jeta Gardens, its aged care centre in Australia by 1H18. Negotiations stalled with the previous counterparty, due to their inability to gain adequate financing. Instead, management aims to complete the exercise by 2H18. We believe 1Q19 onwards could be a more reasonable timeline seeing there is no concrete offer and its already July. While so, KPJ expects a gain on disposal on the already written down investment cost of RM16m.

Positive Impact Once Completed

More importantly, it would alleviate earnings, with Jeta Gardens previously weighing on PBT earnings by c:-4%. Aside from that, it would allow Al-Aqar Healthcare REIT (KPJ owns a 37% stake) to sell the property on which Jeta Gardens sits. Proceeds from the sale would allow Al-Aqar REIT to purchase more hospital assets from KPJ, lowering KPJ’s FY18E net gearing level from a lofty 0.7x. At Al-Aqar’s Jeta Garden fair value of RM140m, it could potential lower KPJ’s gearing down to 0.65x.

Patient Volume Recovery Driven by Improved Prospects

Patient Volume Recovery in Tandem With Overall Consumer Spending

Private healthcare was previously GST-free. However, zero-rated GST is positive on the private operators given that GST treatment on items such as services and consumables resulted in raised fees. Apart from raised fees, higher cost of living adversely affected patient volume growth as inpatients downtraded to outpatient and patients (esp. cash patients) shifting to public hospitals or delayed treatment (Fig 1). Going forward, we expect improved consumer spending and sentiment to positively translate into volume growth, gradually reverting back to previous norms.

Valuation and Recommendation

Earnings Raised by 10-1% for FY18E-20E

Against the backdrop of improved domestic prospects, we lift our patient volume assumption and revenue intensity for FY18E-FY20E (Fig 2). We expect growth to gradually make a recovery off a low base to pre-GST growth rates. Subsequently, our earnings are raised by 10%/9%/1% for FY18/19/20E.

Valuations Need to Recognise Recovery in Prospects

KPJ’s current valuations are trailing both its historical valuations (Fig 3 and 4) and its peers (Fig 5). We believe valuations should eventually narrow to reflect improved domestic prospects and the diminishing regional risk factors. Aside from that, KPJ could be a laggard consumer-proxy play as we expe

Maintain BUY But With Higher TP of RM1.30

We reaffirm our BUY rating on KPJ. Aside from our upward adjusted earnings, we roll forward our valuation to FY19E, raising our TP to RM1.30 from RM1.22. We continue to like KPJ for its: (1) diminishing risk factors - Indonesia and Jeta Gardens, (2) improved industry prospects and (3) attractive valuation vs historical valuation (historical mean of 30x one year forward EPS) and regional peers (56x FY18E PE) Downside risk: (1) spike in cost, (2) delayed corporate exercise and (3) slower-than-expected recovery in patient volume.

Source: Affin Hwang Research - 23 Jul 2018