- We initiate coverage on KPJ Healthcare (KPJ) with a BUY recommendationand a DCF-fair value of RM6.15/share, offering potential returns of ~ 20%. Wesee further upside to the share price in a likely sector-wide re-rating fromthe impending listing of regional healthcare provider Integrated HealthcareHoldings (IHH) which have acquired assets at 16x-26x PERs.

- As it is, KPJ's current valuations are attractive.Fully-diluted PERs of 17x and 20x are at a 10%-13% discount to closest peer,Thailandbased Bumrungrad Hospital, and a wider 23%-33% discount to regionalpeers' average. 

- We like KPJ's defensive earnings profile. Also, a step-upincrease in bed capacity via a pipeline of 7 new hospitals would accelerate earningsmomentum to achieve our conservative 3-year CAGR of 17%. Faster-than-expectedpatient admission growth, coupled with a one-year hiatus from hospitalexpansion, has led to shrinking ready capacity. Current occupancy rate of70%-75% is a tad below overcrowded thresholds of 85%-90%.

- With a sizeable 22% market share, KPJ is Malaysia'slargest private healthcare provider with a national footprint and growingscale. It is well placed to capitalise on the booming and lucrative health tourism,with the doubling of the strategic existing hospital chain in Johor ' a focalarea slated to become the primary destination for medical tourists. 

- Increased demand as spurred by recent regulatory changeson cross border medical reimbursement between Malaysia and Singapore is expectedto power the segment's contribution from 10% currently to 25% of group revenueby 2020F.

- KPJ also operates KPJ International University College ofNursing and Health Sciences (KPJUIC) with annual revenues of RM40-RM50mil.Despite minimal contribution to group earnings, the education arm complementsits hospital operations in that it serves to mitigate staffing risks ofqualified nurses and  medical staff. Managementhas earmarked a RM120mil capex for the Nilai branch expansion and commissioningof a new campus at Bukit Mertajam. It aims to quadruple student in-takes to10,000 in 5 years' time.        

- The non-core operation in the retirement/aged care  industry will remain insignificant in themedium term. Nevertheless, we reckon the 'know-how' attained via KPJ's 51%stake in Australia-based Jeta Gardens Waterford Trust would be beneficial forfuture potential opportunities within the niche market.   

- Net gearing is at a manageable level of 12%, aided by thegroup's asset-light model. Asset injections of hospitals into 49%-owned AlAqarHealthcare REIT (AQAR Mk Equity, BUY) has enabled for better deployment of freecash flows to fund future expansion, whilst lending support to its dividendpolicy. We have assumed a dividend payout of 50% p.a., in line with managementguidance (yields: 3%-4%).  

Source: AmeSecurities