Period  2Q13/1H13

Actual vs. Expectations  The reported 1H13 net profit of RM50.4m (-26% YoY) came in below expectations at only 34% of our and the consensus fullyear earnings estimates. The variance from our result is largely due to higher-than-expected losses incurred in its newly opened hospitals and losses at the support services segment. This quarter marks the second consecutive quarter of earnings disappointment.

Dividends  A second interim single tier dividend of 2.0 sen was declared which brings the 1H13 net dividend to 4.0 sen.

Key Result Highlights  QoQ, the 2Q13 turnover rose 8% to RM587m driven by improvement from Malaysia (+5.9%), Indonesia (+57%), aged care facility (+33%) and support services (+9%). The higher revenue reported is due to the increase in revenue of the existing hospitals and newly opened hospitals. 2Q13 net profit came in flat at RM25.3 as profit from its Malaysian hospitals rose 91% which were negated by the widening losses of the support services segment of RM15m compared to RM1m in 1Q13. In the meantime, aged care facility recorded its maiden pre-tax profit of RM1.6m in 2Q13.

 YoY, 1H13 net profit fell 26% due to (i) losses from the opening of new hospitals namely KPJ Bandar Baru Klang Specialist Hospital and (ii) support services segment’s losses of RM15.8m compared to profit of RM6m in 1H13 (we have to seek further clarification from the management on reason behind the losses).

Outlook  Recall, on 26th July 2013, the Johor Bahru High Court had allowed the claim by Dr Mohd Adnan bin Sulaiman and Azizan Sulaiman (plaintiffs) against KPJ wherein both plaintiffs alleged that KPJ had breached the Joint Venture Agreement dated 30th May 1995 whereby the said High Court had awarded the sum of RM70.6m including costs. According to the quarterly notes accompanying the interim financial report, a notice of appeal against the whole judgement has been filed at the Court of Appeal and case has been fixed on 26th September 2013.

 In the meantime, the above-mentioned judgement sum has not been provided for in this quarterly result. However, for illustrative purposes, the RM70.6m (damages and costs) would reduce KPJ’s 31 March 2013 NTA by 8% or by 11 sen/share from RM1.33 to RM1.22 and our FY13 net profit forecast by 48%. KPJ’s net debt and net gearing would then also increase by RM70.6m from RM568.3m to RM638.9m and 0.54x to 0.60x respectively.

 Earnings contribution over the next two years is expected to come from the setting up of new hospitals as well as the expansion of its existing capacity and services. The planned capex in FY13 and FY14 are estimated at between RM200m and RM250m p.a.

Change to Forecasts  We are downgrading our FY13 and FY14 net profits by 6.3% and 4.4% respectively due to the poor set of results and after taking into account the higher-than-expected losses from its newly start-up hospitals.

Rating    Correspondingly, out TP has been cut by 5% from RM6.02 to RM5.75 based on unchanged 23.5x FY14 Fully diluted (FD) EPS (+0.5 standard deviation above the 6-year forward average PER). Maintain UNDERPERFORM.

Valuation  The stock is now trading above the historical average PER band by >+1 SD above the mean. We believe the company’s growth trajectory has already been reflected in its market valuation, which we believe is rich considering that its profit growth will be at average low teens over the next two years.

Risks  The key upside risk to our earnings forecasts is the faster-thanexpected turnaround of its newly opened hospitals.

Source: Kenanga