Period  3Q13/9M13

Actual vs. Expectations The reported 9M13 net profit of RM70m (-31% YoY) came in below expectations at only 51% and 57% of our and the consensus full-year 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 third consecutive quarter of earnings disappointment.

Dividends  A third interim single tier dividend of 2 sen was declared which brings the 9M13 net dividend to 6 sen going ex on 18 Dec.

Key Result Highlights QoQ, the 3Q13 turnover fell 4% to RM565m largely due to lower contribution from Malaysia (-6%), aged care facility (-6%) Indonesia (-0.3%) but mitigated by support services (+22%). We believe the lower revenue reported is due to the Ramadan month and Hungry Ghost festival in Malaysia. Correspondingly, 3Q13 net profit came in 23% lower at RM19m exacerbated by lower profit contributions from its Malaysian hospitals (-50%) due to losses at Pasir Gudang hospital (open in May 2013) despite narrowing losses at support services segment of RM5m compared to RM15m in 2Q13. In the support services segment, higher 3Q13 revenue from new students’ intake from expansion of KPJ International University College expansion in Nilai as well as the opening of the new Penang campus led to narrowing start-up losses incurred in 2Q13. In the meantime, aged care facility registered further improvement in 3Q13 with a pre-tax profit of RM3.8m (+132% due to low base effect).

 YoY, 9M13 net profit fell 31% due: to (i) losses from the opening of new hospitals namely KPJ Bandar Baru Klang Specialist Hospital and Pasir Gudang; and (ii) support services segment’s losses of RM20.5m compared to profit of RM25.9m in 1H13 due to higher staff costs as a result of new hospitals openings as well as brownfield expansion and start-up cost incurred in new campus expansion.

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 30^th 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 for hearing on 12th Dec 2013.

 In the meantime, the above-mentioned judgement sum has not been provided for yet. However, for illustrative purposes, the RM70.6m (damages and costs) would reduce its NTA by 8% or by 11 sen/share from RM1.35 to RM1.24 based on its financial position as at 30 June 2013. Our FY13 net profit forecast would also be reduced by 50%.

 The openings of hospitals in Sabah, Muar and Rawang schedule in FY14 could negate earnings upside.

Change to Forecasts We slashed our FY13 and FY14 net profits forecasts by 17.5% and 10.0% respectively due to the poor set of results and after taking into account the higher-than-expected losses and operating costs from its newly start-up hospitals.

Rating Correspondingly, out TP has been cut by 10% from RM5.75 to RM5.18 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 currently trading at 35.0x for FY13E and 27.8x for FY14E, which appear rich as compared to its average net profit growth of 5% p.a. over FY13 and FY14.

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

Source: Kenanga