The just announced rate hike for private medical fee at 14.4% came in within expectations. Following our recent upgrade rating on IHH Healthcare to Market Perform in the just-concluded earnings season, correspondingly we upgrade our Healthcare sector from Underweight to Neutral. Specifically, the increase in medical fee involved fees charged by doctors, from general practitioners to specialists and surgeons who are regulated in Malaysia. In a nutshell, the hike results in minimal earnings impact for both KPJ and IHH Healthcare. The main drawback at this juncture is that healthcare stocks including IHH Healthcare (MP, TP: RM3.86) and KPJ Healthcare (UP, TP: RM2.80) are trading at rich valuations while offering low dividend yields at current market prices.

14.4% rate hike. Specifically the increase in medical costs involved fees charged by doctors, from general practitioners to specialists and surgeons. Fees for medical procedures also soared between 14% and 18%. For example, the surgeon's fee for a lumbar puncture has been revised from RM650 to RM745, repair of bladder from RM1,875 to RM2,145 and kidney transplant from RM4,150 to RM4,750. The hike included a spike in consultation charges from between RM10 and RM35, but the new amendment increases this to RM30 and RM125 for general practitioners and from between RM30 and RM125 to RM80 and RM235 for specialist doctors. While the increase has been capped at 14.4%, the medical schedule shows hikes of more than 100% on certain fee ceilings which we have to seek further clarification.

Marginal +1.4% impact to KPJ’s earnings. For illustration purposes, Ceteris Paribus, a 14% hike will raise KPJ’s revenue by 4.2% (on average doctors fees accounts for 30% of KPJ’s revenue. Similarly, since average doctors fees accounts for 10% of net profit, the 14% hike would only raise KPJ’s bottonline by 1.4%. We are keeping our KPJ’s earnings forecasts unchanged. Despite the encouraging news that KPJ has won its appeal against the judgment of the Hospital Penawar civil law suit, the Plaintiffs have filed an Application for leave to appeal to the Federal Court against the Court of Appeal’s decision. This remains a threat to KPJ’s financial prospect. The expansion of existing hospitals will have a positive impact to KPJ, but this will be offset by its new greenfield hospitals, which have an average gestation period between three to five years. Hence, the openings of new hospitals in Sabah, Muar and Rawang scheduled for FY14 could further negate earnings upside for the short to medium term. We maintain our earnings forecast and continue to reiterate our Underperform recommendation because of: (i) KPJ’s fourth consecutive earnings disappointment in 4Q13, which suggest potential earnings downgrade going forward and (ii) startup costs and losses from openings of hospitals in Sabah, Muar and Rawang scheduled in FY14, which could negate earnings upside due to higher operating costs.

Minimal impact to IHH Healthcare. The 14% hike is minimal to IHH’s bottomline considering that vast majority of IHH’s specialists in Malaysia are independent doctors (self-employed). employed). As such, IHH does not have any meaningful share of their professional fees. The stock is currently trading at 41x and 34x on FY14E and FY15E earnings compared to its average net profit growth of 20% p.a. over the next two years. Despite the scarcity premium attached to IHH given its bigger market capitalisation, dominant market position and superior growth potential compared to its regional peers, IHH is already trading above our target price. We believe IHH’s recently announced plan to venture into Hong Kong to build, own and operate a 500-bedroom hospital is in line with its management strategy to expand its international presence apart from its existing three key markets. We believe this could have a positive impact on the group’s margins given the higher ROI expectations as compared to its hospital ventures in Malaysia and Singapore. Growth driver in the next five years will come from the following drivers: (i) In Singapore, the first phase of Mount Elizabeth Novena Hospital comprising 150 (of total 333) beds (all singlebed rooms) and 13 operating theatres, which have already commenced operations in July 2012. (ii) In Malaysia, PPL is currently undertaking expansion projects in four hospitals, Gleneagles Medical Centre Penang, Pantai Hospital Kuala Lumpur, Pantai Hospital Klang and Gleneagles. Greenfield projects meanwhile, namely Gleneagles Kota Kinabalu, Pantai Hospital Manjung and Gleneagles Medini will add an estimated 500 beds by 2014. (iii) In Turkey, Acibadem is currently undertaking expansion projects for two hospitals, Acibadem Sistina Skopje Clinical Hospital, Acibadem Bodrum and Acibadem Maslak Hospital while Acibadem Altunizade is a greenfield development.

Source: Kenanga