We came back from a visit to KPJ Healthcare (KPJ) feeling less sanguine about its prospects for the next few quarters due to start-up losses from the opening of new hospitals and higher operating costs. The key takeaways from the visit include the followings:- (i) management shed some light on 4Q13/FY13 results, which raise a few eyebrows, (ii) expansion plans going forward, (iii) earnings growth is expected to be pedestrian over the next few quarters, and (iv) neutral impact from the recent doctors’ fee hike. We downgrade our FY14 and FY15 net profits by 4.7% and 7.5%, respectively, after taking into account the higher-than-expected losses and operating costs from newly start-up hospitals. Correspondingly, our TP is cut by 4% from RM2.80 to RM2.67 based on unchanged 23.5x FY14 EPS. Maintain UNDERPERFORM.

Management shed some light on 4Q13/FY13 results. KPJ recently announced 4Q13/FY13 results that were below expectations. Recall, excluding a revaluation gain from investment properties of an associate, Al-Aqar Healthcare REIT, amounting to RM9.2m, core 4Q13 net profit came in at RM23.5m (21% QoQ). At first glance, the results appear to show signs of improvement on a sequential basis. However, if we normalised the low 4Q13 depreciation figure of RM14.4m (expected to be restated) to between RM21-23m per quarter, PATAMI would have been lowered by RM5m to RM18.5m. KPJ has provided for depreciation in anticipation of the opening of KPJ Sabah and KPJ Rawang, which was supposed to commence operations in 2013. However, in Q4 with the blessings from the auditor, KPJ has readjusted its depreciation figure lower due to the over-provision since they have yet to obtain licenses to operate in Sabah and Rawang. KPJ Sabah just started operations in early Jan 2014. Elsewhere, aged-care facility losses in 4Q13 was due to the lack of villa sales at Jeta Gardens as well as higher staff costs due to the strict requirements for hiring qualified aged-care workers in Australia. Overall FY13 earnings were dragged down by losses estimated between RM20m to RM23m at KPJ Klang, Pasir Gudang and RS Bumi Serpong Damai (Indonesia).

Expansion plans going forward. KPJ’s expansion driver over the next two years is expected to come from the building of new hospitals as well as expansion of its existing capacity and services. The planned capex in FY14 and FY15 is estimated at between RM300m and RM350m p.a. (compared to our forecast of RM200m). For FY14, the KPJ Rawang Specialist hospital (160 beds), which has been fully constructed, is now awaiting the inspection and approval by the Ministry of Health. Once finalised, it is expected to commence operations in April 2014 while the Muar Medical Centre (120 beds) is expected to start by end-June 2014. Looking into FY15, KPJ is targeting to open KPJ Perlis and KPJ Pahang Specialist. We expect KPJ to expand into Terengganu and Melaka as well, where it currently does not have operations. Elsewhere, we understand that the development of building additional facilities on the remaining balance of a vacant land measuring 30-32 acres in Jeta Gardens will add additional 70 beds, bringing the total to 178 and is expected to be completed by FY14.

Earnings growth is expected to be pedestrian over the next few quarters. In Indonesia, we expect losses in Medika Permata Hijau to persist over the next several quarters due to difficulty in attracting doctors to its establishment leading to lower bed utilisation of 40%. However, this is expected to be negated by the profitable Bumi Serpong Damai. Additionally, KPJ is incurring higher staff costs due to: (i) gradually opening of more beds since it needs to maintain a required ratio of staff per hospital, and (ii) KPJ is also employing more staff in its headquarters to support its ongoing projects. We expect start-up losses from Sabah, Muar and Rawang to drag down earnings once they start operating as typically the gestation period averaged two to three years.

Minimal impact to doctors’ fee hike. The recently announced rate hike for private medical fee of 14.4% came in within expectations. Specifically, the increase involved fees charged by doctors, from general practitioners to specialists and surgeons who are regulated in Malaysia. For illustration purposes, ceteris paribus, a 14% hike will raise KPJ’s revenue by 4.2% (on average doctors fees accounted for 30% of KPJ’s revenue. Correspondingly, since KPJ retains 10% of the doctors’ fees, the net impact from the hike to KPJ’s bottomline is 5% of our FY14 net profit forecast. However, the net effect could be neutral to earnings since a hike in medical fee could offset inpatient admission volume.

Maintain UNDERPERFORM. We downgrade our FY14E and FY15E net profits by 4.7% and 7.5%, respectively, after taking into account the higher-than-expected operating costs from newly start-up hospitals and revised up our capex assumption from RM200m to RM300m. Correspondingly, our TP is cut by 4% from RM2.80 to RM2.67 based on unchanged 23.5x FY14 EPS (+0.5 standard deviation above the 6-year forward average PER). Since our downgrade in Feb 2013, the stock has fallen by 21%. Maintain UNDERPERFORM. The stock is currently trading at PERs of 28x for FY14E and 25x for FY15E, which appear rich as compared to its average net profit growth of 11% p.a. over FY14E and FY15E. 

Source: Kenanga