We maintain our NEUTRAL view on the Healthcare sector. Both IHH and KPJ are currently trading at lofty valuations relative to their net profit growth potentials for FY14 and FY15. Overall, we believe that the healthcare industry in Malaysia will continue to enjoy stable growth supported by the growing healthcare expenditure, rising medical insurance and aging population demographics. The healthcare services sector is considered defensive for its predictability factor and captive earnings streams. In the recently-concluded 4Q13/12MCY13 results season, IHH Healthcare came in within our expectations but KPJ Healthcare performed below our and consensus estimates. The main drawback at this juncture is that the healthcare stocks including IHH Healthcare (MP, TP: RM3.86) and KPJ Healthcare (UP, TP: RM2.67) are trading at rich valuations while offering low dividend yields at current levels.

Budget 2014 an impetus for growth in the Healthcare industry. The Government allocated RM22.1b (+13% Y-o-Y) for the health sector under operating and development expenditure. The allocation will be channelled to programmes and projects, including the construction of Hospital Tanjung Karang and additional blocks for Hospital Jeli, as well as the upgrading of Hospital Kuala Lipis and 30 rural clinics. The Government has set up 234 1Malaysia clinics, and 50 additional 1Malaysia clinics will be established in 2014. Other allocations include: (i) RM66m for the purchase of equipment and the construction of additional blocks in Hospital Queen Elizabeth in Kota Kinabalu, (ii) RM150m to appoint 6,800 more nurses, (iii) RM3.3bn for the purchase of medicines and medical equipments, including expanding the cardiothoracic services in Hospital Ipoh, Kuala Terengganu, Kuantan and Kuching.

Neutral Impact from Medical Fee 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, surgeon 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 of 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 clarifications.

IHH Healthcare. The 14% hike has minimal impact to IHH’s bottomline considering that the vast majority of IHH’s specialists in Malaysia are independent doctors (self-employed). As such, IHH does not have any meaningful share of their professional fees. The stock is currently trading at PERS of 39x and 36x on FY14E and FY15E earnings, respectively, 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 regional peers, IHH is already trading above our target price. We believe IHH’s recent 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 single bed 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.

Expect a de-rating in KPJ Healthcare. 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 be offset by lower inpatient admissions. 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 position. 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 in the 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) start-up costs and losses from its new hospitals in Sabah, Muar and Rawang scheduled in FY14, which could negate earnings upside due to higher operating costs. The stock is currently trading at PERs of 28x for FY14E and 25x for FY15E, which appear rich as compared to its expected average net profit growth of 11% p.a. over FY14 and FY15.

Source: Kenanga