We maintain our UNDERWEIGHT rating on the sector. Both IHH and KPJ are currently trading at lofty valuations when juxtaposed to net profit growth forecasts for FY14 and FY15. Overall, we believe that the healthcare industry in Malaysia will continue to enjoy stable growth supported by growing healthcare expenditure, rising medical insurance and aging population demographics. Looking ahead, the GST implementation and further subsidy rationalisation could dampen private hospitals’ margins and volume growth. We prefer Pharmaniaga for: (i) its defensive earnings as the sole concession holder to purchase, store, supplies and distribute approved drugs and medical products to Government hospitals and clinics nationwide, (ii) its growth exposure in the healthcare and pharmaceutical industry supported by an ageing population, and (iii) decent dividend yield of 5%.

Growth in healthcare supported by ageing population. It is estimated that during the 2010-2040 period, Malaysia's population aged 65 and over is projected to increase more than three-fold of the 2010 population. The increase will lead Malaysia to become an aging population in 2021 when the population aged 65 years and above reach 7.1%. Based on the United Nations (UN)’s definition, an aging society is when the population aged 65 and over constitutes 7% of the total population. Population for the age group 0–14 years is projected to decline from 27.4% to 19.6% for the same period. However, the population for the age group 15–64 years and 65 years and over is expected to increase by 1.4 and 6.4 percentage points respectively for the same period. Longer life spans also result in a larger number of people aged 65 and above. This improvement has been attributed mainly to advances in medical technology, higher personal wealth and growing awareness of the importance of healthcare and disease prevention.

GST could have negative impact on private hospitals margins and lower patients’ volume but pharmaceutical products are more stable. Looking ahead, the implementation of GST and further subsidy rationalisation programme could dampen private hospitals’ margins and volume growth. From our channels check, we understand that several private hospital players are expected to raise prices in order to mitigate the higher operating cost due to the implementation of GST which could ultimately exert a negative impact on their margins. Generally, healthcare services operating expenses is expected to go up since they have to pay for GST on business purchases or raw material costs before selling but unable to claim credit for the GST paid on the inputs. Similarly, higher prices charged by hospitals as well as further subsidy rationalisation programme could dampen purchasing power of consumers leading to lower volume patients.

IHH Healthcare seasonally slower in 3Q14, valuation overdose. IHH’s 3Q14 revenue and EBITDA fell 4% and 13%, respectively, due to a seasonally slow quarter in the summer months in Turkey and seasonality factor in Singapore and Malaysia. In Parkway, lower inpatient admissions in Malaysia were partially offset by higher revenue per inpatient admissions in Singapore and Malaysia. In Acibadem, due to the summer months in Turkey, inpatient admissions were reduced 5.2% but partially offset by the 4.8% increase in the revenue per inpatient admissions, exchange gain and losses on non-TL borrowings. This brings core net profit to RM540.8m (+23%) thanks to double-digit EBITDA growth. The stock is currently trading at PERs of 54.0x and 49.1x on FY14E and FY15E earnings, respectively, compared to its average net profit growth of 13.5% p.a. over the next two years. We believe IHH’s plan to venture into Hong Kong to build, own and operate a 500-bedroom hospital is in line with its management strategy. Growth driver for the next five years will come from the following developments: (i) In Malaysia, IHH is currently undertaking expansion projects in four hospitals, Gleneagles Kuala Lumpur, Pantai Hospital Kuala Lumpur, Pantai Hospital Klang and Pantai Hospital Ayer Keroh. Greenfield projects, namely Gleneagles Kota Kinabalu and Gleneagles Medini will add an estimated 500 beds by end 2014 to end 2016, (ii) 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, and (iii) in overseas market - Gleneagles Hong Kong and Mumbai are expected to be completed by end 2016 and 2014, respectively.

KPJ Healthcare’s 3Q14 results came in above our expectation but inline with market consensus. The recent 3Q14 results came in above our expectation but inline with market consensus. The positive variance from our forecast was due to lower-thanexpected losses at support services division. YoY, 9M14 net profit rose 33% due to higher earnings contribution from Malaysia (+24%), underpinned by reduced losses from new hospitals namely KPJ Rawang and KPJ Bandar Baru Klang Specialist Hospital and lower losses from Indonesia. We continue to reiterate our UNDERPERFORM recommendation because of: (i) rich valuations compared to its pedestrian net profit growth over the next two years. The stock is currently trading at PERs of 34.1x for FY14E and 31.5x for FY15E, which appear rich as compared to its expected average net profit growth of 11% p.a. over FY14 and FY15, (ii) start-up costs and losses from its new hospitals in Sabah, Muar and Rawang scheduled for FY14, which could negate earnings upside due to higher operating costs.

We prefer Pharmaniaga. We prefer Pharmaniaga for: (i) its defensive earnings being the sole concession holder to purchase, store, supplies and distribute approved drugs and medical products to Government hospitals and clinics nationwide, (ii) its growth exposure in the healthcare and pharmaceuticals industry supported by an ageing population, and (iii) decent dividend yield of 4.8%.

Source: Kenanga