News  KPJ Healthcare (KPJ) has entered into a share sale agreement with Al-`Aqar Healthcare REIT (Al-`Aqar or REIT) for the acquisition of the entire equity interests in Crossborder Hall (M) Sdn Bhd and Crossborder Aim (M) Sdn Bhd, wholly-owned subsidiaries of Al-`Aqar, for a total cash consideration of RM4.7m.

 Crossborder Hall owns 50% equity interests each in PT Al-`Aqar Permata Hijau and PT Al-`Aqar Bumi Serpong Damai.

 Crossborder Aim owns the remaining 50% equity interests in PT Al-`Aqar Permata Hijau and PT Al- `Aqar Bumi Serpong Damai.

 The assets acquired are Rumah Sakit Medika Permata Hijau, and Rumah Sakit Medika Bumi Serpong Damai which is barely profitable.

 The proposed acquisition is expected to be completed by 3Q 2015.

Comments  This latest corporate development by KPJ is to rationalise and streamline its operations in Indonesia in a bid to improve operational efficiency as the proposed acquisition will enable KPJ to have more flexibility in managing its Indonesian operations.

 Including the shareholders' advances to the target companies owing to Al-Aqar of which KPJ agrees to settle amounting to RM78.4m, the effective purchase consideration is RM83.0m. Total net book value for both properties is RM80m.

 For illustrative purposes, the acquisition would increase net debt and net gearing from RM946m and 0.72x to RM1b and 0.79x.

 We maintain our earnings forecast since the savings from rental cost will be offset by borrowings cost and depreciation from owning the buildings.

Outlook  Earnings growth is expected to be pedestrian over the next few quarters. In Indonesia, we expect losses in Rumah Sakit Bumi Serpong Damai 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 Rumah Sakit Medika Permata Hijau.

 Looking into FY15, KPJ is targeting to open KPJ Perlis and KPJ Pahang Specialist. Additionally, KPJ is incurring higher staff costs due to: (i) the gradual opening of more beds since it needs to maintain a certain required ratio of staff per hospital, and (ii) more staff being employed in its headquarters to support its on-going projects. We expect start-up losses from Sabah, Muar and Rawang to drag earnings due to the typical gestation period averaging between two to three years.

Change to Forecasts  No changes to our earnings forecast.

Rating & Valuation  Maintain UNDERPERFORM with a TP of RM3.54 based on unchanged 27x FY16 EPS. The stock is currently trading at PERs of 34x and 35x on FY15E and FY16E, which appear rich as compared to its expected pedestrian net profit growths.

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