We maintain our UNDERWEIGHT rating on the sector. The recent 4QCY14 results reporting season saw both IHH Healthcare and KPJ Healthcare coming in within expectations. However, Pharmaniaga beat both our and market consensus full-year forecast due to higher volume sales and unexpectedly lower effective tax rate. 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 programme could dampen private hospitals’ margins and volume growth. On stock picks, 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 4.8%.

Separation of drug prescription and dispensing could pose risk to earnings? Speculation is rife that the Health Ministry may prohibit doctors from dispensing drugs to their patients and hence restrict their roles to only prescribing. It was also reported that organisations representing doctors and pharmacists agreed, in principle, that dispensing be left to the pharmacists. If this materializes, pharmacy operators will be the winners of the new system as their sales should be boosted considerably. However, pharmaceutical players being the source suppliers are unlikely to be affected. Specifically, revenue generated by Pharmaniaga (under our coverage) is supported by government concession agreements, non-government purchasers and exports to a smaller extent.

GST could have a negative impact on private hospitals' margins and lower their 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 are expected to go up since they have to pay for GST on business purchases or raw material costs before selling but are 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 potentially dampen purchasing power of consumers leading to lower volume in patients.

IHH Healthcare reported solid FY14 results, upgrade TP, but valuation still overdose. We are upgrading IHH Helathcare TP from RM4.54 to RM5.00 by raising our sum-of-parts EV/EBITDA and PER valuations due to its execution ability in terms of expansion plans and showing steady improvement in revenue per inpatient. As an indication, quarterly revenue per inpatient has consistently grown by an average of 5-8% YoY over the last few quarters. The stock is currently trading at PERs of 55x and 51x on FY15E and FY16E 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 valuations looking stretched as well. 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 34.5x for FY15E and 34.1x for FY16E, which appear rich as compared to its expected average net profit growth of 4% p.a. over FY15 and FY16. 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%. Maintain Outperform with a TP of RM6.95 based on 16.5x FY16 EPS.

Source: Kenanga Research - 6 Apr 2015