We maintain our UNDERWEIGHT rating on the sector. The recent 1QCY15 results season saw IHH Healthcare (IHH), KPJ Healthcare (KPJ) and Pharmaniaga (PHARMA) performing within expectations. IHH was driven by organic growth intensities of existing hospitals, specifically higher inpatient admissions and revenue intensities across the board while its solid double-digit EBITDA growth was underpinned by higher revenue and operating leverage from higher patient volumes. All in, healthcare stocks under our coverage are already trading at rich PER valuations compared to their low-teens growth. We also believe that their growth potentials are already reflected in the valuations. 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. The main drawback at this juncture is that the healthcare stocks including IHH (UP, TP: RM5.00) and KPJ (UP, TP: RM3.54) are trading at rich valuations while offering low dividend yields. The saving grace for PHARMA (MP, TP: RM6.95) is a decent dividend yield of 4.3%.

Separation of drug prescription and dispensing functions 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 have agreed, in principle, for the dispensing function to be served by pharmacists. If this materializes, pharmacy operators will be the winners of the new system as their sales would be boosted considerably. However, pharmaceutical players being the source suppliers to both the medical fraternity and pharmacies are unlikely to enjoy any new impact. Specifically, revenue generated by PHARMA (under our coverage) is supported by government concession agreements, nongovernment purchasers and exports to a smaller extent.

GST could have 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 providers’ operating expenses are expected to increase as 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 reported solid FY14 results, upgrade TP, but valuation still overdose. The stock is currently trading at PERs of 52.7x and 47.9x 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, PPL is currently undertaking expansion projects in four hospitals, Gleneagles Kuala Lumpur (schedule to open by 2H15), Pantai Hospital Kuala Lumpur (phase 1 to commence operation in Mar15), Pantai Hospital Klang (expected completion end 2016) and Pantai Hospital Ayer Keroh (expected completion end-2017). Greenfield projects meanwhile, namely Gleneagles Kota Kinabalu (to commence operation in May15) and Gleneagles Medini (phase 1 with 150 beds target completion in 2H15), (iii) in Turkey, Acibadem is currently undertaking expansion projects for two hospitals, Acibadem Sistina (target completion 2Q15) Skopje Clinical Hospital, Acibadem Bodrum (target completion in 3Q15) and Acibadem Maslak Hospital (target completion in 2017) while Acibadem Altunizade is a greenfield development (target completion in 2016).

KPJ’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 34.6x for FY15E and 32.5x for FY16E, which appear rich as compared to its expected average net profit growth of 4% p.a. over FY15 and FY16.

PHARMA saving grace is its 4.2% dividend yield. We like PHARMA 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%. We have downgraded the stock in the recently concluded 1QCY15 results due to the strong share price performance. The stock has risen by >50% since our initiating coverage report back in Nov 2014. Due to the strong share price performance and rich FY15 and FY16 PER valuations of 17.9x compared to an average net profit growth of 7.9%, coupled with lack near-term catalyst, we keep the stock as Market Perform. The saving grace is a decent dividend yield of 4.3%. Our RM6.95 target price is based on unchanged 16.5x FY16 EPS. 

Source: Kenanga Research - 3 Jul 2015