We maintain our UNDERWEIGHT rating on the sector. The recent 2QCY15 results season saw IHH Healthcare and Pharmaniaga performing within expectations. However, KPJ Healthcare came in above our expectation due to lower-than-expected losses from its newly opened hospitals. IHH earnings were 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. The main drawback at this juncture is that healthcare stocks including IHH Healthcare (UP, TP: RM5.00) and KPJ Healthcare (UP, TP: RM3.74) are trading at rich valuations while offering low dividend yields. 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 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 Pharmaniaga (under our coverage) is supported by government concession agreements, non-government purchasers and exports to a smaller extent.

IHH Healthcare reported solid 1H15 results, but valuation still overdosed. The stock is currently trading at PERs of 56x 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. The recently announced 1H15 results saw high intensities in patient volume and revenue of existing operations and organic growth of existing operations, the ramping up of Acibadem Atakent Hospital and Pantai Hospital Manjung and the opening of Gleneagles Kota Kinabalu. This lifted EBITDA by 13%. Going forward, IHH’s appetite for expansion could gain traction and lend support to its share price judging from its Indian acquisition namely Continental Hospitals and the recently announced Global Hospitals. 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 (scheduled 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 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 33x for FY15E and 31x for FY16E, which appear rich as compared to its expected average net profit growth of 6% 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 - 8 Oct 2015