We maintain our UNDERWEIGHT rating on the sector. The recent 4QCY15 results season saw a mixed bag of results where IHH Healthcare came in within expectations but Pharmaniaga performed below expectations. However, KPJ Healthcare came in above our expectation due to lower-than-expected losses from its newly opened hospitals. IHH’S 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: RM4.43) are trading at rich valuations while offering low dividend yields. Despite performing below expectations due to higher-than-expected promotional expenses and amortisation of the Pharmacy Information System (PHIS) system, Pharmaniaga offers decent dividend yields of 4%-5% and with a defensive earnings stream being the sole concession holder to purchase, store, supplies and distribute approved drugs and medical products to Government hospitals and clinics nationwide.

Separation of drug prescription and dispensing functions to pose risk to earnings? Speculation is rife that the Health Ministry may prohibit doctors from dispensing drugs to their patients and hence restricting 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, the impact to pharmaceutical players being the source suppliers to both the medical fraternity and pharmacies is neutral. 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 12M15 results, but valuation still overdosed. The stock is currently trading at PERs of 39x and 49x on FY16E and FY17E earnings, respectively, compared to an average net profit growth of 11% p.a. over the next two years. The recently announced FY15 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 11%. 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’s strategy. Growth driver in the next five years will come from the following:- (i) In Malaysia, PPL is currently undertaking expansion projects in four hospitals, namely Pantai Hospital Ayer Keroh (160 beds, completion in end 2017), Pantai Hospital Klang (80 beds), Pantai Kuala Lumpur (120 beds). Greenfield projects meanwhile, namely Gleneagles Medini (phase 1b, 160 medical suites), and (ii) in Turkey, Acibadem is currently undertaking expansion in Acibadem Sistina Skopje (81 beds) and Acibadem Maslak (200 beds, target completion 2017). The greenfield projects are Acibadem Altunizade (325 beds, target completion 2017) and Acibadem Kartal (120 beds, target completion 2018). Over at the international side, Chengdu and Hong Kong are expected to commence in 2H17.

KPJ Healthcare’s valuations looking stretched as well. We continue to reiterate our MARKET PERFORM 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 27x for FY16E and 25x for FY17E, respectively, which appear rich as compared to its pedestrian growth for the two financial years.

Saving grace for Pharmaniaga is 4.8% dividend yield. Despite performing below expectations due to higher-thanexpected promotional expenses and amortisation of the Pharmacy Information System (PHIS) system, Pharmaniaga offers a decent dividend yields of 4%-5% and with fairly defensive earnings being the sole concession holder to purchase, store, supplies and distribute approved drugs and medical products to Government hospitals and clinics nationwide.

Source: Kenanga Research - 6 Apr 2016