We maintain our UNDERWEIGHT rating on the sector. The concluded 4QCY16 results season saw Pharmaniaga coming in below expectations. However, KPJ and IHH came in within expectations. Specifically, IHH reported a maiden quarterly loss due to unrealised foreign exchange loss on translation of non-Turkish Lira borrowings. Pharmaniaga had to contend with losses at the logistics and distribution division, higherthan-expected operating expenses and amortisation of the Pharmacy Information System (PHIS) system. All in, healthcare stocks under our coverage are trading at rich PER valuations in contrast to their expected lowteens earnings growth. We believe 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: RM5.42) and KPJ Healthcare (MP, TP: RM4.38) 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 PHIS system, Pharmaniaga offers decent dividend yields of 4-5% and 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.

Robust inpatient growth, supported by ageing population. 2016 inpatient volume grew for IHH (+6%/+8% YoY in Malaysia/Singapore, +30% in Turkey). However, KPJ saw flat volume growth. We expect growth to be supported by an ageing population and growing awareness in healthcare prevention. It is estimated that during the 2010-2040 period, Malaysian population aged 65 and over will increase to more than three-fold of the 2010 population. The increase will categorise Malaysia as an aging population society in 2021 when the population aged 65 years and above reach 7.1%. Based on the United Nations (UN)’s definition, an aging society is when the population aged 65 and over constitutes 7% of the total population. Population for the age group 0–14 years is projected to decline from 27.4% to 19.6% for the same period. However, the population for the age group 15–64 years and 65 years and over is expected to increase by 1.4 and 6.4 percentage points, respectively, for the same period. Longer life spans will also result in a larger number of people aged 65 and above. This improvement has been attributed mainly to advances in medical technology, higher personal wealth and growing awareness of the importance of healthcare and disease prevention.

IHH Healthcare boosted by intensities in patient volume growth. The stock is expected to continue to be de-rated and weigh down by the unrealised foreign exchange loss on translation of non-Turkish Lira borrowings, which drags down IHH 4Q16 into a loss. Overall, over the short-to-medium term, a slower-than-expected economic outlook and start-up costs on pre-opening of hospitals, including Gleneagles Hong Kong which just recently commenced operations are expected to put pressure on cost and margins at least over the short-term. Growth drivers in the next five years will come from the following:- (i) In Malaysia, PPL is currently undertaking expansion projects in three hospitals, namely Pantai Hospital Ayer Keroh (160 beds, completion in end 2017), Pantai Hospital Klang (80 beds), Pantai Kuala Lumpur (120 beds, completion in end 2017). Greenfield projects meanwhile, namely Gleneagles Medini (phase 1b, 160 medical suites, completion in end 2017), and (ii) in Turkey, Acibadem is currently undertaking expansion in Acibadem Maslak (200 beds, target completion 2018). The greenfield projects are Acibadem Altunizade (180 beds, target completion mid 2017), Acibadem Atasehir (325 beds, target completion 2018) and Acibadem Kartal (120 beds, target completion 2018).

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 27.2x for FY17E and 25.5x for FY18E, which appear rich as compared to its pedestrian growth for the two financial years.

Pharmaniaga offer 4.8% dividend yield but bleak short-term earnings outlook. We expect earnings to be lukewarm in subsequent quarters as well in anticipation of the slower-than-expected general economic growth. Additionally, the roll-out of PHIS is expected to continue to dampen bottom-line over the short-term. Over the longer-term, we expect its manufacturing division to propel earnings. The group aims to add about 200 new products over the next 10 years to its existing portfolio of around 500 products. This should boost demand for its products and lift earnings.

Source: Kenanga Research - 30 Mar 2017