We maintain our UNDERWEIGHT rating on the sector which is expected to be dull in terms of earnings growth and capped by expensive valuations. Specifically, 1QCY17 results season saw IHH coming in below expectations while KPJ and Pharmaniaga barely came in within expectations. IHH continued to be dragged down by pre-operating and start-up costs from the Gleneagles Hong Kong Hospital and Acibadem Altunizade. Pharmaniaga returned to the black in 1Q17 underpinned the recovering logistics division which was in the red in 4Q16. However, we expect earnings to see pedestrian sequential growth for Pharmaniaga in subsequent quarters in anticipation of volatile off-take and potential higher operating expenses. All in, healthcare stocks under our coverage are trading at rich PER valuations in contrast to their expected low teens earnings growth. We believe their growth potentials are already reflected in the valuations. 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.

Robust inpatient growth, supported by ageing population. 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 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 is 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 weighed down by marked-to-market volatility on translation of non-Turkish Lira borrowings. Overall, over the short-tomedium term, a slower-than-expected economic outlook and start-up costs on pre-opening of hospitals, including Gleneagles Hong Kong which has 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 28.6x for FY17E and 26.8x for FY18E, which appear rich as compared to its pedestrian growth for the two financial years. Earnings growth is also expected to be pedestrian over the next few quarters. Going forward, KPJ Perlis (greenfield, 90 beds) and KPJ Seremban (new block with additional 90 beds) are expected to commence operations by end-2017 and early-1Q18. Elsewhere, brownfield expansions include Taiping, Sri Manjung and KPJ Johor Bandar Dato Onn, which are expected to operate by end-2017 and early-2018.

Bleak short-term earnings outlook for Pharmaniaga. We expect earnings to be lukewarm in subsequent quarters in anticipation of volatile off-take and potential higher operating expenses. 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 - 7 Jul 2017