1H17 core net profit of RM288m (-32% YoY) came in below expectations at 30% of both our and consensus full-year forecasts. The negative variance from our forecast is due to higher-than-expected operating cost. This quarter marked the second consecutive quarterly earnings disappointment. We are conservatively cutting our FY17 and FY18 net profits forecasts by 9% to take into account lower margins. Correspondingly, our TP is reduced from RM5.34 to RM5.08 based on SoP. Reiterate UNDERPERFORM.

Key Result Highlights. QoQ, 2Q17 revenue increased 3% due to contribution from Parkway Pantai (+2.4%) and Acibadem (+4.2%) driven by organic growth from its existing operations, and the continuous ramping up of Gleneagles Hong Kong Hospital and Acibadem Altunizade Hospital since their opening in March 2017. EBITDA fell due to accruals for professional fees in relation to potential acquisitions and the ramp-up of hiring and pre-operating costs to prepare Gleneagles Hong Kong Hospital and Acibadem Altunizade Hospital as well as higher operating and staff costs. Excluding RM241m gains from divestment of Apollo Hospitals, 2Q17 core PATAMI came in at RM86.2m (-51%) dragged down by exchange loss on net borrowings and incremental depreciation, amortisation and finance costs with the opening of the two new hospitals in March 2017. No dividend was declared in this quarter as expected.

YoY, 1H17 revenue grew 10% due to: (i) high intensities in patient volume and revenue of existing operations, and (ii) organic growth of existing operations and the continuous ramp-up of the hospitals. The acquisition of Continental, Global Hospitals and Tokuda Group and City Clinic further boosted revenue. However, EBITDA decreased by 6% mainly due to pre-operating and start-up costs from the Gleneagles Hong Kong Hospital and Acibadem Altunizade Hospital, both commencing operations in March 2017. EBITDA also decreased as a result of higher operating and staff costs. The brings 1H17 core PATMI to RM288m excluding gains from divestment of Apollo (RM554.5m) and exchange loss on borrowings which came in lower by 32% and dragged down by incremental depreciation, amortisation and finance costs with the opening of two new hospitals in March 2017.

Outlook. Over the short-to-medium term, start-up costs on pre-opening of hospitals, including Gleneagles Hong Kong (GHK) which commenced operations in Mar 2017 are expected to put pressure on margins. Specifically, the oncology services expected to commence operations in 2H17 are expected to incur additional costs. GHK has gradually taken on more complex cases after its opening and is expected to increase revenue as it ramps up operations. The Group expects higher costs of operations arising from wage inflation as a result of increased competition for trained healthcare personnel in its home markets. We expect key greenfield projects in China, specifically Gleneagles Nanjin (70 beds), Shanghai (450 beds) and Chengdu (350 beds) with expected completion in end 2018 and 2019 to be an impetus for growth.

Downgrade FY17E and FY18E net profit by 9%. We are conservatively cutting our FY17 and FY18 net profits forecasts by 9% to take into account of lower margins due to the higher-than-expected operating cost.

Maintain UNDERPERFORM. Correspondingly, our TP is reduced from RM5.34 to RM5.08 based on sum-of-parts. The stock is currently trading at PERs of 58x for FY17E and 51x for FY18E, which appear rich as compared to its average net profit growth prospects of 10% p.a..

Source: Kenanga Research - 24 Aug 2017