9M17 core net profit of RM413.4m (-36% YoY) came in below expectations at 48%/52% of our/consensus full-year forecasts. The negative variance from our forecast is due to higher-than-expected operating cost. This quarter marked the third consecutive quarterly earnings disappointment. We cut our FY17E/FY18E NP by 15%/6% to take into account lower margins. TP is reduced from RM5.08 to RM5.00 based on SoP. Reiterate UNDERPERFORM.

9M17 missed expectations. 9M17 core net profit of RM413.4m (-36% YoY) came in below expectations at 48%/52% of our/consensus full- year forecasts. The negative variance from our forecast is due to higher-than-expected operating cost. No dividend was declared in this quarter as expected.

Key Result Highlights. QoQ, 2Q17 revenue increased 1% due to the ramping up of Gleneagles Hong Kong Hospital and Acibadem Altunizade Hospital. 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 RM87.5m exchange loss on net borrowings, 3Q17 core PATAMI came in at RM125.4m (+46%) boosted by lower net finance costs as the Group repaid bank loans of RM848m.

YoY, 9M17 revenue grew 12% 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 hospitals. The acquisition of Continental, Global Hospitals and Tokuda Group and City Clinic further boosted revenue. However, EBITDA decreased by 3% mainly due to pre-operating and start-up costs from Gleneagles Hong Kong Hospital and Acibadem Altunizade Hospital. EBITDA also decreased as a result of higher operating and staff costs. This brings 9M17 core PATMI to RM413.4 (-36%) 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. 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-to-medium term, a slower-than- expected economic outlook and start-up costs on pre-opening of hospitals, including Gleneagles Hong Kong (GHK) which had just recently commenced operations are expected to put pressure on cost and margins at least over the short term. GHK has gradually taken on more complex cases after 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.

Downgrade FY17E/FY18E net profit by 15%/6%. We cut our FY17/FY18 net profit forecasts by 15%/6% to take into account lower margins due to the higher-than-expected operating cost.

Maintain UNDERPERFORM. Correspondingly, our TP is reduced from RM5.08 to RM5.00 based on sum-of-parts. The stock is currently trading at PERs of 67x for FY17E and 54x for FY18E, which appear rich as compared to its average net profit growth prospects of 10% p.a.

Key risk to our call includes faster-than-expected ramp up in new hospitals.

Source: Kenanga Research - 28 Nov 2017