We maintain our UNDERWEIGHT rating on the sector which is expected to be dull in terms of earnings growth and further capped by expensive valuations. The recent 4QCY17 results season was unexciting with regards to earnings. KPJ offers the only bright spot, reporting earnings above expectations due to better-than-expected improvement in recently opened hospitals. Pharmaniaga came in within expectations, while IHH came in below. IHH’s results marked the fourth consecutive quarterly earnings disappointment, hit by ramp-up of hiring, pre-operating costs and incremental depreciation from newly built hospitals, amortisation and finance costs. All in, healthcare stocks under our coverage are trading at rich PER valuations in contrast to their expected low-teens earnings growth. Maintain Outperform on KPJ Healthcare. Following KPJ’s stellar FY17 result on the back of lower-than-expected losses from newly opened hospitals, valuations are looking undemanding. The stock is currently trading at 20% and 44% discount compared to historical average of 25x and regional peers of 35x, respectively. Our stock calls are KPJ (OP; TP: RM1.05); IHH (UP; TP: RM4.90); and PHARMA (MP; TP: RM3.85).

Weak FY17 results and pedestrian growth while longer-term growth supported by ageing population. Overall 4Q17/FY17 results came in below expectations. Specifically, 4QCY17 results season saw both Pharmaniaga and IHH coming in below expectations while KPJ came in above expectations. IHH’s results marked the fourth consecutive quarterly earnings disappointment, hit by ramp-up of hiring and pre-operating costs to prepare Gleneagles Hong Kong Hospital and Acibadem Altunizade Hospital and unrealised foreign exchange loss of non-Turkish Lira borrowings. KPJ’s stellar FY17 results were on the back of lower-than-expected losses from newly opened hospitals. Over the longer term, growth is expected to be supported by an ageing population and growing awareness in healthcare maintenance and disease 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.

IHH missed consensus earnings for fourth successive quarters. 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 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 2020), Pantai Hospital Klang (120 beds, completion in 2020), Pantai Kuala Lumpur (120 beds, completion in 2018). Greenfield projects meanwhile, namely Gleneagles Chengdu (350 beds, completion in end 2018), Gleneagles Nanjing (70 beds, completion in 2020), Gleneagles Shanghai (450 beds, completion in end 2019), and (ii) in Turkey, Acibadem is currently undertaking expansion in Acibadem Maslak (195 beds, target completion 2018). The greenfield projects are Acibadem Atasehir (325 beds, target completion 2019) and Acibadem Kartal (120 beds, target completion 2019).

Bleak short-term earnings outlook for PHARMA. We expect Pharmaniaga (PHARMA)’s earnings to be lukewarm in subsequent quarters in anticipation of volatile off-take and potential higher operating expenses. 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, which should boost demand for its products and lift earnings.

KPJ valuation appears to be attractive again, Reiterate OP. We believe values are starting to emerge with the recent weakness in the share price following the recently announced stellar FY17 result. The stock is currently trading at 20% and 44% discount compared to historical average of 25x and regional peers of 35x. The 44% discount to regional peers is wider compared to the historical 30%. Earnings growth is expected to come from narrower losses and profitability for hospitals built 2-3 years ago including KPJ Rawang, Maharani, Pasir Gudang and Pahang. Going forward, KPJ Perlis (greenfield, 90 beds) and KPJ Seremban (new block with additional 90 beds) are expected to commence operations by 2018. Elsewhere, brownfield expansions include Taiping, Sri Manjung and KPJ Johor Bandar Dato Onn which are expected to operate by early 2018.

Source: Kenanga Research - 6 Apr 2018