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 4QCY18 results season saw a mixed bag of results. IHH’s 4Q18 earnings came in above expectations due to higher-than-expected revenue per inpatient. KPJ came in within expectations due to improvement in newly opened hospitals. Pharmaniaga came in below expectations, hit by lower-than-expected volumes sales. KPJ is confident that start-up costs from new hospital openings will be absorbed by: (i) incremental ramp-ups from earlier openings, and (ii) steady contributions from matured hospitals. The stock is currently trading at 15% and 40% discount compared to its historical average of 28x and regional peers of 35x, respectively. The 40% discount to regional peers is wider compared to the historical average of 30%. All in, healthcare stocks under our coverage are already trading at rich PER valuations in contrast to their expected low-teens earnings growth.

Mixed bag of 4QCY18 results. The 4QCY18 results season saw a mixed bag of results. IHH’s 4Q18 earnings came in above expectations due to higher-thanexpected revenue per inpatient. KPJ came in within expectations due to improvement in newly opened hospitals. Pharmaniaga came in below expectations, hit by lowerthan-expected volumes sales. 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.

Fortis is a concern for IHH. IHH’s 4Q18 earnings came in above expectations due to higher-than-expected revenue per inpatient. However, we are concerned over issues at Fortis, including an auditor’s qualified audit report in FY18, which has been carried forward into the quarterly review on 13 Feb 2019, risk of more provisions, lapses in internal controls, which led to regulatory probing, which could well mean execution risk exposure. However, earnings continued to be dragged down by foreign exchange losses on Acibadem Holding’s non-Turkish Lira denominated borrowings. 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. Looking ahead, over the short-to-medium term, IHH is expected to face higher operating costs arising from wage inflation as a result of increased competition for trained personnel and start-up costs on pre-opening of hospitals, including Gleneagles Hong Kong (GHK) which will put pressure on cost and margins. Since June 2018, the Turkish Lira has depreciated significantly against USD, Euro and MYR, with continued volatility in the currency. This will results in foreign exchange translation losses on the Group’s balance sheet and income statement.

Pharmaniaga clouded by uncertainty in the renewal of medical supplies concession. The de-rating is on concerns of Government reviewing all medical supplies concession agreements of which Pharmaniaga has a 10-year contract ending in November 2019. We are uncertain of the renewability of the contract but Pharmaniaga has the track record, platform and systems in place for the distributions of medical supplies. Its Indonesian operations remain a key area of growth, while further progress is being made in the European Union as the Group seeks to expand its global presence. In tandem with this, the Group is focused on implementing continuous cost optimisation measures across its operations. Over the longer term, we expect its manufacturing division to propel earnings growth. 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 revenue and lift earnings.

KPJ’s valuation appears to be attractive again, Reiterate OP. The group is confident that start-up costs from new openings will be absorbed by: (i) incremental ramp-ups from earlier openings, and (ii) steady contributions from matured hospitals. 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. KPJ Perlis (greenfield, 90 beds). Elsewhere, brownfield expansions include KPJ Miri (96 beds) and KPJ Kuching (150 beds) which are expected to start operating by 2Q 2019. KPJ Bandar Dato Onn has commenced operation in end 4Q 2018. The stock is currently trading at 15% and 40% discount compared to its historical average of 28x and regional peers of 35x, respectively. The 40% discount to regional peers is wider compared to the historical average of 30%.

Source: Kenanga Research - 5 Apr 2019