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. However, we believe that the healthcare industry will continue to enjoy stable growth, supported by the growing healthcare expenditure, rising medical insurance and an ageing population demographic. The latest 4QCY19 results season saw a mixed bag of results. IHH and Pharmaniaga’s earnings came in line with expectations. KPJ stole the show with the help of investment tax allowance. However, IHH’s FY19 earnings were impacted by lacklustre performance from Acibadem and wider losses in its India operation. Despite in-line results, Pharmaniaga reported earnings were hit by amortisation of the PHIS system under the concession agreement. On picks, we like KPJ as (i) start-up costs from new openings will be absorbed by incremental ramp-ups from earlier openings and steady contributions from matured hospitals and (ii) the stock is currently trading at 20% and 40% discounts compared to historical average of 25.5x and regional peers of 35x, respectively.

Growth in healthcare supported by ageing population. It is estimated that for the 2010-2040 period, Malaysian population aged 65 and over is projected to increase more than three-fold of the 2010 population. The increase will lead Malaysia to become an ageing population nation in 2021 when the population aged 65 years and over reach 7.1%. Based on the United Nations (UN) definition, an aging society is when the population aged 65 and over achieve 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 are expected to increase by 1.4 and 6.4 percentage points, respectively. Longer life spans have also resulted in a larger number of people aged 65 and above. This improvement has been attributed mainly to advances in medical technology, higher personal wealth and awareness of the importance of healthcare.

India is a concern for IHH. IHH’s FY19 earnings were impacted by widening losses at India operation. FY19 revenue and EBITDA increased 29% and 34%, respectively, underpinned by sustained organic growth from existing operations and the continuous ramp-up of Gleneagles Hong Kong Hospital (decreasing start-up losses) and Acibadem Altunizade as well as contribution from Acibadem Maslak. The acquisition of Amanjaya in Oct 2018 and Fortis in Nov 2018 also bolstered FY19 revenue and EBITDA. Looking ahead, over the medium term, IHH is expected to face tough operating conditions on the back of: (i) the uncertain Turkish Lira which has depreciated against USD, Euro and MYR with continued volatility, and (ii) execution risk at Fortis as well as uncertainty over its timeline in terms of a turnaround to profitability.

Pharmaniaga’s supply concession ceases, but concession for logistics and distribution extended. Pharmaniaga’s 4QFY19 result was hit by contractual obligations where the remaining unamortised costs in PHIS were amortised under the concession agreement. With the new contract arrangement as explained, the remaining unamortised rights to supply have been fully recognised. The Government has agreed to provide a 25-month interim period for procurement of drugs to Pharmaniaga Bhd after its concession ended on 30th Nov 2019. The interim period from 1st Dec 2019 to 31st Dec 2021 was to avert supply chain disruption in the supply and distribution of medicines nationwide while an open tender and appointment of a new concessionaire is developed. However, starting from 1st Dec 2019, the government awarded Pharmaniaga a five year contract extension for logistics and distribution of medicines based on its capabilities and performance. We highlight here that PBT margin for Logistics & Distribution segment is razor-thin, averaging at 0.8% over the past 13 quarters. We believe the contract extension for logistical support lies in Pharmaniaga’s capability in the development of a procurement and logistical computerised system i.e. Pharmacy Information System (PHIS) which is a vital and integral role in ensuring the distribution of drugs to patients and effective management of stock levels. We continue to remain less optimistic on Pharmaniaga and as such roll forward our valuation from FY20E to FY21E. TP is cut from RM1.85 to RM0.90 based on 5x FY21 EPS (-2.0 SD below 5-year historical forward average). The share price has since retraced by 50% since our downgrade. Reiterate Underperform.

KPJ’s valuation appears to be attractive again, Reiterate OP. The group 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. As indication, start-up losses are only seen in KPJ Perlis and KPJ Bandar Dato Onn. Earnings growth is expected to come from narrower losses and earnings from hospitals built 2-3 years ago. We like KPJ as (i) start-up costs from new openings will be absorbed by incremental ramp-ups from earlier openings and steady contributions from matured hospitals and (ii) the stock is currently trading at 20% and 40% discounts compared to historical average of 25.5x and regional peers of 35x, respectively.

Source: Kenanga Research - 3 Apr 2020