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 pedestrian but stable growth, supported by growing healthcare expenditure, rising medical insurance and an ageing population demographic. The latest 2QCY20 results season saw both IHH and KPJ’s earnings coming in below expectations, hit by the COVID pandemic leading to lower bed occupancy and inpatient volume. However, Pharmaniaga came in line. IHH’s 2QFY20 earnings sank into the red due to lower contribution across the aboard, further exacerbated by losses in India and Acibadem. For stock pick, 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 an ageing population. It is estimated that for the 2010-2040 period, the Malaysian population of the over 65 age bracket is projected to increase more than three-fold. The increase will lead Malaysia into becoming an ageing population nation in 2021 when the population aged 65 years and over reaches 7.1%. Based on the United Nations (UN) definition, an aging society is when the population aged 65 and over reaches 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 and Turkey are concerns for IHH. IHH’s 2QFY20 earnings were impacted by lower contribution across the board as inpatient admission fell between 25% to 43% in the group’s operating units including Singapore, Malaysia, India and Turkey where Acibadem losses widened. With the re-opening of economies, the group expect subsequent quarters to show marked improvement. The group has undertaken cost initiatives measures to defer non-essential capex and opex to mitigate any shortterm revenue shortfall. Due to the COVID-19 pandemic, the opening of Parkway Shanghai has been postponed to 2021. Thus far, the group has further deleveraged its non-lira debt in its Turkish operations from EUR267m to EUR180m as at June 2020. Looking at performance of IHH’s 62%-owned Continental Hospitals and 74%-owned Global Hospitals acquired in 2015 where their EBITDAs are hardly positive, India is seen as a tough operating environment for IHH. We are also concerned over issues at Fortis, including an auditor’s qualified audit report in FY19, potential risk of provisions, lapses in internal controls leading to regulatory probing, which could well mean execution risk.

Pharmaniaga’s supply concession ceases, cloudy earnings visibility beyond Dec 2021. The share price has risen sharply since July on talks that Pharmaniaga will be selected to package the Covid-19 vaccine once it is developed. However, we caution that such talks are premature and even if selected, there may be multiple packagers of the vaccine. It is also unclear at this stage as to the financial impact of such a venture, mindful that the government will likely want to see it delivered in the most competitive manner as possible. TP is raised from RM1.35 to RM1.80 based on 8x FY21E EPS (previously 6x) due to improved short to medium-term outlook. However, this raised multiple is -1.5SD below 5-year historical forward mean due to lack of earnings clarity beyond FY21. The recent run-up in its share price has rendered current valuation to be unattractive, which seems to have overpriced the positive near-term prospects. The Government has agreed to provide a 25-month interim period for procurement of drugs to Pharmaniaga Bhd after its concession ends on 30th Nov 2019. The interim period from 1st Dec 2019 to 31st Dec 2021 is to ensure no 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 has awarded Pharmaniaga a fiveyear 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 0.2% over the past 20 quarters.

KPJ’s valuation appears to be attractive again, Reiterate OP. 1QFY20 earning was impacted by additional expenses incurred mainly from the increase in the purchase of material costs and personal protection equipment for the pandemic front liners. The Group also contributed in terms of providing additional manpower, loaning of equipment and cash donations to the Ministry of Health (MOH) in managing the pandemic. Earnings growth is expected to come from narrower losses and earnings from hospitals built 2-3 years ago. In summary, 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 - 7 Oct 2020