Resilience in healthcare

• 3Q16 earnings were in-line; dragged by higher costs
• FY16 earnings to be supported by improved operations in Malaysia and Indonesia
• Aggressive expansion plan ahead; earnings to improve in the long term after new hospitals go through gestation period

What’s New

• KPJ Healthcare booked RM32.5m net profit in 3Q16 (-15% y-o-y). This is in line with our forecast but below consensus expectations.

• Revenue increased by 6% y-o-y to RM767m, backed by improved contributions from its healthcare operations in Malaysia and Indonesia, despite the challenging economic environment and entry of new players into the industry.

• However, the increase in revenue has been offset by the increase in administration and operating expenses, as well as finance costs owing to the new hospital not generating sufficient revenue relative to the expenses incurred.

• Inpatient volume and outpatient volume remained flat in the quarter. In addition, the average length of stay also remained flat at 2.55 days in 3Q16 compared to 2.53 days in 3Q15.

• Gross margin declined to 30.1% in 3Q16 (-1.4ppts yo-y).

• KPJ also declared an interim dividend of 1.50 sen per share, implying a payout ratio of 48%, in line with our expectations.

Aggressive growth plan

• KPJ has around 21% market share in terms of private licensed beds with 1,100 specialist doctors in its network. Pricing strategy is influenced by local competition that each hospital operates in.

• The group opened a new hospital, KPJ Pahang Specialist, in May 2016. Furthermore, KPJ Selangor recently completed its renovation works and is slated to be re-opened by 1Q17.

• In the medium to long term, Indonesia is going to be the next market that KPJ intends to expand to, given that it already has a strong brand presence among Indonesians who make up its largest foreign patient group. Currently, KPJ operates two hospitals in Indonesia. However, KPJ intends to focus on completing its domestic expansion plan first before embarking on expansion plans in Indonesia. (See Exhibit 1).

• KPJ is planning to build eight new hospitals over the next five years. To date, one of the hospitals is completed with another four expected to be operational by end-FY18F. In addition, the group is expanding eight of its existing hospitals in FY16-17F. This will enable the group to maintain its pole position as the largest hospital operator in Malaysia.

Valuation

We maintain our HOLD rating, with a TP of RM4.60. Our TP is based on SOP-valuation (15x FY16F EV/EBITDA for hospital operations, 6% yield for its 49% stake in Al-Aqar Healthcare REIT) and implies 29x FY16F PE and 4.0x P/BV

Key risk

Longer-than-expected gestation period for new hospitals. A new hospital takes around 3-5 years to be profitable. KPJ’s near-term earnings could be hit by high start-up losses at its new hospitals, if the gestation period turns out to be longer than expected, or if its expansion plan proves to be too rapid.

Source: Alliance Research - 1 Dec 2016