INVESTMENT HIGHLIGHTS

• 3Q16 earnings within expectations

• Stable revenue growth across all markets

• Earnings affected by increasing costs

• Headline operational metrics remains intact

• Maintain NEUTRAL with unchanged TP of RM4.05

Within expectations. KPJ’s 3QFY16 earnings of RM32.5m came in broadly within our and consensus expectations, accounting for 70% of full year earnings forecasts respectively. Revenue increased year-overyear by +6.3% while earnings declined by -14.8%. On a quarterly sequential basis, KPJ’s revenue and earnings recorded an increase of +0.3% and +3.3% respectively. In addition, a dividend of 1.50sen was also declared during the quarter under review.

Stable revenue growth across all markets. In 3QFY16, KPJ recorded an increase in revenue contributed by the combination of organic growth from existing hospitals as well as the increasing revenue from newly opened hospitals across all its markets. The revenue from Malaysian hospitals increased by +5.1%yoy due to the aforementioned reasons while the Indonesian operations revenue recorded an increase by +6.1%yoy mainly attributable to the increase in number of patients at both hospitals especially from Rumah Sakit (RS) Medika Bumi Serpong Damai. Its Australian aged care service also reported an encouraging revenue growth of +69.1% year-over-year which was mainly attributed to the higher capacity of the retirement village, with additional beds which has been opened in phases from mid of 2015 until May 2016. PBT and net margins have also improved marginally against the preceding quarter due to the better revenue recorded.

Earnings affected by increasing costs. Despite the healthy revenue growth, KPJ’s earnings were marred by: (i) increase in depreciation from newly opened hospitals including KPJ Sabah and KPJ Pahang; (ii) increase in finance costs and; (iii) provisions made for ESOS during the quarter. We view the current condition to be temporary in nature as we believe the increase in costs mentioned previously will be offset by the increasing revenue from newer hospitals opened in 2014 and 2015. We also think that its Indonesian hospitals have yet to reach its full potential and are able to contribute more to the group

Headline operational metrics remains intact. In 3QFY16, we note that the number of admissions was flattish yearover-year with an increase in inpatient (+0.8%yoy) and decline in outpatient (-0.9%yoy) due to persistent soft consumer sentiment. Inpatient admission was recorded at 212,198 for the 9MFY16 vs 210,536 in 9MFY15 while occupancy rate for beds declined to 67.5% (vs 68.8% in 9MFY15) with an average length of stay of 2.55days.

Earnings forecast. We are maintaining our FY16-17 earnings forecasts for now as we expect that KPJ will be able to meet our earnings projections. This is due to the fact that fourth quarter is traditionally a strong quarter for healthcare players due to the holiday season. The key risks to our earnings are: (i), delay in opening of new hospitals, (ii) longerthan-expected gestation period for new hospitals; (iii) lower-than-expected inpatient admissions and revenue per patient and; (iv) increasing cost of operations.

Maintain NEUTRAL with unchanged Target Price (TP) of RM4.05. We are reiterating our NEUTRAL recommendation on KPJ with an unchanged SOP-based TP of RM4.05 per share (TG: 3.0%, WACC: 8.3%). We think this is fair given the challenging operating environment with the increasing operational costs as well as the persistent soft consumer sentiment which leads to cost-sensitive patients switching to public hospitals or delaying their procedures. We are also wary on the fact that the current currency environment of a strong USD against MYR might add additional pressure on their operating expenses.

Source: MIDF Research - 1 Dec 2016