INVESTMENT HIGHLIGHTS

• Sector earnings remain resilient despite higher OPEX

• Organic growth to continue driving revenue and earnings

• Slower pace of expansion leaves plenty of room for earnings recovery

• Resilience in demand to continue

• Maintain POSITIVE on the sector

Sector earnings remain resilient despite higher OPEX. In the recently concluded earnings season, all of the healthcare operators under our coverage posted earnings that were in line with our full-year earnings estimates. Due to this, we have maintained our full-year earnings estimates for both IHH Healthcare (BUY, TP: RM7.06) and KPJ Healthcare (NEUTRAL, TP: RM4.30). However, we have revised our earnings estimate for Pharmaniaga (NEUTRAL, TP: RM4.66) as we opine that meaningful recovery in earnings will only be visible in 2H18. With that, we have revised down our TP for Pharmaniaga to RM4.66 (from RM5.19 previously). During the quarter, most operators experienced high operating costs associated with opening of new hospitals which disrupted earnings growth. That said, most healthcare operators reported year-over-year improvement in earnings due to the: (i) revision in prices to accommodate inflation effect on OPEX; (ii) increase in number of complex cases undertaken and; (iii) increase in contribution from existing and newly opened hospitals. In addition, we opine that current condition of high OPEX is temporary as the high OPEX will be offset by higher contribution from the newly opened hospitals going forward.

Organic growth to continue driving revenue and earnings. We reiterate our view that we expect earnings of the private healthcare operators to display further improvements from 4Q17 onwards. From 4Q17 onwards, we are expecting revenue and earnings growth to be mainly driven by organic growth from existing hospitals as well as hospitals that were newly opened back in 2015 and 2016. In addition, we are also expecting the opening of new specialization wards in recently opened hospitals will contribute positively to the operators’ earnings as well. Furthermore, as the contribution from newly opened hospitals grows, it will offset the high operating expenditures associated with the opening of the new hospitals.

Slower pace of expansion leaves plenty of room for earnings recovery. Aside from the organic growth from existing and new hospitals, we are expecting earnings to pick up again from 4Q17 onwards now that most healthcare operators have passed the CAPEX-intensive period due to the aggressive expansion plans undertaken for the past two years. We believe that this will leave plenty of room for earnings recovery as it will potentially free up working capital used to finance the expansions. Major hospital operators under our coverage have indicated that at most, one new greenfield hospitals will be added each year as compared to two greenfield hospitals previously. Aside from that, the only CAPEX these operators will incur will only be on the expansion of existing hospitals.

Maintain POSITIVE. All in, we are reiterating our POSITIVE stance on the sector as we expect demand for healthcare services to remain robust for the remainder of 2017. We opine that the sector’s earnings growth will remain resilient which is evident by the increase in inpatient admissions despite the ongoing battle against inflationary costs. Our

POSITIVE stance is premised on: (i) strong demand for quality healthcare and, (ii) lack of public healthcare amenities to cater for patients especially in the urban areas. We also opine that private healthcare operators will continue to be the preferred choice for the urban dwellers with higher disposable income and insurance coverage. IHH Healthcare (BUY; TP: RM7.06) is our Top Pick for the sector. We like IHH for its: (i) geographically-diversified revenue base; (ii) robust balance sheet and; (iii) strategic expansion plans.

Source: MIDF Research - 19 Sept 2017