INVESTMENT HIGHLIGHTS

• 1HFY19 earnings marginally dropped by -1.7%yoy resulting from MFRS 16 and higher effective tax rate

• This is in spite of higher revenue (+5.4%yoy), driven by the recent opening of new hospitals

• KPJ Batu Pahat and Kluang Specialist expected to commence operation in 2HFY19

• Third interim dividend declared of 0.5sen per share

• Maintain NEUTRAL with a revised TP of RM0.96

1HFY19 earnings dropped by -1.7%yoy. KPJ Healthcare Bhd’s (KPJ) 2QFY19 earnings came in at RM43.1m. This brings its cumulative 1HFY19 earnings to RM83.4m which met ours and consensus expectations, accounting for 45.0% of ours and consensus full year FY19 forecasts. In comparison to the prior period, 1HFY19 revenue rose by +5.6%yoy to RM1715.4m. However, 1HFY19 earnings reduced by - 1.7%yoy to RM83.4m mainly due to the adoption of MFRS 16 and higher effective tax rate.

Rawang, Pasir Gudang and Johor achieved better profitability. The group earnings continues to be supported by the Malaysian operation whereby 1HFY19 revenue and PBT improved by +5.4%yoy and +6.0%yoy respectively. This is driven by the: (i) commencement of new hospitals such as KPJ Perlis and KPJ Bandar Dato’ Onn and; (ii) higher profitability achieved particularly for KPJ Rawang, KPJ Pasir Gudang and KPJ Johor as a result of increase in number of patient visit, number of beds and complex cases. However, we are concern on the declining group’s occupancy rate to 66.0% (-3.0ppts). We reckon that this could be due to the slew of new hospitals opening.

MFRS 16 and higher tax costs partially depressed earnings. The adoption of MFRS 16 requires the group to reflect majority of the Group’s hospitals that are leased from Al-‘Aqar Healthcare REIT (Neutral, TP:RM1.49) in its balance sheet starting from 1st January 2019. In 1HFY19, the depreciation charges and interest expense to amortise these assets and liabilities amounted to RM53.6m. As this amount is higher than the quarterly lease expense charged pre-MFRS 16 of RM48.1m, KPJ’s PBT for the 1HFY19 was partially depressed by - 4.0%yoy. Moreover, the increase in effective tax rate by +6.0ppts yoy to 30.2% during the period further dragged earnings.

Commencement of new hospitals. Two new hospitals are slated to commence operation in 2HFY19 namely KPJ Batu Pahat (60 operating beds by 3QFY19) and Kluang Specialist (90 operating beds by 4QFY19). In addition, the group is also undertaking major hospital expansion at its existing hospitals and most are expected to be completed in the 2HFY19. For instance, KPJ Seremban and KPJ Ampang will each add 87 additional operating beds in 3QFY19 and 4QFY19 respectively. Hence, we expect a higher start-up cost to be incurred in the 2HFY19.

Third interim dividend declared. The third interim dividend for FY19 was declared of 0.5sen per share. This brings its cumulative dividend to 1.5sen per share (vs FY18: 1.5sen).

Impact to earnings. We are revising our FY19F and FY20F forecast downwards by -3.6% and –3.0% to take into account the higher start-up cost and effective tax rate.

Target price. Post earnings announcement, we are revising our target price of RM0.96 per share (previously RM0.98). Our target price is derived from DCF valuation with terminal growth of 3.0% and WACC of 8.3%.

Maintain NEUTRAL. KPJ currently leads the local private hospital operator market with a 19.0% market share. In order to improve this, the group will sustain its efforts to increase new hospital developments as well as expanding the capacity of its exiting hospitals. The aggressive opening of greenfield and brownfield developments would further accelerate the revenue growth rate for the year. However, we are expecting the higher start-up costs to drag earnings in the shortterm. All factors considered, we are maintaining our NEUTRAL recommendation. The key risks to our call recommendation are: (i) delay in opening of new hospitals; (ii) lower-than-expected revenue per patient and; (iii) increase in operations cost.

Source: MIDF Research - 3 Sept 2019