KEY INVESTMENT HIGHLIGHTS

• 2QFY20 earnings came in at RM12.7m, lower by -70.0% year-over-year

• Revenue was impacted by enforcement of MCO during the quarter which resulted in decline in patient visits

• Decline in earnings was arrested by prudent cost savings initiatives in various forms

• Recovery in BOR and increase in procedures undertaken to boost earnings in 2HFY20

• Second interim dividend of 0.03sen declared

• Upgrade to BUY with an unchanged TP of RM0.94

2QFY20 earnings largely met expectations. KPJ Healthcare Bhd’s (KPJ) 2QFY20 earnings came in at RM12.7m. This brings its 1HFY20 earnings to RM51.2m which was largely within ours and consensus expectations, accounting for 30.7% and 35.4% of our and consensus’ full year FY20 forecasts respectively. Revenue during the quarter declined by -27.0%yoy whilst earnings dipped by -70.0%yoy mainly attributable to the lower revenue recorded by the Malaysian hospitals year-over-year following the continued enforcement of the Movement Control Order (MCO) by the Malaysian government. The MCO which remained in force during the quarter resulted in lower revenue recorded for the Malaysian hospitals operation at RM597.9m vs RM844.6m in revenue recorded in 1QFY20 prior to the implementation of MCO.

Earnings impacted by lower inpatients and outpatients admissions. The group’s decline in revenue during 2QFY20 was mainly attributable to lower revenue recognition from its Malaysian hospitals by -27.0%yoy following the enforcement of MCO during the quarter. This has resulted in the: (i) decline in number of patient visits; (ii) delay in non-critical procedures as well as; (iii) drop in bed occupancy rate (BOR) to an average of 34% during the quarter from 64% in 2QFY19. Consequently, PBT margin was also reduced to 3.0% in 2QFY20 (from 7.4% in 2QFY19).

Cost optimisation arrested the decline in earnings. That said, the impact on earning was also cushioned by various cost savings initiatives undertaken during the quarter. In particular, cost of sales and admin expenses recorded a decline -22.0%yoy and -31.0%yoy as a result of this, despite fixed costs continued to be incurred to ensure smooth running of the hospitals. During the quarter, cost of sales was recorded at 74.6% similar to that of 2QFY19 at 70% whilst admin expenses remained relatively unchanged at 18.7% vs 19.7% in 2QFY19 – which is in proportion to the lower revenue. Furthermore, we understand that KPJ has also benefitted from: (i) salary subsidy; (ii) rebate on rental from Al-Aqar REIT of RM6.0m for two months and; (iii) six months loan moratorium introduced by the Government

which have helped to support its daily business operations despite the decline in business activities during the quarter under review.

Lacklustre performance from international operations. Meanwhile, revenue from its Indonesian operations dipped by -61.1%yoy due to the implementation of Pembatasan Sosial Berskala Besar (PSBB) which impacted patient visits in Indonesia. This has resulted in the Indonesian operation registering a loss before tax of –RM1.93m vs RM1.9m profit in 2QFY19. Meanwhile, Jeta Gardens’s revenue and earnings were down by -4.3% and -15.2% year-over-year respectively which dragged the contribution from the international segment further.

Second interim dividend of 0.03sen declared. In line with its lower earnings, a second interim dividend of 0.03sen per share was declared for 2QFY20. This brings its 1HFY20 dividend declared to-date to 0.08sen vs 0.10sen in 1HFY19. This also represents a 66.7% payout from its 1HFY20 EPS of RM0.12sen which translates to an annualised yield of 2.0% to yesterday’s closing price. While the dividend payout was lower than we projected however; we are maintaining our FY20- 21F dividend projections for now as we believe that the dividend declared in the second half of FY20 will make up for the shortfall.

Impact to earnings. We are making no changes to our FY20-21F earnings estimates at this juncture as we expect the earnings from second half of FY20 will make up for the short fall of the current year earnings.

Target price. Maintained at RM0.94 per share. Our target price is derived from DCF valuation with terminal growth of 3.0% and WACC of 8.3%.

Upgrade to BUY. Following its analyst briefing, we turn more positive on KPJ’s future earnings trajectory. While FY20 will prove to be a challenging year for private hospital operators, we view positively the post-MCO recovery in terms of BOR (at 49% in July 2020) and increase in procedures undertaken (up to 7,653 in July from the low of 3,377 in April) given that the pent up in restriction of non-medical services will finally be relieved albeit, gradually towards the remainder of the year given the easing of Covid-19 measures.

In addition, we note that there will be further cost optimisation that KPJ can leverage on for the remainder of the year such as the salary subsidy (for certain affected hospitals that are still in gestational period) and potential extension of its loan moratorium (if applicable) into 4QFY20 which could help soften the impact from the decline in its 1HFY20 earnings. The group also intends to continue growing its revenue organically via expanding existing hospital capacities as well as opening greenfield and brownfield developments which is expected to further accelerate the revenue growth rate going forward.

Furthermore, we are expecting the adverse impact from the international operations to be kept at a minimal level as the company works towards re-strategising its international presence. Hence, we are upgrading our recommendation on KPJ to

BUY (from Neutral previously). The key risks to our recommendation are: (i) delay in the execution of expansion plan; (ii) lower-than-expected revenue per patient and; (iii) increase in operations cost.

Source: MIDF Research - 28 Aug 2020