Cost optimisation initiatives over the past several quarters are bearing fruits. This coupled with expected ramped-up organic growth from new hospitals are expected to drive growth in 2H18. BUY with TP of RM1.35 based on 28x FY19E EPS (historical average 5-year forward PER). The stock is currently trading at 15% and 40% discount compared to its historical average of 28x and regional peers of 35x, respectively. The 40% discount to regional peers is wider compared to the historical average of 30%. 

Over the past few years the group has undertaken cost optimisation measures including better inventory and billing systems, and cost management in administration expenses. Additionally, the group plan to phase out or convert four-bedded rooms to twin-bedded ones for better rates. 

Earnings growth is expected to come from narrower losses and profitability for hospitals built 2-3 years ago including KPJ Kiang, Rawang, Maharani, Pasir Gudang and Pahang. KPJ Perlis (90 beds) has commenced operations in 2Q18. Beyond 2018, we expect KPJ Ampang (149 new beds), KPJ Johor (40 new beds) and KPJ Seremban (90 new beds) to drive earnings beyond 2018. New expansions namely Kuching, Sri Manjung and KPJ Johor Bandar Dato Onn are expected to start operating by 2Q19. The group is confident that start-up costs from new openings will be absorbed by: (i) incremental ramp-ups from earlier openings, and (ii) steady contributions from matured hospitals. 

New SST regime to be net positive for hospital operators like KPJ with exemptions to: (i) doctor's consultation fees, (ii) most or all medications likely to be exempted, and (iii) equipment. Any savings is expected to pass-through in FY19. We understand that KPJ is in the midst of disposing of its 57% stake in its aged-care business in Jeta Gardens. Given that this non-core segment has been loss-making over the years, the divestment is expected to be positive. Since the investment has been written down in year 2016, any gains arising from the divestment is only expected to be reflected in the balance sheet. 

Source: Rakuten Research - 14 Sept 2018