Aggressive expansion plans of two new hospitals p.a. could help KPJ maintain its dominance in the local healthcare sector, while an active pursuit of the lucrative healthcare tourism market, could lift the company’s profile over the longer term. We maintain our Buy call on the stock given the defensive qualities of the healthcare industry as well as its undemanding valuations of 21.8x CY13 PER (vs. 27.0x for regional peers).

- Aiming for a larger slice of the healthcare tourism pie. Management has set an internal target of growing its medical tourism business to a targeted revenue contribution of 25% by 2020 (from <10% currently). For this purpose, KPJ has earmarked its new flagship hospital in Bandar Dato’ Onn as a medical tourism hub. We are positive on this, as KPJ’s bold move into the more competitive but lucrative medical tourism industry, could lead to improvement in margins over the longer term.

- Not yielding anytime soon. As competition in Malaysia’s private healthcare sector heats up with most major players aggressively expanding capacity, management has reaffirmed that KPJ would stick to its internal target of opening at least two new hospitals p.a., in order to meet its longerterm goal of owning at least 40 hospitals in Malaysia by 2020. Thus far, KPJ’s asset-light business model has allowed the company to expand at a more aggressive rate and maintain its position as Malaysia’s largest private
hospital operator.

- Valuations are still attractive. KPJ’s aggressive expansion plans of two new hospitals p.a. could help the company maintain its dominance in the local healthcare sector, while its active pursuit of the lucrative healthcare tourism market, could lift the company’s profile over the longer term. We have raised our target multiple from 23.5x to 26.0x to be in line with the increase in regional peers’ valuation. The stock remains attractive given the defensive qualities of the healthcare industry as well as its cheaper valuations of 22.0x CY13 PER (vs. 26.0x for regional peers). We maintain our Buy call on the stock with a revised fair value for KPJ of MYR7.14 (from
MYR6.45).

KPJ recently participated in our Asean Corporate Day event, which was held on 25 Apr. We set out below the key highlights of the event.

New flagship Bandar Dato’ Onn hospital to spearhead growth in medical tourism.

Malaysia’s medical tourism market remains relatively small in comparison to its neighbours, Thailand and Singapore, despite registering strong growth of 22% p.a. over the last five years. As such, the Malaysian Government had, under the Entry Point Project 4 (EPP 4) of the Healthcare National Key Economic Areas (NKEA), targeted an additional 1,900 beds to achieve its target of attracting 2m healthcare travellers by 2020. We understand that this initiative also serves to encourage private healthcare players to broaden its patient base beyond the Indonesian market and to position themselves as a provider of higher-end medical treatments.

For KPJ, management has set an internal target of growing its medical tourism business to a targeted revenue contribution of 25% by 2020 (from <10% currently). Currently, the largest contributors to the group’s medical tourism business are the KPJ Johor Specialist and KPJ Ampang Puteri Specialist hospitals, which we believe is due to hospitals’ proximity to foreign communities and the availability of more specialised medical treatments. Most of KPJ’s hospitals are, however, located closer to local communities and are more occupied with servicing the domestic market. Thus, in order to grow the medical tourism business further, KPJ intends to transform three of its existing hospitals (Damansara, Johor and Ipoh) into reference centers for oncology treatment. These hospitals would be upgraded to include new facilities in oncology and radiotherapy treatment, while an additional nuclear medicine facility would be introduced at the KPJ Johor Specialist hospital by 2Q13. In addition, KPJ has earmarked its new flagship hospital in Bandar Dato’ Onn as a medical tourism hub. Upon opening in 2014, the hospital would house six Centres of Excellences in the field of field of Oncology, Women & Child, Cosmetics and Reconstruction, Orthopedic, Cardiology and Geriatrics. Management mentioned that services rendered in the hospital would be priced competitively in order to tap on the more price-sensitive foreign community from Singapore. While KPJ is still a long way from achieving its target, we are positive on its bold move into the more competitive but lucrative medical tourism industry, which would see margins improving over the longer term. Separately, management said that its acquisition of a 23.4% stake in the 263-bed Vejthani Hospital was a strategic move to gain entry into the Thai healthcare market and bridge the gap with its larger competitors. Management also stated its intentions to extract value via mutual patient referrals with Vejthani hospital given the latter’s strong presence in the medical tourism segment.

Not yielding anytime soon.

KPJ is currently the largest private healthcare service provider in Malaysia with an existing network of 24 hospitals and a total of 2,772 beds which, based on our estimates, account for approximately 20% market share of beds locally. As competition in Malaysia’s private healthcare sector heats up with most major players aggressively expanding capacity, management has reaffirmed that KPJ would stick to its internal target of opening at least two new hospitals p.a., in order to meet its longer-term goal of owning at least 40 hospitals in Malaysia by 2020. Among KPJ’s pipeline of hospitals, two in Pasir Gudang and Muar is scheduled to begin operations by this year, while the operations at Sabah Medical Centre’s new hospital building is expected to commenced with 80 beds (Phase 1) by early-2Q. In total, the above expansion plans are expected to lift KPJ’s capacity to 2,871 beds (from 2,716 currently) by end-2013 and thus, help bring down its occupancy rate to a more healthy level of 70% (from 80% currently). We have assumed annual capex of MYR200m in our FY13-14 earnings forecasts. In our view, the above pipeline of new hospitals coupled with KPJ’s strong execution track record means that we remain comfortable with the group’s ability to continue delivering sustainable earnings growth moving forward.

Separately, we note that, despite adopting an aggressive growth strategy, the company has not faced any shortage of working capital thus far, as completed hospital buildings are typically injected into the Al-‘Aqar Healthcare REIT. This would allow the company to fully realise the value of its hospital assets and free up vital cash flow for further expansion, and thus, allow KPJ to focus on its core business as a private healthcare service provider. Thus far, this asset-light business model has allowed KPJ to expand at a more aggressive rate and helped maintain its position as Malaysia’s largest private hospital operator.

Aged care business in Malaysia could kick off over the next five years

Recall that KPJ had earlier venture into Australia’s retirement village and aged care business back in 2010 via the acquisition of a 51% stake in Jeta Gardens, which owns and operates a 25.6 hectare retirement village and aged-care facility in Queensland, Australia. While there is no immediate plans to start up a similar business in Malaysia anytime soon, management said that the company is considering to startup a similar aged care business in Malaysia on a smaller scale, over the next three to five years. Management has intentions to leverage on the expertise of its earlier investment in 51%-owned Jeta Gardens for this purpose.
We are positive on this potential new startup given Malaysia’s rising proportion of population above 65 years of age (2002: 4.1% vs. 2012: 5.2%). Based on the Ministry Of Health’s (MOH) estimates, the percentage of population above 65 years of age is expected to increase further to 5.5% by 2015 and this could create a need for more well-equipped aged care facilities. In our view, Malaysia’s aged-care market, which currently comprises old-folk homes and small-scale NGO-operated facilities, is still relatively young and lacks proper medical attention from qualified nurses. Thus, KPJ’s plan to venture into the aged care business could potentially create the first large-scale aged care service offering in Malaysia that could provide the group with a new revenue stream.

Forecasts
No change to our earnings forecasts.

Investment case
KPJ’s aggressive expansion plans of two new hospitals p.a. could help the company maintain its dominance in the local healthcare sector, while its active pursuit of the lucrative healthcare tourism market, could lift the company’s profile over the longer term. We have raised our target multiple from 23.5x to 26.0x to be in line with the increase in regional peers’ valuation. The stock remains attractive given the defensive qualities of the healthcare industry as well as its cheaper valuations of 22.0x CY13 PER (vs. 26.0x for regional peers). We maintain our Buy call on the stock with a revised fair value for KPJ of MYR7.14 (from MYR6.45).

Source: RHB