We see further upside to IHH as we expect demand for premium private healthcare services to remain robust, underpinned by exposure to strategic markets and rising health insurance coverage. Upgrade to BUY (from Neutral) with a new DCF/SOP-derived TP of MYR7.00 (24% upside). IHH’s expansion pipeline over the next 3-5 years should drive longer-term structural growth for the company.

Solid prospects. We now expect IHH’s earnings to grow 38% in FY15, 22% in FY16 and 25% in FY17 driven by revenue intensity improving at 8-10% CAGR and inpatient admissions growth. This is on the back of: i) exposure to markets with ageing population which should result in more incidences of complex cases, and ii) growing adoption of healthcre insurance coverage that insulates patients from the actual medical costs. With a strong pipeline of new hospital openings and capacity expansions planned, we expect a structural growth in earnings over the longer-term.

Strong balance sheet. We expect IHH’s net gearing levels to remain manageable at 9-11% in FY15-17F despite aggressive expansion plans. Its strong operating cashflow generation and interest coverage should allow IHH to make further inroads into existing key markets and raisedividend payout over the longer term.

Forecasts and risks. We raised our FY15-17 earnings forecasts by 0.2-40.8% to realign with IHH’s strong 1Q15 performance and reflect recent currency movements. The risks to our forecasts are: i) insurers imposing higher co-payment to stem overbilling; ii) pandemic outbreak, diluting revenue intensity and iii) prolonged civil unrest which would disrupt operations.

Investment case. We upgrade IHH to BUY (from Neutral) based on our new DCF/SOP-derived TP of MYR7.00 which values the company at 22.6x FY16F EV/EBITDA. IHH’s share price has outperformed both the FBM KLCI and MSCI Emerging Market Healthcare Index YTD. Itcurrently trades at a 5% discount to its 12-month forward mean P/E of 44.3x and 20.7x 12-month forward EV/EBITDA, which is in line with the regional sector average. We believe IHH deserves to trade at a wider premium to its regional peers given the structural growth expected and its expansive dominance in all three of its home markets.

Investment case Panacea for uncertain times. IHH Healthcare’s (IHH) share price recorded a 16%increase YTD, outperforming both the KLCI Index and the MSCI Emerging Market Healthcare Index by 21% and 5.2% respectively. While the strong outperformanceagainst the CI is partly amplified by market jitters, we believe IHH’s share price strength also reflects its resilient earnings prospect which appeals to investors given the lack of strong growth catalysts in the market.Notwithstanding, we believe there is further upside as the stock trading at fairly undemanding valuation based on these factors:  P/E is still below 2-year mean. The stock currently trades at 42.2x 2-year forward P/E which is below its historical mean P/E of 44.3x. Considering its strong growth prospects, we believe the stock deserves to trade at a higher PE multiple amidst the potential structural earnings growth from future expansions.

EV/EBITDA ‘premium’ is not representative. IHH currently trades at 20.7x 12-month forward EV/EBITDA or over one standard deviation above its 2-year mean EV/EBITDA of 18.8x (Figure 2). However, we believe the premium does not represent its true value given the structural earnings growth that we expect on the back of IHH’s aggressive expansion plans and robust demand for quality premium healthcare services. Based on our forecasts, we expect IHH’s EBITDA to grow at 12% CAGR over FY14-17F.

Strong growth expected. We revised our earnings forecasts for IHH following our asset re-allocation exercise. We now expect 3-year (FY14-FY17F) earnings CAGR of 28% driven by:  Robust and sustainable demand. We expect demand for quality premium healthcare services to sustain due to: i) exposure to ageing affluent population in countries such as Singapore and Hong Kong; and ii) growing adoption of health insurance coverage which insulates patients from actual rise in m edical costs.

New hospital openings and capacity expansion. Based on the pipeline, IHH expects to add over 3,000 beds to its existing system of close to 5,000 beds over the next 3-5 years. We also expect IHH to reap the benefits from hospital openings in recent years. These would translate to a structural earnings growth.We have assumed inpatient admissions to grow alongside revenue intensity . Our forecasts imply revenue intensity growing at 8-10% CAGR due to price increments and higher complex cases attended. We believe the expectation is fair as revenue intensity over FY10-14 grew at 6-13% CAGR with no impediments to inpatient admissions growth.

Strong balance sheet and cashflow generation. As of 1Q15, IHH’s balance sheet boasts a net gearing level of 11% or net debt/NTA of 29%. Coupled with its strong operational cashflow of c.MYR1.6bn and interest coverage of c.50x, we believe there is ample room to fund future acquisitions and expansions.

We believe IHH offers one of the best value proposition amongst its regional peers based on the following:  Higher P/E justified by stronger earnings CAGR. Amongst regional peers, IHH has one of the strongest earnings growth profile, which is only second to Siloam (SILO IJ, NR). While IHH commands a hefty premium amongst its peers on P/E terms, the stock is one of the cheapest based on its PEG multiple of 1.1x which is below the sector average of 1.6x and Siloam’s 1.4x.

EBITDA margin should expand as its portfolio of hospitals mature. IHH’s EBITDA margin of 27-28% is well above the sector average of 18-20% andcomparable to that of Phoenix Healthcare (1515 HK, NR), Bangkok Chain Hospital (BCH TB, NEUTRAL, TP: THB7.00) and Raffles Medical Group (RFMD SP, BUY, TP: SGD4.70).

Looking at EV/EBITDA multiples, IHH is trading close to the sector average and is at a discount to most of its larger regional peers. We believe that there is room for a re-rating as IHH’s current earnings and margins are distorted by its aggressive expansion plan, which dilutes the company’s earnings intensity. We believe IHH’s EBITDA margins could expand further once new hospitals mature.  Market leadership. IHH is by far the largest healthcare operator, by market capitalization, in the region. This is followed by Ramsay Health Care (RHC AU, NR) at USD9.4bn, which is similar to Bangkok Dusit (BDMS TB, BUY, TP: THB24.20). IHH also has a large regional footprint and market leading positions in all three home markets. We are of view that its resilient earnings growth profile via its Singapore and Malaysia operations, strong earnings growth potential from the ramping up of Mount Elizabeth Novena (Novena) and potentially Gleneagles Hong Kong should allow the stock to trade at a wider premium over its peers.

Valuation DCF/SOP-derived TP of MYR7.00, upgrade to BUY. We upgrade IHH to BUY from Neutral with a sum-of-the-parts (SOP) target price (TP) of MYR7.00 following our earnings revision. This implies FY15F P/E and EV/EBITDA multiples of 57.2x and 25.8x respectively, before easing to 47x and 22.6x in FY16F. The breakdown to ourSOP valuation is as follows:

Still decent upside if we exclude GHK. While the premium looks excessive, our valuation captures the potential value of the Gleneagles Hong Kong (GHK) Hospital which is expected to open in FY17. Excluding our valuations for Gleneagles Hong Kong, our TP for IHH worked out to MYR6.20 (Figure 5), which still implies an upsidefrom current share price.

Adoption of DCF method. Our revised TP is largely premised on the discounted cashflow (DCF) valuation method on each of IHH’s core operations and key hospitals. We segregated these divisions by country so as to better reflect the specific country risks through the weighted average cost of capital (WACC) and longterm growth assumptions. Our WACC assumptions range from 7.9% -18.3% while our long-term growth rates are from 1.5%-5%.

We valued IHH’s main operating divisions using the DCF method due to the company’s sustainable cashflow generation and resilient growth prospects. In our view, the DCF valuation method would best capture the potential earnings accretion, especially for assets which have only started or could potentially add value to thegroup in the future.

Solid prospects underline its attractive growth profile Strong earnings growth. We have turned positive on IHH as we expect demand for quality private healthcare to remain robust. Our new forecast implies a 3-year (FY14-17F) earnings CAGR of 28% driven by: i) capacity expansions at its major hospitals,ii) opening of new hospitals, iii) higher revenue intensity due to price adjustments and more complex cases and iv) continued growth in inpatient admissions (Figure 6).

Our assumption of private healthcare demand remaining robust is premised on:  Ageing and affluent population. IHH’s Singapore operation is poised to benefit from an ageing population (at 39.3 years old – one of the oldest in the region)which should result in more complex cases and higher revenue intensity. WithSingapore having one of the highest GDP per capita globally, we expect moreprospective patients to be able to afford IHH’s premium healthcare services.  Increase in adoption of health insurance. The growing adoption of healthinsurance coverage, both via employers’ or personal capacity, has lowered the cost to access private healthcare services. This is prevalent in Malaysia due to the absence of universal health coverage system. In Singapore and Turkeywhere the system exists, employer/personal insurance coverage supplements the universal health coverage, which allows more people to access privatehealthcare services.

Favourable currency movements. We expect IHH to benefit from the strong SGD which offsets earnings impact from the weak TRY. YTD, SGD strengthened by 5.9% (Figure 7) while TRY depreciated by 7.1% against the MYR (Figure 8). We estimate that every 1% change in SGD and TRY would have a 0.5% net impact on earnings.

Strong balance sheet. We are not too concerned over management’s indication of IHH increasing its net gearing going forward, to finance recent and future acquisitions plans given its strong balance sheet. At the end of Mar 2015, IHH’s net gearing wasat 11%, inching up from 8% at end FY14.

This figure might be distorted by IHH’s huge intangible assets which make up 40% of total assets. Relative to its net tangible assets (NTA), the net debt to NTA ratio is still at 0.29x. Couple with IHH’s strong interest coverage (c.50x) and operating cashflow generation (over MYR1.6bn in FY14), we believe IHH is able to stomach a higher net gearing position.

Given IHH’s strong balance sheet position, we do not rule out the company making further inroads within its key markets such as China and India as well as potentially foray into new countries. Over the longer term, we expect IHH to raise its dividend payout given its strong cashflow generation.

Healthy pipeline of capacity expansion. IHH has a slew of new bed additions through capacity expansion of an existing hospitals as well as new hospital openings. This should add over 3,000 beds to its existing hospital network of c. 5,000 beds over the next 3-5 years (Figure 9).

Novena Hospital. During its latest 1Q15 results conference call, management hadindicated that it would be adding another 30 beds to its flagship hospital – the Mount Elizabeth Novena Hospital (Novena). This would bring the total operational beds to 189 out of the planned 333-bed capacity. The new beds that would be introduced in 3Q15 are in tandem with the opening of the Oncology Centre of Excellence (COE).The launched of the Oncology COE is just over a year after Novena opened up its maternity wards. The addition of the maternity wards and introduction of more range of consultants with varying specialties has led to higher daily census and eventually culminated to the hospital turning profitable in 1Q15 with EBITDA margin 30% based on 159 beds in operation. This was just over 2 years after it was opened.

We expect Novena’s profitability to improve going forward with more beds and new specialties introduced. We have assumed Novena hitting full capacity by the end of FY17. This should also partially mitigate the impact from the start-up costs incurred from the opening of Gleneagles Hong Kong during that year.

Gleneagles Hong Kong. Another key catalyst to IHH’s earnings growth would be the opening of the Gleneagles Hong Kong (GHK). On full capacity, the hospital would operate 500 beds. However, just over 50% of this capacity is reserved for local citizens under a stipulated package pricing while the remaining capacity is available for non-local citizens with no price restrictions. Management has guided for theconstruction of GHK to complete in FY16 and the opening to be in FY17.

We view IHH’s foray into Hong Kong as a step in the right direction given the market’s favourable dynamics. Some of the favourable macro indicators are: i) Hong Kong’s life expectancy is over 80 years old for both male and female, ii) the median age of the population is 43.2 years old, and iii) existing public hospitals are overwhelmed as the ublic healthcare system is heavily-subsidised by the government.

In our view, the market profile is similar to Singapore’s but with pricing point s being much higher. A rough survey indicates that surgical procedures in Hong Kong cost30%-40% more than in Singapore.

Source: RHB Research - 1 Jul 2015