We see further upside to IHH’s share price on expectations that demand for premium private healthcare services would remain robust, given its exposure to strategic markets. Maintain BUY with a new DCF/SOP-derived MYR8.20 TP (from MYR6.70, 25% upside). The strong SGD and a resurgent TRY is likely to mitigate any possible weakness in its Malaysian operations.

Prospects intact. We now expect IHH Healthcare’s (IHH) earnings to grow 41% in FY15 before easing to 38% (FY16) and 26% (FY17), implying an earnings CAGR of 35% over FY14-FY17F. The growth is driven by a combination of continued growth in revenue intensity, new bed additions from capacity expansions and new assets acquired and a favourable forex rate. Given IHH’s strong balance sheet and low net gearing position of only 12% as at end-1H15, we expect to see more acquisition targets in FY16, particularly within China and India.

Earnings upgrade. We raise our FY15F-17F earnings by 4-21% following a revision of our currency assumptions for SGD/MYR to MYR2.85-3/SGD (from MYR2.75-2.80/SGD) to reflect the house view and a higher TRY/MYR exchange rate to MYR1.63-1.90/TRY (from MYR1.33-1.45/TRY). This was due to the strengthening TRY in the wake of the Justice and Development Party’s (AKP) commanding performance in the snap election in early November. This was partially offset by a mild reduction at IHH’s Malaysia operations as we err on the side of caution in anticipation of an economic slowdown and the protracted impact from the goods and services tax (GST) on consumer spending. We have also factored in contributions from the recently-acquired Global Hospitals, which is margin dilutive in the near to medium term.

Earnings risks. The risks to our forecasts are: i) insurers imposing higher co-payments to stem overbilling, ii) a pandemic outbreak diluting revenue intensity, and iii) prolonged civil unrest disrupting operations.

Investment case. We reiterate our BUY call on IHH with a new DCF/SOP-derived MYR8.20 TP (from MYR6.70) that values the company at a FY16F of 22.9x EV/EBITDA and 47.8x P/E. We corroborate our findings with a peer comparison; despite trading at premium valuation multiples relative to its regional peers, the stock offers good value proposition. Cast against its earnings CAGR, IHH implies a PEG of 1.1x, well below the sector average of 2.1x.

Investment case

Ray (of hope) in disarray. YTD the stock is up 36% (Figure 1) and outperformed the KLCI by 44%. We believe the strong performance was mainly due to: i) increasing scarcity of growth stocks amidst the global and domestic economic slowdown, ii) IHH benefiting from the weak MYR due to sizeable non-MYR earnings, and iii) its recent acquisition trail. While the latter has miniscule earnings impact in the near to medium term, it enhances the company’s long-term growth profile. We continue to see further upside to IHH’s share price on the back of 35% earnings CAGR over FY14-FY17F and 22% EBITDA CAGR . This is likely to be driven by a combination of growing revenue intensity, new bed additions from expansion plans and newly-acquired assets and favourable forex rates. We expect more acquisitions in FY16, particularly within China and India, as the company continues to establish a presence in these markets. As at end 1H15, IHH’s net gearing position stood at only 12%, with management indicating that the latest acquisition (ie Global Hospitals) would push it to 20%.

Valuations fairly undemanding. On revised earnings, IHH currently trades at 39.5x 1-year forward P/E which is below its 2-year historical mean of 42x. In EV/EBITDA terms, the stock currently trades at 19.4x which is 1SD above its 2-year historical EV/EBITDA mean of 18.4x; we believe the elevated EV/EBITDA multiple is justified. This is ahead of what we expect to be a structural earnings growth on the back of IHH’s aggressive acquisition trail and capacity expansion plans, vis-à-vis the expectations of robust demand for quality premium healthcare services.

Peer comparison. On the surface, IHH seems to trade at a premium to its peers, commanding lofty P/E multiples of 31-54x over FY15F-17F, EV/EBITDA multiples of 16-24x, and P/BV multiples of 2-3x (Figure 4). However, given its strong earnings CAGR we believe the “premium” multiples are warranted.

IHH implies one of the best values amongst regional peers and in addition we believe IHH’s multi-national exposure to strategic markets throughout Asia is a scarcity premium over its peers, which makes it an even more compelling investment case:

i. Higher P/Es justified by stronger CAGR. IHH’s earnings CAGR of 35% is only exceeded by Siloam International Hospitals’ (Siloam) (SILO IJ, NEUTRAL, TP: IDR13,000) 50% and Fortis Healthcare’s (Fortis) (FORH IN, NR) 41%. Aside from Fortis, IHH implies a lower PEG multiple of 1.1x vs Siloam’s 1.5x, although both are still below the sector average of 2.1x. Fortis has the lowest PEG multiple of 0.5x, but we believe this corresponds with its lower EBITDA margins of 6-10%.

ii. EV/EBITDA backed by stronger CAGR. IHH trades at EV/EBITDA multiples of 16-24x, which are slightly above the sector average of 15-20x but are dwarfed by Mitra Keluarga Karyasehat’s (Mitra) (MIKA IJ, BUY, TP: IDR3,150) 33-45x and Bumrungrad Hospital’s (Bumrungrad) (BH TB, SELL, TP: THB143.00) 23-25x. Relative to IHH’s EBITDA CAGR of 22%, he stock implies EV/EBTIDA-G (EV/E-G) multiple of only 0.9x, which is below the EV/E-G multiples of Mitra’s 2.4x and Bumrungrad’s 1.9x. While we expect IHH’s EBITDA margins to decline in 2016 and 2017, this is transient in nature as it reflects the temporary margin impact from the opening of two key hospitals in 2015 in Malaysia (Gleneagles Kota Kinabalu and Gleneagles Iskandar), start-up costs from Gleneagles Hong Kong (slated to open in 2017) and earnings dilution from its India operations.

iii. High P/BV multiples despite lower ROE returns. Thanks to its goodwill-inflated book value, IHH commands one of the lowest ROEs (albeit on an increasing trend) of 5-7%. However, this corresponds with its low 2-3x P/BV multiples.

Earnings upgrade mainly due to currency assumptions. We raised our FY15F-17F earnings by 4-21% after making the following key changes: i. Currency assumptions. Our SGD/MYR exchange rate is raised to MYR2.85-3.0/SGD from MYR2.75-2.80/SGD to reflect the house view. Meanwhile we have also assumed a higher TRY/MYR exchange rate of MYR1.63-1.90/TRY from MYR1.33-1.45/TRY to reflect the strengthening Turkish currency following the commanding performance of the AKP in the early November snap election. We estimate that every 1% change in the MYR/SGD and MYR/TRY exchange rate would impact earnings by 0.7% and 0.3% respectively. ii. Lowering expectations for MY operations. Gains from the higher exchange rate assumed were partially offset by a mild reduction in the Malaysia operations as we err on the side of caution. This is given the anticipated economic slowdown and the protracted impact from the GST imposition on consumer spending. In 2Q15, IHH’s Malaysia operations noted a marginal decline in inpatient admission, which management attributed to the GST. iii. Factoring in India. We also factored contributions from the recently-acquired Global Hospitals, which is margins dilutive in the near to medium term. Despite the minimal earnings contribution, we are positive on IHH’s longer term prospects there. After a long hiatus in India – with the 10.85% stake in Apollo Hospitals and a subsequent forgettable partnership with the Khubchandani Group – IHH made two acquisitions in 2015. The first, in March, was a 51%-stake in Continental Hospitals – a 750-bed hospital in Hyderabad – for INR300 crore (or INR3,000m) At end-August, the company acquired a 73.4%-stake in Global Hospitals, which operates a 5-hospital chain in Chennai, Hyderabad, Bangalore and Mumbai.

All in, we expect IHH’s net earnings and EBITDA to grow at a 3-year CAGR (FY14-FY17F) of 35% and 22% respectively. Our underlying view on the company’s prospects is broadly unchanged, as we continue to expect growth to be underpinned by: i. Robust and sustainable demand for quality premium healthcare services. We expect demand for quality premium healthcare services to sustain. This is given the: i) exposure to an ageing affluent population in countries such as Singapore and Hong Kong, and ii) growing adoption of health insurance coverage that insulates patients from actual medical cost inflation. ii. New hospital openings and capacity expansion. IHH expects to add over 3,000 beds to its existing system of close to 5,000 beds over the next 3-5 years. This excludes bed additions from recent and potential acquisitions, which we expect to take place over the next 2-3 years. While we anticipate some margins pressure in the near term while the new assets are “digested”, we believe this could quickly recover over the medium term on the back of higher revenue intensity and inpatient admissions, as well as brownfield expansions.

Valuing IHH Maintain BUY with a revised SOP TP of MYR8.20 (from MYR6.70) following our earnings revision and after rolling our valuations one year forward. This implies FY16F P/E and EV/EBITDA multiples of 47.8x and 22.9x respectively. Our SOP breakdown is as follows:

Some notable changes to our valuation assumptions: i. Lower WACC for Singapore. We lowered our WACC for the Singapore-based operations to 8.8% (from 9.8%) on the back of lower risk premiums assumed. ii. Lower WACC for Turkey. Similarly, we lowered our WACC for the Turkey operations to 12.9% (from 18.3%) on the back of lower risk premiums assumed following the recently-concluded Turkish elections. iii. Higher WACC for the international operations division (IOD). Our WACC for the IOD operations is raised to 12.9% from 7.9% to reflect the WACC for the India operations.

Source: RHB Research - 23 Nov 2015