We remain positive on KPJ Healthcare’s longer-term prospects, but turncautious over its near-term outlook amidst the weak economicbackdrop. BUY, with a revised SOTP-derived TP of MYR5.00 (from MYR4.70) as we roll over valuations to FY16. We also lower our FY16earnings forecasts by 4%, after assuming slower patient volume and higher operating expenses.

Near-term jitters. We emerged from a recent analyst briefing feelingcautious over KPJ Healthcare’s (KPJ) near-term prospects on the back of macroeconomic headwinds and rising living costs. Management expects further price adjustments in FY16 on higher medication costs,given the weak MYR. While higher costs are passed on to patients,management is also cautious over the impact on the volume of patients

9M15 volume. 9M15 patient volume growth was flattish, as outpatient volume dipped 1% YoY and inpatient volume only grew 0.3% YoY. This contrasts against IHH Healthcare’s (IHH MK, BUY, TP: MYR8.20) 0.2% YoY decline (for its Malaysian operations), although we believe KPJ’s two new hospital openings in FY14 vs IHH’s one contributed to thefavourable growth. Despite the growing adoption of healthcare insurance coverage, about 33% of KPJ’s inpatient bills are paid out of pocket.

Brownfield pipeline to boost operating leverage. It has a slew ofbrownfield expansions and two new hospital openings planned for FY16 (Figure 3). We expect brownfield expansions to lift its existing hospitals’ operating leverage. This should better insulate margins from potential dilution from new openings although any delays would limit the upside.

Forecasts and risks. We tweak our forecasts and trim FY16F earnings by 4.3% on higher operating expenses to reflect the escalation in medication costs (Figure 4). We think price adjustments would only offset cost inflation partially, mitigating the softer volume impact. Our FY15 and FY17 projections are unchanged. We now expect KPJ’s FY16 earnings growth to moderate to 8.7% (from 13.6%).

Investment case. On revised earnings estimates, KPJ is trading at 27.1x and 13.5x of its one-year forward P/E and EV/EBITDA respectively(Figures 1 and 2), ie below their 3-year historical means. We believe current levels have more than priced in the potential earnings risks. BUY, with a new SOP TP of MYR5.00 after rolling over valuations to FY16.