• Maintain sector OVERWEIGHT; our Top Pick is now KPJ Healthcare (KPJ). The healthcare sector continued to see encouraging growth in the number of patients in 3Q22 (KPJ: +13.5% QoQ; IHH Healthcare (IHH): +3.3% QoQ). Post further lifting of restrictions related to COVID-19, the sector should benefit from a spike in local and foreign patient visits. Moreover, the spillover effect from public- and private-sector procurement of medication and treatments should continue to benefit the pharmaceutical players under our coverage, ie Duopharma Biotech (DBB) and Kotra Industries (Kotra).

• Healthcare service providers. IHH’s 9M22 results fell below expectations, being hampered by headwinds ranging from the weakening TRY, escalating operating costs (predominantly in Turkey), and the nursing staff shortage in Singapore. KPJ’s 9M22 core earnings more than doubled YoY, on ongoing cost optimisation strategies and a pick-up in its Malaysia bed occupancy rate (BOR) by 22ppt YoY to 66%, which boosted its operating efficiency. The company expects to maintain its cost optimisation initiatives in the coming quarters. Both IHH and KPJ saw relatively lower revenue intensity as a result of a higher number of elective surgery cases (which have lower ASPs), as many such procedures were deferred when the MCO was in effect.

• Pharmaceutical. DBB’s 9M22 results beat our expectations as drug restocking from the private and public sectors pointed to robust demand, albeit offset by normalised sales from the consumer healthcare (CHC) segment. Meanwhile, Kotra’s 1QFY23 (Jun) results were boosted by surging demand for over-the-counter (OTC) medicine, as well as a pick-up in export sales. We expect Kotra’s numbers to begin tapering off in 2HFY23, as medicine restocking activities (primarily OTC products) should normalise then.

• Outlook and sector pick. Both IHH and KPJ have continued to record a strong recovery in their respective healthcare tourist (HT) numbers – their HT- related revenue recovered to 4% and 4% of total group revenues (vs 5% and 5.5% prior to the pandemic). Our sector Top Pick is now KPJ, underpinned by its robust patient growth trajectory – it has not been affected by nursing staff shortages – as well as its potentially earnings-accretive disposal of an overseas entity by 2023F. While we remain sanguine on the recovery prospects of the healthcare service providers, we also think that KPJ’s greater domestic focus accords it greater earnings stability. For the pharmaceutical sector, we expect a normalisation of raw material prices, easing supply chain bottlenecks leading to lower freight costs, which should alleviate their margin pressures in 2023 – DBB and Kotra rely on cross-border access to facilitate raw material procurement and export sales. However we expect CHC and OTC segmental growth to normalise, as restocking activities taper off as concerns on a drug shortage continue to dissipate.

• Key downside risks to our sector call: Higher-than-expected operating costs, lower-than-expected patient visits and revenue intensity growth, and an unfavourable drug pricing mechanism from the Ministry of Health.

Source: RHB Research - 6 Dec 2022