• Stay OVERWEIGHT; KPJ Healthcare (KPJ) remains our sector Top Pick. The March reporting season saw a pick-up in hospital activities amid inflationary pressure. Nevertheless, consumer demand appeared resilient with patient growth in 1Q23 (KPJ: +0.1% QoQ; IHH Healthcare (IHH) – Malaysia: +3.0% QoQ) despite a seasonally weaker quarter. The pick-up in export sales as well as robust procurement activities from the public and private sectors also benefited pharmaceutical players under our coverage, Duopharma Biotech (DBB) and Kotra Industries (KTRI).

• Healthcare service providers. KPJ’s 1Q23 core earnings more than doubled as increased bed occupancy rate (BOR) of 23ppts YoY to 70% led to better operating efficiency, coupled with increased inpatient visits (+39% YoY) from a more complex case mix during the quarter. IHH’s 1Q23 disappointed (-18% YoY), dragged by headwinds ranging from escalating operating costs, Singapore’s nursing staff shortage, and Turkey’s hyperinflationary environment. Revenue intensity across segments was higher YoY except for the Malaysia division as more elective cases were carried out. Overall patient volume grew in the range of 9-41% YoY except for the Singapore division, as the nursing shortage continued to constrain bed capacity.

• Pharmaceutical. DBB’s 1Q23 earnings were above expectations, boosted by a pick-up in export sales and sustained drug procurement from the public and private sectors, offset by normalised sales from the consumer healthcare (CHC) segment. KTRI’s 3QFY23 results were above our expectations due to sequential weakness in topline performance. Earnings were boosted by a pick-up in export sales as well as robust demand for prescriptive drugs. DBB and KTRI continued to demonstrate resilient margin performance, which we think was largely associated with the drug makers’ timely ASP adjustment coupled with the easing of logistics costs. We downgraded KTRI to SELL after the March reporting season, based on its rich valuation of 12x FY24F P/E (+0.6SD above its pre-COVID-19 mean) and expected slower topline growth due to sequential weakness from over- the-counter (OTC) sales (60% of its sales are OTC products).

• Outlook and sector pick. Still O/W on the healthcare sector, underpinned by relatively inelastic demand which offers investors a defensive play amid ongoing macroeconomic challenges that could adversely affect the resilience of consumer demand going forward. KPJ remains our sector Top Pick due to its organic expansionary strategy to drive patient growth, being less impacted by nursing staff shortages, and the gradual increase in health tourism. As we remain sanguine on healthcare service providers, we think KPJ’s greater domestic focus offers better earnings stability. In the pharmaceutical sector, we keep our view that the momentum of drug restocking activities – especially CHC and OTC products – will normalise in 2H23 as restocking activities taper off with concerns on drug shortages dissipating.

• Risks: Higher-than-expected operating costs, lower-than-expected patient visits/revenue intensity growth, unfavourable drug pricing mechanism.

Source: RHB Research - 7 Jun 2023