• Still OVERWEIGHT; Top Pick: IHH Healthcare (IHH). Recent news flows on a diagnosis-related group (DRG) financing system's implementation here will ultimately benefit hospitals and patients, in our view. However, while it could reduce unnecessary procedures and optimise hospital resource allocations, it also adds a layer of uncertainty in terms of the extent of implementation. Hence, we advocate investors to switch to IHH, given its diversified asset base that enables it to better navigate the local regulatory uncertainties.
• DRG is a healthcare payment system that specifies a fixed amount based on the complexity of a case rather than conventional fees-for-services. Hospitals receive a pre-determined price between the payer and themselves. Hospitals will then have to manage resources within that budget by focusing on cost-effective treatments, ie patient outcome, streamlining unnecessary procedures, and over-prescribing medication.
• Implications. We understand the insurance industry has been pushing for private hospitals to move from fee-for-service payment models to DRG or value-based healthcare since 2023. Concurrently, hospitals under our coverage - IHH and KPJ Healthcare (KPJ) - have already embarked on advocating value-based healthcare. We think DRG's implementation still requires extensive study and engagement with various stakeholders, given the complexity of each medical procedure and their underlying costs.
• Our thoughts. Ultimately, DRG is not a price-capping mechanism, but could be viewed as a cost-discipline approach on streamlining patient care. We think DRG benefits both hospitals (via optimising resources and efficiency) and patients (better medical outcome). We view the recent sell-downs as potential buying opportunities, as they may be driven by short-term uncertainties surrounding the transition. We believe the sell-off could present an attractive entry point for investors who understand the long-term structural changes occurring within the healthcare industry. Once the transition to DRG is successfully navigated, we expect both hospitals and patients to gain from a more efficient, cost-effective, and outcome-focused healthcare system. Should DRG rates turn out to be unfavourable, we believe Sunway (SWB MK, BUY, TP: MYR5.75) - with its exposure to data centre construction, property development, and hospitality - should be able to cushion the potential impact to its healthcare unit (healthcare PBT contributed 14.5% of group PBT for 9M24 and 34% of our RNAV).
• We maintain our OVERWEIGHT sector call with IHH as sector Top Pick, given its diversified asset base, which enables it to better navigate the regulatory uncertainties here. In addition, IHH's valuation remains appealing - it currently trades at 13x EV/EBITDA or 0.4SD below its historical mean vs KPJ, which already trades at 2SD above historical mean. Key downside risks include: i) Higher-than-expected operating costs, ii) lower-than-expected patient visits and revenue intensity growth, and iii) unfavourable regulatory risks associated with DRG systems.

Source: RHB Securities Research - 13 Dec 2024