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1 After a site visit to Wenzhou Kangning Hospital (KNH) s Shenzhen Yining hospital (undergoing decoration and furnishing), we believe it is on track to contribute revenue in 1H2017. It is targeting >30% growth in the number of beds a year in 2016 and 2017 by fast expansion through both setting up new hospitals and the light-asset hospital management mode. Its current valuation of 27x 2017E PER looks fair based on 33% EPS growth. But the tight supply of qualified psychiatric doctors may be a potential obstacle to meeting its ambitious expansion goals. 2016E hospital expansion target remains solid: As of 1H2016, KNH owned 2,300 beds and managed 700 beds. Management targets increasing the total number of beds to ~8,000 by 2019, implying a CAGR of ~35%. Pingyang Kangning Hospital and Quzhou Yining Hospital are well on track to open by end Based on our channel check, Shenzhen Yining hospital can finish decoration and furnishing by end We expect it to start contributing to revenue in 1H2017, but for it to take 2-3 years to break even. We think Shenzhen Yining is critical for the Company as Shenzhen has huge psychiatric treatment needs and average daily inpatients costs are ~25% higher than those in Wenzhou. With the high medical insurance reimbursement level, if Shehzhen Yining successfully promotes the Kang Ning brand in Guangdong, the Company can expand, adding new hospitals in other Pearl River Delta areas like the mode of Wenzhou KN. Overall, we expect the total number of beds at end-2016 to reach ~3200, up 34.5% YoY compared to 2,380 at end-2015, so the 2016E hospital expansion target remains intact. 2017E hospital expansion under way: In 2017, the Company aims to meet the ~35% increase in bed numbers (i.e. an increase of ~1,100 beds in 2017E) mainly through (1) adding 300 beds from opening new hospitals (planning Hangzhou Yining, Sihui KN and Taizhou KN hospitals); (2) managing more hospitals; and (3) expanding existing hospitals (except for Cangnan Kangning Hospital and Pingyang Changgeng Ward, which have limited room to increase bed capacity; the other KNH hospitals have ample expansion room). To fuel this expansion, we estimate KNH will need ~RMB500m in capex for next three years to reach 8,000 beds (~RMB80, ,000 per bed), which can be funded largely from operating cash flow for next three years. Any further shortfall can be made up by cash on hand (RMB272m as of 1H2016), A-share listing proceeds, or banks loans, as the Company is currently in a net cash position. Qualified doctors the key: Currently the Company has >200 doctors, including resident physicians ( 住院醫師 ) and physicians-in-charge ( 主治 醫師 ) or above. The Company targets a 15:1 bed-to-doctor ratio and a 1:0.35 bed-to-nurse ratio, both of which meet the criteria for Grade III psychiatric hospitals. To fulfill the 8,000-bed target by 2019, we estimate ~300 more doctors must be recruited. As it takes 2-3 years for a psychiatric undergraduate to become a resident physician and another 3-5 years to be promoted to physician-in-charge, we don t think in-house training can fulfill KNH s immediate doctor shortage. KNH s expansion, therefore, will depend largely on recruiting external qualified psychiatric doctors. However, it should be noted that finding enough qualified doctors may be difficult, and a doctor shortfall would hinder hospital expansion. Wenzhou Kangning Hospital Co., Ltd. (2120.HK; NOT-RATED) (HK$) Nov15 Market Cap: US$363.6m; H-Free Float: 82.2%; Source: Bloomberg consensus Turnover (RHS) May16 Price (LHS) Short-term margin pain, long term gain: In our note dated June 13, 2016, we pointed out that KN s margins would under pressure. In 1H2016, we did see a margin squeeze due to more expenses associated with new hospitals opening and the establishment of an online psychiatric platform. We continue to expect margin pressure in 2H2016 and 2017E as a result of new hospitals opening. Usually new hospitals need 2-3 years to build a reputation (especially for hospitals outside Wenzhou, such as Shenzhen Yining) and break even, so we think margin pressure means short-term pain but longterm gain. Valuation: The Company is trading at 36x/27x 2016E/17E PER, slightly higher than its peers. We think the current valuation is fair, since the market is expecting EPS CAGR of 34% in 2016E-2018E (considering RMB depreciation, the CAGR would drop to ~30% in terms of HK$). We think the growth will be driven mainly by fast new-bed expansion. Catalysts: New hospitals; A-share listing (improved recognition of the KNH brand would help raise the H-share valuation) Risks: Slower-than-expected expansion progress (HK$ million) E 2017E 2018E Revenue (RMB m) EBIT (RMBm) Net profit (RMB m) Net margin 17.3% 16.2% 15.6% 15.2% 17.0% EPS (RMB) n.a ROE (%) n.a Dividend yield (%) n.a PER (x) n.a PBR (x) n.a Background: Established in 1996 and based in Zhejiang Province, KNH has seven self-owned hospitals and manages six hospitals; it focuses primarily on providing psychiatric specialty care

2 Figure 1: Hospital expansion plan Hospital Commence No.of beds as KNH's operation of June 30, interest date 2016 Owned 2,300 Source: Company, CGIS Research Remarks Contract years Wenzhou Kangning Hospital % 970 ~1,500 beds after expansion by 2016 n.a Qingtian Kangning Hospital 4/ % 180 Target beds by 2019 n.a Cangnan Kangning Hospital 6/ % 430 limited bed expansion room n.a Yongjia Kangning Hospital 12/ % 260 Target 300 beds by 2019 n.a Yueqing Kangning Hospital 9/ % 180 Target beds by 2019 n.a Linhai Kangning Hospital 4/ % 100 Target 200 beds by 2019 n.a Geriatric Hospital 5/ % 180 Target 600 beds by 2019 n.a Pingyang Kangning Hospital 2H % ~100 beds for stage I, 300 beds by 2019 n.a Quzhou Yining Hospital 2H % ~100 beds for stage I, 300 beds by 2019 n.a Shenzhen Yining Hospital 1H % ~100 beds for stage I, beds by 2019 n.a Hangzhou Yining Hospital Site selection n.a n.a n.a Managed 700 Pingyang Changgeng Ward 1/2011 0% 175 limited bed expansion room 10 Chengdu Renyi Ward 4/2015 0% 37 Target 200 beds by Yanjiao Furen Hospital 4/2015 0% 150 Target 600 beds by Beijing Yining Hospital 11/ % 38 Target 300 beds by Pujiang Huangfeng Psychiatry Specialty Hospital 1H2016 0% 200 Target 300 beds by Chun an Huangfeng Kang en Hospital 1H2016 0% 100 Target 300 beds by China psychiatric market in supply shortfall: Current demand for psychiatric care in China far exceeds what public sector can provide (16m patients but only ~20,000 psychiatric doctors and ~400,000 beds in 2015), so there is strong demand for private psychiatric specialty care. Hospital expansion plan: The Company s total number of beds increased from 2,380 at end-2015 to 3,000 as of 1H2016, including the addition of 200 beds in Pujiang Huangfeng Psychiatry Specialty Hospital and 100 beds in Chun an Huangfeng Kang en Hospital in 1H2016. Expansion in the number of beds is the key to KNH s growth. Management targets increasing the total number of beds to ~8,000 by 2019, implying a CAGR of ~35%.

3 Figure 2-1: Shenzhen Yining Hospital Figure 2-2: Shenzhen Yining Hospital Inpatient building Hospital complex Source: CGIS Research Source: CGIS Research Shenzhen Yining Hospital: Located in the Shenzhen Longhua District Hi-Tech Industrial Park ( 深圳市龍華新區觀瀾高新技術產業園三嘜產業 園 ). It is Grade II psychiatric hospital with 100 beds in Stage I. Currently, it is undergoing decoration and furnishing, which is expected to be finished by end The hospital is expected to open in 1H2017. KNH is collaborating with local Shenzhen hospitals for the introduction of patients. We think this is critical for the Company as Shenzhen has huge psychiatric treatment needs and the daily inpatients costs are ~25% higher than those in Wenzhou. With the high medical insurance reimbursement level, if Shehzhen Yining successfully promotes the Kang Ning brand in Guangdong, the Company can expand, adding new hospitals in other Pearl River Delta areas like the mode of Wenzhou KN.

4 Figure 3: Peer comparison table MMkt cap PER(x) PBR(x) ROE(%) EV/EBITDA (x) Company name Ticker Price (HK$) (HK$m) E 2017E E 2017E E 2017E E 2017E WENZHOU KANGNI-H , PHOENIXHEALTH , HARMONICARE MEDI , Simple average Weighted average AIER EYE HSPTL-A , TOPCHOICE MEDI-A , Simple average Weighted average Source: Bloomberg, CGIS Research

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