June 02, 2016 Saudi Arabia Healthcare: Safe bet with limited upside

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1 SICO Research Sector Report June 02, 2016 Saudi Arabia : Safe bet with limited upside Saudi Arabia healthcare sector has strong fundamentals and a good track record but stretched valuations We downgrade the sector to Neutral from Positive following the recent outperformance. Within the sector, we continue to like Dallah (TP SAR 100/sh, Buy) and Mouwasat (TP SAR 150/sh, Buy) We initiate on Middle East with a TP of SAR 75 and Neutral rating; maintain Buy on Dallah and Mouwasat; downgrade Al Hammadi and Care to Sell from Buy rating Nitin Garg, CFA ext 5059 Nitin.Garg@sicobahrain.com Strong fundamentals are already priced in Saudi healthcare names have recovered sharply from January lows, outperforming the broader Tadawul index by a considerable margin. Dallah recovered (+65%), Care (+41.7%), Hammadi (+27.9%) and Mouwasat (+36.3%), from January lows outperforming the Tadawul index which has increased 18.1%. While we like the sector s strong fundamentals, valuations look stretched and stocks offer limited upside. Accordingly, we downgrade the sector to Neutral from Positive. Our top pick is Dallah (TP SAR 100/sh, Buy) Dallah s revenue grew 19% YoY in 1Q16, higher than 12%/8%/13%/9% in the past four quarters. We see robust revenue growth and stronger margins ahead, and accordingly revise up our 2016/17/18 net income estimates by 3%/2%1% respectively, and increase our target price to SAR 100/sh from SAR 85/sh. The company s total capacity is expected to reach 1,003 beds/642 clinics by 2018 from 448 beds/163 clinics, translating into a net income growth CAGR of c.20% during the period. Dallah has no plans to add any capacity in 2016, and higher patient volume plus increasing utilisation of existing assets would account for the bulk of 2016E earnings growth. Beyond 2016, Dallah s equity story would depend on the success of the greenfield Namar Hospital (initial 300 beds with c.70% capacity addition) that is set to start in We also like Mouwasat (TP SAR 150/sh, Buy) but the stock offers limited upside Mouwasat s revenue grew 21% YoY in 1Q16, led by higher contribution from Riyadh Hospital, stronger than 4%/12%/7%/12% revenue growth witnessed over the past four quarters, respectively. We see higher revenue growth and stronger margins post strong 1Q, and accordingly revise up our 2016/17/18 net income estimates by 1%/2%3% respectively, and increase our target price to SAR150/sh from SAR 140/sh. We maintain the stock at Buy rating Initiate on Middle East (TP SAR 75/sh, Neutral) We initiate on Middle East (MEH) with a Neutral rating and target price of SAR 75/sh. MEH trades at a 15.9x EPS (2016e) and offers 7.4% CAGR ( ) EPS growth. Unlike its peers, the company does not have any aggressive growth plans. It is planning to add 150 beds/35 clinics in 2Q16 at Hail (33% stake) and 150 beds/100 clinics in 1Q18 at Dammam, taking its total capacity from 788 beds/281 clinics to 986 beds/392 clinics in Beyond this MEH has not announced any further bed capacity addition in the mediumterm, unlike its peers - Dallah, Mouwasat and Al Hammadi. The six-year CAGR ( ) bed capacity growth for Middle East is only 3.8%, much lower than 14.4%/15.8%/28.1% for Dallah, Mouwasat and Hammadi, respectively. Accordingly, earnings growth potential for the company is weaker relative to its peers over the longer-term. SICO 2016 All Rights Reserved Attention is drawn to the disclaimer and other information in the end

2 Contents Saudi Arabia : Safe bet with limited upside... 1 Performance since sector initiation 2 1Q16 result summary: Strong performance overall 2 Valuations.6 Middle East (initiation) : Lacking growth drivers... 9 Al Hammadi Company for Development and Investment: Facing margin pressure Dallah : Top pick Mouwasat: Buy with modest upside National Medical Care Co

3 Performance since sector initiation We initiated on the Saudi sector on 13 October 2015 titled KSA - Prescription for long term growth and healthy returns with a positive sector rating, and Mouwasat as our top sector pick. Since our initiation, Mouwasat has delivered a 5.3% return, outperforming the broader Tadawul index by 22.4%, and the stock has also been a better performer than its peers. Exhibit 1: Performance since recommendation Recommendation during initiation return Performace Current w.r.t. recommendation Tadawul Mouwasat Initiated at "Buy" rating 5.3% 22.4% Buy Care Initiated at "Add" rating 0.0% 17.5% Sell Dallah Initiated at "Add" rating -7.1% 10.0% Buy Al Hammadi Initiated at "Add" rating -23.3% -6.2% Sell Source: SICO Research, Note: return based on 31st May 2016 closing prices 1Q16 result summary: Strong performance overall Exhibit 2: 1Q16 result summary Company Net Inc LCY ---1Q Q16 Forecast-- Actual vs % YoY % QoQ Cons SICO Cons SICO Al Hammadi 22-47% -40% % -33% Care 33 19% -6% % 6% Dallah 58 22% 7% % 10% Mouwasat 71 27% 32% % 15% Source: SICO Research Saudi names, with the exception of Hammadi, reported strong results in 1Q16. All names under our coverage reported double-digit YoY revenue growth, with Mouwasat at 21%, Dallah 18.6%, Care 15.7% and Hammadi at 11%. SThe sector s operating margins also expanded, led by Dallah (+130bps), Mouwasat (+110bps) and Care (+80bps), while Hammadi s margins declined significantly, due to a fire at Olaya Hospital. Exhibit 3: YoY revenue growth 30% 1Q15 2Q15 3Q15 4Q15 1Q16 20% 10% Exhibit 4: Operating margin trend 35% 1Q15 2Q15 3Q15 4Q15 1Q16 30% 25% 20% 15% 0% Mouwasat Dallah Care Hammadi 10% Mouwasat Dallah Care Hammadi Source: Company data, SICO Research Source: Company data, SICO Research 3

4 Longer payment cycle: A concern for MEH, Care and Hammadi Among Saudi hospitals, Care and Middle East already have had high receivable days owing to government exposure, while the spike is more recent in the case of Hammadi. The receivable days worsened to 246 days in 2015 for Care, 208 days for MEH and 162 days for Hammadi. We are more comfortable with working capital cycles of Dallah and Mouwasat, where receivable days have been close to 100 days during the past three years. Exhibit 5: Receivable days on hand Source: SICO Research Dallah Mouwasat Al Hammadi Care Middle East 208 Capacity growth to boost earnings The four hospitals under our coverage plan to add c.1,800 beds and c.550 clinics over the next four years, increasing the total capacity by 73% and 71% respectively. Al Hammadi has the highest bed capacity growth, with the number of beds increasing from 300 in 2014 to 1,328 in 2019, implying a 6- year CAGR of 28%. The respective bed capacity CAGR for Mouwasat, Dallah and Care is 16%, 15% and 4%, respectively. Growth from clinics business is the highest in Dallah, with the number of clinics increasing from 163 in 2014 to 642 in Exhibit 6: Bed capacity growth Mouwasat Hammadi Dallah Care MEH Source: SICO Research, based on disclosed plans 4

5 Exhibit 7: Clinic capacity growth Mouwasat Hammadi Dallah Care MEH Source: SICO Research Saudi Arabia Vision 2030: what s in it for? Below are the two key takeaways for the healthcare sector from Vision 2030: Corporatisation: The Vision 2030 looks at the prospects of public facilities competing with the private sector. This will enhance the capability, efficiency and productivity of care and treatment, and increase the options available to citizens. Private medical insurance for all: The Vision 2030 document says private medical insurance for all, suggesting that listed names should benefit in the long run as an insured person will always prefer private hospitals to those run by the Ministry of Health. Saudi Arabia allocated SAR 105bn (+28% YoY from SAR 82bn in 2015) towards health and social development in its 2016 budget. In 2015's original budget allocation, SAR 160bn was allocated for both (civil and military healthcare services); we believe the allocation for military health has been removed by SAMA from this category and added to defence & security expense for Exhibit 8: Saudi Arabia spending Source: SICO Research Budget allocation % of total 12.5% 9.5% % 12% 10% 8% 6% 4% 2% 0% 5

6 Exhibit 9: Valuation- earnings growth and margin outlook summary Valuation Valuations: Our preferred names Dallah and Mouwasat are trading at reasonable multiples The Saudi healthcare sector is trading at a median 2017 PER of 20.6x and offers five year earnings CAGR ( ) of 15%. Both our preferred names - Dallah and Mouwasat - are trading in line with the median at 20.6x and 20.7x respectively. Al Hammadi continues to trade at a 58% premium to its peers, at a 2017 PE of 32.5x; pricing in clear visibility on its expansion plans. Unlike Mouwasat and Dallah, where expansions are expected to come online after 2-3 years, Al Hammadi has already started commercial operations of Al-Suweidi Hospital and completed 82% of its hospital in Al-Nuzha as of 31 March Near term Margin outlook Long term earnings growth Actual CAGR (4 year) Earnings growth CAGR (3 year) Forecast CAGR (5 Year) Hammadi Premium due to more visibility on expansion plans High 12.0% 15.4% 19.7% Dallah Attractive High 9.8% 20.8% 20.4% Mouwasat Reasonable Medium 9.0% 16.3% 14.6% Care Cheap due to receivables exposure to Govt. and slower growth Low 8.4% 12.5% 9.7% MEH Cheap due to receivables exposure to Govt. and slower growth Low 6.0% 7.4% Source: SICO Research Care and MEH are trading at a discount to median, as both offer only singledigit 5-year ( CAGR) earnings growth at 7.4% and 6.0% respectively. The valuation discount also prices in the longer payment cycle and receivable exposure to government entities. Our top pick - Dallah - offers earnings CAGR of 20% over , with a scope of near-term margin improvement; however, valuations fail to capture the premium the stock truly deserves. Exhibit 10: PE (FY2017) vs 5 Year CAGR EPS growth Source: SICO Research 6

7 Exhibit 11: Coverage summary Name Stock Price, LC Rating Target Price, LC Dividend yield 2016e 2017e 2015e 2016e Al Hammadi 41.4 Sell % 2.4% Dallah 81.9 Buy % 1.6% Mouwasat Buy % 2.2% National Medical Care 58.8 Sell % 3.4% Middle East 69.4 Neutral % 2.9% P/E Note: Potential return based on 31st May 2016 closing prices Source: SICO Research Exhibit 12: Relative Valuation Name Relative Valuation In general, healthcare companies trade at a premium to the broader market, because of their defensive nature with low beta and high growth expectations. In Saudi Arabia, healthcare stocks are currently trading at a premium (2016E P/E of 25.5x) to the broader market. The Saudi hospital sector trades at a 24.0% discount to emerging market peers Currency Stock price Mkt Cap (in USD) EV/ EBITDA 2016e 2017e 2016e 2017e Netcare Ltd South Africa ZAr 3,309 3, Mediclinic International Ltd South Africa ZAr 20,112 9, Life Group Holdin South Africa ZAr 3,856 2, Bangkok Dusit Med Service Thailand THB 24 10, Bumrungrad Hospital Pub Co Thailand THB 197 4, Bangkok Chain Hospital Pcl Thailand THB Raffles Medical Group Ltd Singapore SGD 2 2, Ihh Bhd Malaysia MYR 6 12, Kpj Berhad Malaysia MYR 4 1, Apollo Hospitals Enterprise India INR 1,369 2, Fleury Sa Brazil BRL 26 1, Nmc Health Plc UAE GBp 1,140 3, Emerging market mutiples Al Hammadi Saudi Arabia SAR , Dallah Saudi Arabia SAR , Mouwasat Saudi Arabia SAR , National Medical Care Saudi Arabia SAR Middle East Saudi Arabia SAR , S audi mutiples P/ E Note: based on 31st May 2016 closing prices Source: SICO Research 7

8 Company Sections 8

9 Company Initiation Report SICO Research Apr-16 Apr-16 May-16 May-16 May-16 May-16 GCC Equities Price Data (SAR) Current Price Target Price wk High/Low 78.50/66.75 Ratings Short-term Long-term Risk Profile Market Data Sector Market Cap Primary Exchange Other Exchange Reuters Bloomberg Neutral Neutral Normal USD 1.70bn Saudi Arabia 4009.SE MEH AB Equity Free Float 37% Valuation Ratios 2015A 2016E P/E x P/BV x EV/EBITDA x Div Yld % Trading Data Daily Vol (6M Avg) 0.0 Daily T/o (6M Avg USD) 0.0 Issued Shares 92.0 All in millions Relative Price Performance 1.20 Tadawul MEH Middle East : Lacking growth drivers Limited earnings growth potential over the long-term due to absence of aggressive growth plans High receivables and longer payment cycle are also concerns Initiate with an Neutral rating and price target of SAR 75 Slower growth compared to peers Unlike its peers, Middle East (MEH) does not have aggressive growth plans. It is planning to add 150 beds/35 clinics in 2Q16 at Hail (33% stake) and 150 beds/100 clinics in 1Q18 at Dammam, taking its total capacity from 788 beds/281 clinics to 986 beds/392 clinics in Excluding this, the company has not announced any further bed capacity addition in the mediumterm, unlike Dallah, Mouwasat and Al Hammadi. The six-year CAGR ( ) bed capacity growth for MEH is only 3.8%, much lower than 14.4%/15.8%/ 28.1% for Dallah, Mouwasat and Hammadi, respectively. Lack of new capacity additions beyond the hospitals at Hail and Dammam implies weaker growth potential for the company over the longer-term. Optimum utilisation to support earnings growth In the absence of aggressive expansion plans, we expect MEH to operate at higher utilisation levels, resulting in lower direct costs, administrative fees and selling expenses. However, improvement in utilisation levels along with higher average price per patient, should result in three-year earnings growth CAGR ( ) of only 6.0%, well below 21% / 16% for Dallah/Mouwasat. Concern on increasing and ageing receivables MEH s receivables have increased to SAR 875mn at FY15-end from SAR 600mn at FY14-end. The receivable days have also worsened to 208 days in 2015 from 157 in 2014, much higher than 96 days for both Dallah and Mouwasat. Total account receivables as of 30 June 2016 stood at SAR 755mn, out of which SAR 447mn (59%) is due from the Ministry of Health and SAR 180mn from Insurance companies (24%) Valuation and rating We initiate on Middle East with a Neutral rating and a target price of SAR 75. The company trades at 15.9x EPS (2016e) and offers 7.4% CAGR ( ) EPS growth. The stock has returned 8.4% since its listing on Tadawul, but we do not see much value given our expectation of lower EPS growth. Restated to 100 Performance (%) 1m 3m 12m Absolute (6.4) Relative (1.1) Source: SICO Research, Bloomberg Nitin Garg, CFA ext 5059 Nitin.Garg@sicobahrain.com Summary Financials SAR mn 2014A 2015A 2016E 2017E 2018E CAGR (%) Sales 1,399 1,535 1,587 1,696 1, Gross Income Gross Margin (%) Operating Income Operating Margin (%) Net Income Net Margin (%) EPS Source: Company, SICO Research, Bloomberg SICO 2016 All Rights Reserved 9 Attention is drawn to the disclaimer and other information in the end

10 Company Profile The company s main activity is to own, manage, operate and maintain hospitals. Currently, Middle East fully owns four hospitals located in Jeddah (SGH Jeddah), Riyadh (SGH Riyadh), Al Madinah (SGH Madinah) and Khamis Mushait (SGH Aseer). MEH also owns 32.33% of the share capital of NHC (a company subsidiary), a closed joint stock company registered in Hail to set up, manage, operate and maintain hospitals. NHC is currently in the process of developing a new hospital in Hail (SGH Hail), expected to commence operation in In addition, the company is currently developing the necessary designs and plans to build a new hospital in Dammam (SGH Dammam 100% owned), to be established on a plot of land owned by MEH,. buthas not yet initiated the construction work. MEH also entered into Management Supervision Agreements in relation to a number of hospitals outside the Kingdom, namely in Dubai, Cairo and Sanaa. These hospitals use the Saudi German Hospital brand as their trade name. Exhibit 13: Shareholding pattern Shareholding Pattern Pre offering Post offering Bait Al-Batterjee Medical Company 78.13% 54.69% IFC 12.04% 8.43% Zuhair Ahmed Al- Sebai 4.66% 3.26% IDB 2.08% 1.45% Arab Fund 1.63% 1.14% Sobhi Abduljaleel Batterjee 1.38% 0.96% Source: Company data Exhibit 14: Share of revenue by segment, 2015 Inpatient revenue Outpatient revenue Pharmacy 18.2% Exhibit 15: Share of revenue by client type, 2014 Insurance Ministry of Health Cash Clients Direct Clients 10.4% 19.0% 39.8% 25.3% 56.5% 30.9% Source: Company data Source: Company data The company s business is divided into three segments: inpatient, outpatient and pharmaceuticals. The inpatient segment accounted for 56.5% of revenues in 2015 (declining from 58.2% in 2014), while the outpatient segment s contribution increased from 23.3% to 25.3%. The pharmaceutical segment s share of revenues remained flat at 18.2% in At a revenue level, insurance customers accounted for 39.8% of revenues in 2014, Ministry of Health patients accounted for 30.9%, while cash clients and direct corporate clients formed 19.0% and 10.4% of revenues in

11 Exhibit 16: Inpatient market share 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Riyadh Jeddah Madinah Aseer Total Source: Company data Exhibit 17: Outpatient market share 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% Riyadh Jeddah Madinah Aseer Total Source: Company data Exhibit 18: Middle East Hospitals SGH Jeddah Hospital (Established 1988) SGH Riyadh Hospital (Established 1988) SGH Aseer Hospital (Established 2000) SGH Madinah Hospital (Established 2002) AJ sons (Established 2004) SGH Dammam Hospital (Established NHC Hospital (Established 2014) 191 Beds 105 Clinics 219 Beds 69 Clinics 194 Beds 56 Clinics 184 Beds 51 clinics 114 Beds 36 clinics 150 Beds 100 clinics 150 Beds 35 clinics Source: Company Data Saudi German Hospital Jeddah Commencing operations in 1988, SGH Jeddah is a tertiary care hospital covering all medical and surgical specialties, diagnostic facilities and support services, with 191 beds. The hospital is located on Batterjee Street in the prime Al Zahra district area of Jeddah, close to Jeddah airport. The facility consists of the main building (inpatient hospital building) with a built-up area of 18,745 square metres, and the medical tower with a built-up area of 10,902 square metres. Saudi German Hospital Aseer SGH Aseer started operations in March It is a 194-bed multi-specialty tertiary care hospital located on the Abha Khamis Mushait Highway in Aseer. The main hospital building has a built-up area of 35,893 square metres. The hospital is easily accessible from the airport and by road from other parts of Aseer and neighbouring regions. Saudi German Hospital Riyadh SGH Riyadh is a 219-bed multi-specialty tertiary care hospital located on the King Fahad Road close to the main business and residential districts, easily accessible from all areas of Riyadh city and neighbouring areas. The hospital is built on a plot area of 29,880 square metres, with a built-up area of 35,188 square metres. Saudi German Hospital - Madinah 11

12 SGH Madinah is a 184-bed multi-specialty tertiary care hospital under operations since The hospital is located in Madinah outside the Haram area located on Prince Naif bin AbdulAziz Road. The hospital is built on a plot of 70,771 square metres, with the main hospital building having a built-up area of 34,751 square metres. Exhibit 19: Middle East hospitals Hospital Land area in sq meters Built up area Number of clinics Number of beds Number of doctors SGH Jeddah 33,375 57, SGH Riyadh 37,567 46, SGH Aseer 55,644 49, SGH Madinah 65,606 48, Source: Company data Growth prospects: not aggressive, unlike peers Expanding in new cities: MEH intends to grow by establishing new hospitals in Hail and Dammam. SGH Hail s capacity will be 150 beds and 35 outpatient clinics, with construction expected to be completed during 1H16. The company has finalised the preliminary designs for the construction of SGH Dammam, which will have a capacity of 150 beds and 100 outpatient clinics. It intends to appoint a contractor to begin the construction of SGH Dammam. We have pencilled in 2017 as the start up for Hail project, and a 2019 startup for the Dammam project in our valuation model. Exhibit 20: Bed capacity growth 1000 Exhibit 21: Clinic capacity growth Source: Company data 12

13 The following table shows a summary of SGH Hail and SGH Dammam projects: Exhibit 22: Middle East : upcoming projects Des cription S GH Hail S GH Dammam Stake owned 32.30% 100.0% Capacity 150 beds 35 outpatient clinics 6 operating rooms 150 beds 100 outpatient clinics 8 operating rooms Project land area 89,213 m2 30,000 m2 Project s built-up area (hospital buildings excluding staff housing) 19,551 m2 39,283 m2 Project s expected cost (excluding land cost) SAR 176mn SAR 307mn Project s expected cost (including land cost) SAR 180mn SAR 350mn Expected date of completion of construction 1Q16 4Q17 Expected date of operation 2Q16 1Q18 Completion Percentage (Paid Value) Main licenses obtained Main Licenses to be obtained 61.16% (achieved from the entire project) 81.38% (the main hospital) 87.51% (staff housing) Ministry of Municipality and Rural Affairs license in respect of the civil construction works, MOH preliminary approval Final license from Hail Municipality Civil Defense License MOH License MOH preliminary approval Project land ownership Owned by NHC Owned by the Company Source of funding Source: Company Data Shareholder equity 38.26% Loan from MoF 33.17% Suppliers Credit 6.67% Bank loans 21.90% Self-funding sources Loan from MoF Suppliers Credit Bank loans Expand current facilities of existing hospitals: MEH is in the process of implementing plans to increase thebed capacity at its existing hospitals by a further 85 beds over the next three years (SGH Jeddah 32 beds, SGH Riyadh 30 beds, and SGH Madinah 23 beds). Furthermore, it also plans to open 62 new outpatient clinics during the same period (SGH Jeddah 22 clinics, SGH Aseer 40 clinics). We will incorporate these expansions plan into our valuations once tangible progress is made. Financial Review Revenue and earnings growth We expect Middle East s revenues to rise 7.7% over E, primarily driven by the company s expansion plans and higher average price per patient. The bulk of growth during E should come from improving utilisation levels of existing hospitals; while the earnings growth in later years ( ) will come from greenfield expansions: Hail hospital and Dammam Hospital. MEH s total capacity is expected to reach 986 beds in 2018 from the current 788 beds. We expect the company s net profit to grow at a CAGR (15-20E) of 7.4%, reaching SAR 558mn in FY20. Margin analysis We expect operating margins to increase by 40bps in 2017 and 60bps in 2018, reaching 25.1% in 2018 from 24.1% in Post 2018, we expect margin 13

14 pressure as Dammam hospital will come online in We forecast 23.3% operating margin in Debt levels and capital expenditure MEH s capex requirements are not significant, especially in the context of the industry. The company s capital structure is conservative, with a net debt to equity for 2015 at 11% compared to 26% for Hammadi and 32% for Dallah, and capex requirements can be easily met by debt finance. MEH is expected to remain free cash flow positive, with cumulative operating cash flow generation > SAR 1.0bn over We believe the company is in a comfortable position to not only service its debt, but also maintain and possibly increase dividend payments to shareholders. Dividend payment We assume MEH to increase its dividend pay-out ratio from an average 45% in to 55% starting FY18. Dividend yields are expected to remain in the range of %. Valuation: Target price SAR 75, Recommendation Neutral We use a standard Discounted Cash Flow (DCF) model based on a detailed 5- year forecast, followed by a further 5 years based on assumptions for key lines such as sales growth, margins, capital expenditure and terminal value. We have considered a 10-year period for DCF instead of the usual 5-year period as the company is currently in growth phase and would take a few years to reach stability. Based on current expansion plans, we assume to be normalised years in order to provide a realistic basis on which to project outer years. We believe a DCF valuation reflects the value of the producing assets and likely new projects over the longer-term. The DCF approach yields a 1-year target price of SAR 75 per share the DCF value is based on a nominal Weighted Average Cost of Capital (WACC) of 9.05% (and we have assumed 3% longterm growth beyond 2025), a 5.25% risk-free rate, 6.0% risk premium and beta of Our valuation assumptions used for DCF are presented below: Beta: Since the company has only two months of trading history, we have used beta of 1.00x for valuation purposes. Risk Free Rate: The risk free rate is calculated as 5.25% which is a sum of 3.25% (80% weightage to last 15-year average of US 10-year bond yield; and 20% weightage to last one-year average of US 10-year bond yield) + 1.5% (1.5* Saudi Arabia country risk premium). Equity Risk Premium: We have assumed an equity risk premium of 6.0% comprising 4.5% of global equity risk premium adjusted for developing countries. We add 1.5% standard premium to Equity premium to account for illiquidity and lower disclosure risks Cost of Equity: Based on the above assumptions, Middle East 's cost of equity equates to 11.29%. WACC: We assume a cost of debt of 4%, which is conservative as the government provides an interest-free funding facility of up to SAR 200mn or 50% of set-up costs for private hospital projects, with attractive repayment terms. Based on the above assumptions, the estimated WACC works out to be 9.05%. 14

15 Terminal Growth: We have assumed a terminal growth rate of 3% for valuation purposes based on expected long-term nominal growth of the Kingdom. Exhibit 23: Cost of equity assumptions Metric Value Remarks Base risk-free-rate A 3.25% (0.8)* (Average of US 15 Year bond)+(0.2)*(average of preceding year US 10 yr bond) Country risk premium B 2.0% 1.5 x Country default spread Saudi Risk Free Rate C = A + B 5.25% Global equity risk premium D 4.5% Long-term equity market returns for global markets. This takes into account the returns generated by the S&P 500 (which has the longest history, and represents the most developed equity market in the world) for the period Accordingly, during this period, the S&P 500 generated an excess return of 4.62% over the risk free asset (US 10- year treasury) Beta E year Beta of the more liquid names in the sector Country equity risk F 1.5% Illiquidity and disclosure premium premium Cost of equity G = C + F + (D x E) Source: SICO Research Risks Huge receivables and exposure to Govt. entity MEH s receivable days worsened to 246 days in 2015 from 157 days in 2014 owing to government exposure. Total account receivables as of 30 June 2016 stood at SAR 755mn, out of which 447mn (59%) are due from Ministry of Health and SAR 180mn from Insurance companies (24%). Delays or cost overruns in expansion plans Any delay in adding new beds or higher-than-expected capex incurred could pose a significant risk to our estimates and impact our valuations. Constraints on availability of skilled talent pool The sector is expanding aggressively and will need to add medical staff commensurate with its expansion. There could be constraints to the availability of experienced medical staff, which could potentially hamper growth plans. Policy formulation A restrictive policy that discourages private sector participation would adversely affect the strong sector fundamentals. Improvement at government hospitals Efficiency and service quality improvement at government hospitals could pose a risk to the private players. Recently, Arabian Business reported that expatriates in Saudi Arabia will be able to use government hospitals for treatment as long as they pay a designated fee and follow the centres rules and regulations, according to the Ministry of Health. The decision was taken due to a large number of expats living in rural areas where few or no private hospitals are provided. We believe that listed Saudi hospital names would be least impacted as all names operate in urban areas like Riyadh, Jeddah and Dammam. Also, insurance is mandatory for expats, and an insured will always prefer private hospital to those run by the Ministry of Health. Saudisation risk Stringent Nitaqat regulations could force the company to hire Saudi nationals in order to maintain Saudisation levels 15

16 Others risks Other risks are related to cost management. Higher-than-expected cost inflation (labour, raw materials and fuel costs are the greatest risks) will erode margins. Financials Income Statement (Consolidated) Year ending 31 Dec (SAR mn) 2014A 2015A 2016E 2017E 2018E Revenue 1,399 1,535 1,587 1,696 1,770 Cost of Goods Sold (649) (724) (753) (797) (821) Gross Profit Selling, General and Admin. Expenses (430) (424) (452) (483) (504) EBITDA Operating Profit Other Income Net Interest Income (4) (4) (3) (3) (3) Tax (1) Minority Interest Net Profit Balance Sheet (Consolidated) Year ending 31 Dec (SAR mn) 2014A 2015A 2016E 2017E 2018E Cash & Short Term Deposits Other Current Assets 710 1,006 1,077 1,147 1,194 Investments Net Fixed Assets Net Intangible Assets Other Non-Current Assets Total Assets 1,778 2,057 2,243 2,449 2,649 Current Liabilities Total Debt Other Liabilities (69) (73) (44) (32) (19) Total Liabilities Minority Interest Share Capital Reserves & Surplus ,063 Shareholders Funds 1,140 1,353 1,570 1,776 1,984 Total Equity & Liabilities 1,778 2,057 2,243 2,449 2,649 16

17 Financials Cash Flow Statement (Consolidated) Year ending 31 Dec (SAR mn) 2014A 2015A 2016E 2017E 2018E Net profit before minority Depreciation Other Adjustments Working Capital Changes (47) (266) (70) (59) (41) Cashflow from Operations Capital Expenditure (110) (83) (100) (100) (100) Other Investing Activities (14) (32) Cashflow from Investing (123) (115) (100) (100) (100) Debt Raised/Repaid (34) 4 (31) (11) (13) Dividend (92) (166) (184) (230) (258) Other Financing Activities (7) Cashflow from Financing (134) (159) (215) (241) (271) Net Chg in Cash 92 (80) Note: The above statements may not match the published cash flow statements due to adjustments made by us. Key Ratios (Consolidated) Year ending 31 Dec (SAR mn) 2014A 2015A 2016E 2017E 2018E EPS EPS Growth (%) Gross Margin (%) EBITDA Margin (%) EBITDA Growth (%) (3.2) Net Margin (%) ROAE (%) ROAA (%) Debt/Equity (%) Valuation Ratios PER (x) PBV (x) Dividend Yield (%) EV/EBITDA (x) Source: Company, SICO Research, Bloomberg 17

18 GCC Equities Price Data (SAR) Current Price Target Price wk High/Low 65.75/32.00 Ratings Short-term Neutral Long-term Sell Risk Profile High Market Data Sector Market Cap USD 1.3bn Primary Market Saudi Arabia Other Exchg Reuters 4007.SE Bloomberg AlhammadAB Free Float 30% Valuation Ratio 2015A 2016E P/E x P/BV x EV/EBIDTA x Div Yld % Trading Data Daily Vol (6M Avg) 0.3 Daily T/o (6M Avg USD) 3.7 Issued Shares All in millions Performance (%) 1m 3m 12m Absolute Relative Source: SICO Research, Bloomberg Nitin.Garg@sicobahrain.com Al Hammadi Company for Development and Investment: Facing margin pressure Fire at Olaya Hospital and longer working capital cycle are the key concerns Poor 1Q at all levels, net income at SAR 21.6mn (-47.4% YoY, -40% QoQ), a big miss on our SAR 32mn estimate Downgrade to Sell rating with a revised price target of SAR 40 (SAR 45) 1Q16 result review: poor numbers across the board Al Hammadi reported 1Q16 net income of SAR 21.6mn (-47.4% YoY, -40% QoQ), missing our SAR 32mn estimate. Gross profit grew by 8% YoY due to an 11% increase in revenues, led by increase in inpatient traffic. However, operating profit and net income declined 39% and 47%, respectively due to: (i) increase in depreciation expenses and financial charges attributable to the opening of Al Sweidi hospital; (ii) closure of Olaya branch during 1Q16 as a result of an electrical contact incident on 7 February 2016; and (iii) the collection of SAR 9.8mn written-off debt in 1Q15 which resulted in higher base. Exhibit 24: 1Q16 Result summary LCY % YoY % QoQ Cons SICO Cons SICO Revenues % -9% 152-5% Gross Profit % -23% Gross margin 37.9% EBIT % -34% % EBIT margin 18.4% 25.3% Net Profit % -40% % -33% Net margin 15.0% 21.1% Source: Company data, SICO Research ---1Q Q16 Forecast-- Actual vs Temper near-term expectations: faces near-term margin pressure Revenues grew 26% YoY and 22% YoY in 3Q15 and 4Q15, but slowed to 11% in 1Q16 due to a fire at Olaya Hospital. This facility is currently closed and all inpatients have been shifted to Al Suweidi Hospital. We pencil in a January 2017 start up for Olaya Hospital in our model. The receivable days have also worsened to 162 days in 2015 from 100 in 2014, much higher than 96 days for Dallah and Mouwasat. Stock still trades at premium to peers Al Hammadi continues to trade at premium to Saudi peers. On our 2017 estimates, Hammadi trades at PE of 30.0x, implying 44% premium to median of Saudi peers and pricing in clear visibility on its expansion plans. Unlike Mouwasat and Dallah, where expansions are coming online after 2-3 years, Al Hammadi has already started commercial operations at Al Suweidi Hospital and completed 82% of its hospital in Al- Nuzha as of 31 March Cut target price to SAR 40 (from SAR 45) and downgrade to sell rating We see slower revenue growth and weaker margins post poor 1Q, considering the impact of fire at Olaya hospital. We revise down our 2016/17/18 estimates by 22%/13%/15% and cut our DCF based target price to SAR 40 from SAR 45 while downgrading the stock to Sell from Buy Rating. 18

19 Al Hammadi Company for Development and Investment Financials Income Statement (Consolidated) Revenue ,002 Cost of Goods Sold (315) (443) (651) Gross Profit Selling, General and Admin. Expenses (93) (118) (170) EBITDA Operating Profit Other Income Net Interest Income (6) (7) (8) Tax (9) (8) (11) Minority Interest Net Profit Cash Flow Statement (Consolidated) Net profit before minority Depreciation Other Adjustments Working Capital Changes (150) 75 (65) Cashflow from Operations Capital Expenditure (175) (253) (74) Other Investing Activities Cashflow from Investing (175) (253) (74) Debt Raised/Repaid (271) 270 (73) Dividend (75) (84) (120) Other Financing Activities Cashflow from Financing (346) 186 (193) Net Chg in Cash (454) 173 (91) Note: The above statements may not match the published cash flow statements due to adjustments made by us. Balance Sheet (Consolidated) Cash & Short Term Deposits Other Current Assets Investments Net Fixed Assets 1,556 1,766 1,765 Net Intangible Assets Other Non-Current Assets Total Assets 1,936 2,248 2,246 Current Liabilities Total Debt Other Liabilities (276) (523) (452) Total Liabilities Minority Interest Share Capital 1,200 1,200 1,200 Reserves & Surplus Shareholders Funds 1,386 1,425 1,470 Total Equity & Liabilities 1,936 2,247 2,245 Key Ratios (Consolidated) EPS EPS Growth (%) 9.6 (13.2) 34.9 Gross Margin (%) EBITDA Margin (%) EBITDA Growth (%) 27.1 (3.9) 45.0 Net Margin (%) ROAE (%) ROAA (%) Debt/Equity (%) Valuation Ratios PER (x) PBV (x) Dividend Yield (%) EV/EBITDA (x) Source: Company, SICO Research, Bloomberg 19

20 GCC Equities Price Data (SAR) Current Price Target Price wk High/Low /49.50 Ratings Short-term Positive Long-term Buy Risk Profile High Market Data Sector Market Cap USD 1.3bn Primary Market Saudi Arabia Other Exchg Reuters 4004.SE Bloomberg DallahAB Free Float 40% Valuation Ratio 2015A 2016E P/E x P/BV x EV/EBIDTA x Div Yld % Trading Data Daily Vol (6M Avg) 0.2 Daily T/o (6M Avg USD) 3.1 Issued Shares 59.0 All in millions Performance (%) 1m 3m 12m Absolute Relative Source: SICO Research, Bloomberg Nitin.Garg@sicobahrain.com Dallah : Top pick Strong expansion plans; however, majority will materialise from ; near-term growth from brownfield expansions at Al Nakheel Hospital Strong 1Q at all levels, net income at SAR 58.3mn (+22% YoY, +6.8% QoQ), 9.5% higher than estimates Maintain Buy rating and increase price target to SAR 100 1Q16 result review: strong quarter Dallah reported 1Q16 net income of SAR 58.3mn (+22% YoY, +6.8% QoQ), 9.5% higher than our SAR 53mn estimate. Gross profit was SAR 132.8mn (+30.1%YoY, +13.7%QoQ), with operating profit at SAR 62.2mn (+26.2%YoY, +9.1%QoQ). YoY improvement came from an increase in revenues led by higher number of inpatients and outpatients, better operating rate from the North clinics building, and enhancing some contractual terms for services which led to increase in overall average operating capacity. Operating margin expanded to 21.8% compared to 20.5% in 1Q15 and 20.6% in 4Q15. We expect margins to be sustained at these levels, as Dallah is not adding any new capacity in 2016; and forecast 17.8% operating margin in 2016, +70bps from 17.1% in Exhibit 25: 1Q16 Result summary LCY % YoY % QoQ Cons SICO Cons SICO Revenues % 3% 272 5% Gross Profit % 14% Gross margin 46.6% EBIT % 9% % EBIT margin 21.8% 20.3% Net Profit % 7% % 10% Net margin 20.5% 19.5% Source: Company data, SICO Research ---1Q Q16 Forecast-- Actual vs Strong expansion plans; however, majority not until The company s total capacity is expected to reach 1,003 beds/642 clinics by 2018 from 448 beds/163 clinics, translating into a net income growth CAGR of 20% during the period. Dallah has no plans to add any capacity in 2016, and therefore higher patient volume along with increasing utilisation of existing assets would account for the bulk of 2016E earnings growth. Revenue grew 19% YoY in 1Q16 higher than 12%/8%/13%/9% over past four quarters. Considering strong 1Q, we estimate 14.7% revenue growth in 2016 compared to 10.2% in Beyond 2016, Dallah s equity story would depend on the success of the greenfield Namar hospital (initial 300 beds with c.70% capacity addition) that is set to commence operations in Increase target price to SAR 100 (from SAR 85), maintaining Buy rating We forecast higher revenue growth and stronger margins post strong 1Q and accordingly revise up our 2016/17/18 net income estimates by 3%/2%1% and increase our DCF based target price to SAR100 from SAR 85. Dallah is currently our top pick in the sector and we maintain our Buy rating the name. 20

21 Dallah Holding Co. Financials Income Statement (Consolidated) Revenue 986 1,131 1,340 Cost of Goods Sold (578) (623) (730) Gross Profit Selling, General and Admin. Expenses (239) (251) (293) EBITDA Operating Profit Other Income Net Interest Income (5) (11) (16) Tax (10) (12) (15) Minority Interest Net Profit Cash Flow Statement (Consolidated) Net profit before minority Depreciation Other Adjustments Working Capital Changes 54 (70) (43) Cashflow from Operations Capital Expenditure (185) (550) (440) Other Investing Activities (142) 0 0 Cashflow from Investing (327) (550) (440) Debt Raised/Repaid (25) Dividend (47) (89) (118) Other Financing Activities Cashflow from Financing (143) Net Chg in Cash (312) Note: The above statements may not match the published cash flow statements due to adjustments made by us. Balance Sheet (Consolidated) Cash & Short Term Deposits Other Current Assets Investments Net Fixed Assets 1,145 1,767 2,123 Net Intangible Assets Other Non-Current Assets Total Assets 2,002 2,886 2,981 Current Liabilities Total Debt 393 1,158 1,133 Other Liabilities (245) (1,010) (985) Total Liabilities 609 1,392 1,373 Minority Interest Share Capital Reserves & Surplus ,017 Shareholders Funds 1,393 1,494 1,607 Total Equity & Liabilities 2,002 2,886 2,980 Key Ratios (Consolidated) EPS EPS Growth (%) Gross Margin (%) EBITDA Margin (%) EBITDA Growth (%) Net Margin (%) ROAE (%) ROAA (%) Debt/Equity (%) Valuation Ratios PER (x) PBV (x) Dividend Yield (%) EV/EBITDA (x) Source: Company, SICO Research, Bloomberg 21

22 GCC Equities Price Data (SAR) Current Price Target Price wk High/Low /94.00 Ratings Short-term Positive Long-term Buy Risk Profile Normal Market Data Sector Market Cap USD 1.7bn Primary Market Saudi Arabia Other Exchg Reuters 4002.SE Bloomberg MOUWASATAB Free Float 48% Valuation Ratio 2015A 2016E P/E x P/BV x EV/EBIDTA x Div Yld % Trading Data Daily Vol (6M Avg) 0.1 Daily T/o (6M Avg USD) 1.8 Issued Shares 50.0 All in millions Performance (%) 1m 3m 12m Absolute Relative Source: SICO Research, Bloomberg Nitin.Garg@sicobahrain.com Mouwasat: Buy with modest upside Strong 1Q with net income at SAR 71mn (+27% YoY, +32% QoQ), 15% higher than estimates Riyadh Hospital operations stabilised, and we expect 190bps operating margin improvement in 2016 over 2015 Maintain Buy rating with a revised price target of SAR 150 1Q16 result review: better operating margins push earnings Mouwasat reported 1Q16 net income of SAR 71.1mn (+27.2% YoY, +32.2% QoQ), 15% higher than our SAR 62mn estimate. Gross profit was SAR 146.1mn (+23.2%YoY, +28.2%QoQ), with operating profit at SAR 78.4mn (+26.2%YoY, +29.2%QoQ). According to management, Riyadh Hospital contributed to the overall revenue growth. Operating margin expanded to 25.5% compared to 24.5% in 1Q15 and 22% in 4Q15. We highlighted this in our initiation report KSA - Prescription for long term growth and healthy returns (published on 14 October 2015) - that margins should improve from 2016 onwards as Riyadh Hospital matures. We expect margins to be sustained at these levels, and forecast 24.2% operating margin in 2016, +190bps from 22.3% in Exhibit 26: 1Q16 Result summary LCY % YoY % QoQ Cons SICO Cons SICO Revenues % 11% 300 2% Gross Profit % 13% Gross margin 47.6% EBIT % 29% % EBIT margin 25.6% 23.0% Net Profit % 32% % 15% Net margin 23.2% 20.7% Source: Company data, SICO Research ---1Q Q16 Forecast-- Actual vs Aggressive expansion plan to drive strong earnings growth The company s total capacity is expected to reach 1,290 beds/318 clinics by 2019 from 710 beds/198 clinics in 2015, translating to a net income growth CAGR of 15% during the period. The company has no plans to add any capacity in 2016/17/18 except 100 additional beds at Jubail Hospital in 2016, which is a brown field expansion and carries lower risk on margins. Mouwasat has obtained approval from the Ministry of Health to start operations at the Jubail Hospital extension and has guided for 4% revenue growth from this unit. Higher patient volume plus increasing contribution from Riyadh hospital would account for the bulk of E earnings growth. The revenue grew 21% YoY in 1Q16 led by contribution from Riyadh hospital, higher than 4%/12%/7%/12% growth achieved in past four quarters. We estimate 15% revenue growth in 2016 compared to 6%/11% in 2014/15. Increase target price to SAR 150 (from SAR 140) and maintain Buy rating We see higher revenue growth and stronger margins post strong 1Q and accordingly revise up our 2016/17/18 net income estimates by 1%/2%/3% and increase our DCF based target price to SAR 150 from SAR 140. We continue to maintain Buy rating on Mouwasat with modest 15.0% upside. 22

23 Mouwasat Medical Services Co. Financials Income Statement (Consolidated) Revenue 1,055 1,218 1,431 Cost of Goods Sold (501) (549) (642) Gross Profit Selling, General and Admin. Expenses (266) (314) (362) EBITDA Operating Profit Other Income Net Interest Income (7) (11) (13) Tax (16) (22) (27) Minority Interest (14) (18) (22) Net Profit Cash Flow Statement (Consolidated) Net profit before minority Depreciation Other Adjustments Working Capital Changes (103) (12) (40) Cashflow from Operations Capital Expenditure (217) (150) (125) Other Investing Activities Cashflow from Investing (214) (150) (125) Debt Raised/Repaid Dividend (100) (125) (150) Other Financing Activities (5) 0 0 Cashflow from Financing (69) (105) (106) Net Chg in Cash (101) Note: The above statements may not match the published cash flow statements due to adjustments made by us. Balance Sheet (Consolidated) Cash & Short Term Deposits Other Current Assets Investments Net Fixed Assets 1,236 1,284 1,344 Net Intangible Assets Other Non-Current Assets Total Assets 1,875 2,083 2,346 Current Liabilities Total Debt Other Liabilities (309) (394) (461) Total Liabilities Minority Interest Share Capital Reserves & Surplus Shareholders Funds 1,136 1,292 1,479 Total Equity & Liabilities 1,875 2,083 2,347 Key Ratios (Consolidated) EPS EPS Growth (%) (13.0) Gross Margin (%) EBITDA Margin (%) EBITDA Growth (%) Net Margin (%) ROAE (%) ROAA (%) Debt/Equity (%) Valuation Ratios PER (x) PBV (x) Dividend Yield (%) EV/EBITDA (x) Source: Company, SICO Research, Bloomberg 23

24 GCC Equities Price Data (SAR) Current Price Target Price wk High/Low 69.00/40.70 Ratings Short-term Neutral Long-term Sell Risk Profile High Market Data Sector Market Cap USD 0.7bn Primary Market Saudi Arabia Other Exchg Reuters 4005.SE Bloomberg CAREAB Free Float 59% Valuation Ratio 2015A 2016E P/E x P/BV x EV/EBIDTA x Div Yld % Trading Data Daily Vol (6M Avg) 0.5 Daily T/o (6M Avg USD) 6.2 Issued Shares 44.9 All in millions Performance (%) 1m 3m 12m Absolute Relative Source: SICO Research, Bloomberg Nitin.Garg@sicobahrain.com National Medical Care: Searching for catalysts Limited growth potential over the long-term, receivables exposure to Govt. entities, and longer payment cycle are the chief concerns Strong 1Q numbers at all levels, SAR 33mn net income beating our SAR 31mn estimate Downgrade to Sell rating with a revised price target of SAR 55 1Q16 result review: strong quarter Care reported 1Q16 net income of SAR 33mn, +19% growth YoY beating our estimates of SAR 31mn. Gross profit was SAR 67.2mn (+24% YoY, +33.5% QoQ) and operating profit stood at SAR 35mn (+20% YoY, +4% QoQ). Operating margin expanded to 13.8%, +80bps YoY. We highlighted margin improvement potential for Care in our initiation report KSA - Prescription for long term growth and healthy returns (published on 14 October 2015) as the 200 new beds added at Riyadh National hospital mature. We expect margins to further improve in coming quarters, and forecast 15.8% operating margin in 2016, up from 12.4%/14.7% in 2014/15. Exhibit 27: 1Q16 Result summary LCY % YoY % QoQ Cons SICO Cons SICO Revenues % 15% 241 5% Gross Profit % 34% Gross margin 26.5% EBIT % 4% % EBIT margin 13.8% 14.1% Net Profit % -6% % 6% Net margin 13.0% 12.9% Source: Company data, SICO Research Slower growth compared to peers ---1Q Q16 Forecast-- Actual vs Unlike its peers, Care does not have aggressive growth plans. It is planning to add 250 beds (150 new renovation) / 30 clinics in Riyadh National Hospital in two phases, taking its total capacity from 620 beds/140 clinics to 770 beds/170 clinics. It expects to start building the first phase in 2Q16 and second phase in 4Q17. Beyond this, the company has not announced any further bed capacity addition in the medium-term, unlike Dallah, Mouwasat and Al Hammadi. The six-year CAGR ( ) bed capacity growth for Care is only 3.7%, much lower than 14.4%/15.8%/28.1% for Dallah, Mouwasat and Hammadi, respectively. Lack of new capacity additions beyond renovation and expansion at Riyadh National Hospital implies weaker earnings growth potential for the company over the longer-term. Increase target price to SAR 55 (from SAR 50) and downgrade to Sell rating on share price run We see higher revenue growth and stronger margins post strong 1Q and accordingly revise up our 2016/17/18 net income estimates by 3%/4%6% and increase our DCF based target price to SAR 55 from SAR 50. We downgrade the stock to Sell from Buy rating on share price run. Care trades at 19.0x EPS (2016e) and offers 9.7% five year ( ) CAGR EPS growth. 24