KPJ Healthcare. The Malaysia healthcare stock

Transcription

1 MALAYSIA An undervalued healthcare leader Initiate with Outperform, RM7.1 target price We initiate coverage of (KPJ), the largest private hospital network operator in Malaysia (by number of hospitals) with an Outperform recommendation based on 12-month sum-of-parts target price of RM7.1, implying 13% upside from current levels and FY13E and FY14E PER of 23x and 2x, respectively. Despite no official dividend policy, we expect KPJ to continue paying 5% of its net profit on a quarterly basis, which implies a 2.2% FY13E dividend yield. Driver 1: Benefiting from the public-to-private switch KPJ MK Price (at CLOSE#, 5 Sep 212) Outperform RM month target RM 7.1 Upside/Downside % 13.2 Valuation - Sum of Parts RM GICS sector Health Care Equipment & Services Market cap RMm 3,988 3-day avg turnover US$m 1.3 Market cap US$m 1,282 Number shares on issue m Investment fundamentals Year end 31 Dec 211A 212E 213E 214E Revenue m 1,99. 2,68.9 2, ,598.9 EBIT m EBIT growth % Reported profit m Adjusted profit m EPS rep sen EPS rep growth % EPS adj sen EPS adj growth % PER rep x PER adj x Total DPS sen Total div yield % ROA % ROE % EV/EBITDA x Net debt/equity % P/BV x Source: FactSet, Macquarie Research, September 212 (all figures in MYR unless noted) Analyst(s) Chi Hoong Ng chihoong.ng@macquarie.com Yeonzon Yeow yeonzon.yeow@macquarie.com 1 September 212 Macquarie Capital Securities (Malaysia) Sdn. Bhd. Supported by the rise in income and increased acceptance of medical insurance, private healthcare has become accessible to the public. Private healthcare operators like KPJ should also continue to benefit from overcrowded public hospitals, as more than 8% of the healthcare budget is dedicated to supporting public hospital operating expenditures. Despite the demand increase, new entry is limited by the zoning requirements implemented by the Private Healthcare Facilities and Services Act 1998 which limits the numbers of bed counts within an area. Driver 2: Growing edge in captive market Capitalising on its market share advantage, KPJ has been acquiring hospitals around the nation to enter new markets while strengthening its number-one position. By disposing the hospital assets to its associate Al-Aqar Healthcare REIT, KPJ is able to unlock part of the investment value upfront while continuing with its acquisitions, without the need to raise additional funds. Al-Aqar Healthcare REIT is the only healthcare-focused REIT in Malaysia. Driver 3: The blue-sky scenario RM7.6 (21% upside) There could be more upside to our base-case scenario target price of RM7.1, as we assume that the three new hospitals beginning operation this year will only start to positively contribute in 214. We believe that the scenario could change, as KPJ was able turn around KPJ Kajang within a year of operation. If such a scenario were repeated, we could see potential upside to RM7.6. Driver 4: Historical valuations no longer valid Our implied valuation is demanding compared to KPJ s historical average; however, the stock fundamentals have significantly changed from two years ago. With JCorp trimming its stake from 81% in 22 to the current 41% and the listing of IHH Healthcare (IHH MK, Not Rated), liquidity and interest in KPJ stock have improved significantly. Another rerating catalyst could also be a JV or M&A with a Singapore-based medical group providing the potential to gain access to Singaporean treatment in Malaysia paid by Medisave. The Malaysia healthcare stock For investors seeking to invest in the growing Malaysia healthcare market, we believe that KPJ, with its Malaysia-focused operation and undemanding 23x FY13E PER with a 2.2% div yield (vs IHH at 33x consensus FY13E PER with no dividend upside) is a compelling opportunity. Please refer to the important disclosures and analyst certification on page 2 and the inside back cover of this document, or on our website

2 Inside An undervalued healthcare leader 3 Valuation, recommendation, risks 6 Benefiting from the public to private switch12 Growing edge in a captive market 16 Unsuspected derivative play on interest rate 19 Malaysia Healthcare and its future 2 KPJ shareholding chart Others 32% Jcorp* 45% Berhad (KPJ MK) Company profile Berhad (KPJ) is a leading private healthcare provider in Malaysia with 21 hospitals in Malaysia and two in Indonesia. With more than 2,6 licensed beds, KPJ currently owns the largest private-hospital network in Malaysia. In 211, KPJ treated 2.4m outpatients and 24, inpatients through its network hospital. As the availability of new hospital sites becomes more limited within the city boundaries, private operators are now either working with property developers or going further inland to expand their presence. We think KPJ s acquisition growth strategy is viable as the risk associated with it is lower than setting up new sites. Despite the government s focus on transforming Malaysia into a medical-tourism destination, we believe this is a long-term plan, as Malaysia is less competitive in services compared to peers. Fig 1 KPJ s operation snapshot Foreign 12% EPF 11% *JCorp shareholdings includes Waqaf An-Nur Corp stake As of 3 April 212 Source: Company data, Macquarie Research, September 212 KPJ number of patients trend (') Outpatients Intpatients 3, 2,5 2, 1,5 1, Source: Company data, Macquarie Research, September 212 KPJ MK rel KLCI performance, & rec history Note: Recommendation timeline - if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period. Source: FactSet, Macquarie Research, September 212 (all figures in MYR unless noted) Source: Company data, Macquarie Research, September 212 KPJ started as the healthcare division of state-owned Johor Corporation (JCorp) in In 1994, JCorp decided to list KPJ as the first listed healthcare group in Bursa, Malaysia. Currently, JCorp owns 45% of KPJ shares. Key Management and Directors Kamaruzzan Abu Kassim, Chairman Kamaruzzaman, aged 48, was appointed as a Non-Independent Non- Executive Director of KPJ on 3 January 211 and subsequently as Chairman of KPJ on 12 January 211. He is currently the President & Chief Executive Officer of Johor Corporation (JCorp). Datuk Paduka Siti Sa diah Sheikh Bakir, Managing Director Siti Sa diah, aged 59, graduated with a Bachelor of Economics from the University of Malaya in 1974 and holds an MBA from Henley Management College, University Reading, UK. Her career with Johor Corporation (JCorp) commenced in 1974 and she has been directly involved with JCorp's Healthcare Division since She was appointed as the Chief Executive of Kumpulan Perubatan (Johor) Sdn Bhd (KPJSB) from 1989 until the listing of KPJ in November She has been the Managing Director of Berhad (KPJ) since 1 March September 212 2

3 An undervalued healthcare leader Initiating coverage with Outperform recommendation Outperform recommendation with target price of RM7.1, which implies a 13% return The macro environment looks positive for Malaysia private healthcare player We are initiating coverage of (KPJ) with an Outperform recommendation and a target price of RM7.1 based on our sum-of-parts methodology, which implies 13% upside to the current share price. With the widest hospital network in Malaysia, we think KPJ is poised to benefit from the overstretched public system. In addition, we think that the recent listing of IHH Healthcare (IHH) has improved interest in KPJ stock, as investors view KPJ as a pure Malaysia healthcare stock with an undemanding valuation. Switching to private healthcare Despite allocating a similar annual budget to the healthcare system, most of the funds have shifted from capex to opex due to the rising operational costs of public hospitals. On average only five hospitals were built over the last five years with public hospital beds only growing by 2% from Unless the government decides to allocate more funding to the public healthcare system, we believe that private providers will likely be big beneficiaries, as more patients are forced to seek treatment with private operators, as the level of overcrowding at public hospitals is expected to worsen. Fig 2 More inpatients are now seeking medical treatment at private healthcare facilities Private 26% 28 Private 28% 211 Public 74% Public 72% Based on number of inpatients: 3.mn (28) and 3.2mn (211) Source: MOH, Macquarie Research, September 212 Source: MOH, Macquarie Research, September 212 In our view, the rise in income and acceptance of medical insurance among Malaysians will help improve affordability and hence increase demand for private healthcare. In addition, Malaysia is expected to reach an aging population status by 235 (aging population status is defined by WHO as one where at least 1% of the population is above the age of 6). As such, there could be another opportunity for KPJ to offer elderly-care services in Malaysia. Al-Aqar Healthcare REIT, benefiting KPJ in two ways Al-Aqar benefits: 1) Lowering investment cost for KPJ 2) Potential uplift in overall valuation The Private Healthcare Facilities and Services Act 1998 (the Act) governs all activity within the private healthcare sector, which includes the building and expansion of new and established private hospitals. Within the Act, the zoning requirement also limits the population to number of beds ratio (1:5) within a 14km radius. The limitation benefits established operators like KPJ as it limits the entry of new competitors. Capitalising on the Act s limits, KPJ is has been making several acquisitions, acquiring at least one hospital annually from 26 in an effort to either enter new markets or block competitors from entering the market. We believe KPJ has a competitive edge as it has been able to lighten its balance sheet and unlock the value of its hospital assets by disposing it to its associate, Al-Aqar Healthcare REIT (Al-Aqar). With the REIT, KPJ can outbid its competitors (if needed) knowing they can recoup part of their investment upfront, while improving the investment s return. KPJ is the only operator to own a healthcare REIT in Malaysia. 1 September 212 3

4 Base case RM7.1 (13% upside) Bull case RM7.6 (21% upside) Bear case RM5.2 (18% downside) Turning around a new hospital within a year is possible, as it has been done before There is an investment trend toward high-yielding companies that pay dividends from strong defensive cash flow, to seek higher returns. We believe KPJ could be an indirect beneficiary of this investment trend as its 49% owned Al-Aqar could potentially be valued higher as it has similar earnings stability and dividend payout ratios to telco and consumer stocks. If valued at 3.5% yield (vs the current yield at 5.2%), it would equate to an additional 4% upside to our target price. The bull case at RM7.6 implies 21% upside Base case RM7.1 (13% upside) In our base-case scenario, we did not factor in any possible synergy from the two recently acquired hospitals, Sabah Medical Centre (21) and Sibu Specialist Medical Centre (211) in East Malaysia. As no new capacities have been installed over the past two years, we are forecasting the number of outpatients and inpatients to grow moderately at 7.% and 7.5% for both 212 and 213, respectively. The number of patients growth rate should see improvement post-213, as we expect KPJ Klang Specialist Hospital (May 212), Sabah Medical Centre and Pasir Gudang Specialist (total capacity of 57 beds), to start contributing positively after more than one and half years of operation. Management also indicated that new hospitals usually take two to three years to break-even. Blue-sky scenario (bull case) RM 7.6 (21% upside) In our bull-case scenario, instead of expecting improvement in patients admissions post- 213, we assume that the new hospitals would positively contribute within a year of operation as KPJ Kajang (KPJ Kajang Specialist Hospital) managed to break even within its first year of operation. With the above in mind, we expect the total of number of patients could grow by % from 213 to 215, as opposed to our base-case scenario of %. The increase in the number of patients would translate to a revenue increase of.7 5.1%, which would provide uplift to our target price of RM7.1 (18% upside). Combined with the potential increase to Al- Aqar s share price, our bull-case scenario could reach as high as RM7.6 (21% upside). We expect a 1% chance this scenario will work. Bear-case scenario RM5.2 (18% downside) In our bear-case scenario, we assume that inpatient numbers drop by 3.3%, 2.9% and 2.6% in 213, 214 and 215, respectively, to reflect the drop in foreign patient numbers following macroeconomic weakness. The fall in inpatient numbers would translate to an 8-21% drop in revenue from FY13 to FY15. Currently, the medical tourism segment contributes around 1% of KPJ s revenue. Why not invest in Thai hospital operators? Fig 3 KPJ trades at 22x FY13E earnings vs regional peers at 21x 3x FY13E earnings Bbg ticker Up/ (Down) Market Div Yield 3-year EPS Price Target side cap PER (x) EV/EBITDA (x) (%) CAGR (lcy) (lcy) (%) Rec (US$m) FY12E FY13E FY14E FY12E FY13E FY14E FY13E (%) Malaysia KPJ MK OP 1, IHH Healthcare IHH MK 3.11 NR 8, Thailand (Jitima Ratanatam) Bangkok Dusit BGH TB OP 5, Bumrungrad BH TB UP 1, Bangkok Chain BCH TB N India (Abhishek Singhal) Apollo Hospitals* APHS IN OP 1, Fortis Healthcare* FORH IN UP 68 nmf nmf Opto Circuits* OPTC IN OP Simple Average Mkt Weighted Average Priced as of market close 5 September 212 *APHS IN, FOTH IN and OPTC IN are based on 3/FY13 3/FY15 Source: Bloomberg, Macquarie Research, September September 212 4

5 Some may ask why not invest in Thai hospital healthcare operators, which currently trade at a premium to KPJ but have apparent better growth prospects? In our view, given the macroeconomic uncertainty, investors may be reluctant to invest in Thai operators as 26-59% of their revenue comes from foreign patients as opposed to KPJ where foreign patients only account for 1%. We saw a significant fall in the number of foreign patients visiting Thai hospitals during the peak of the global financial crisis (27-29). Fig 4 SWOT analysis Strength: KPJ is a well-established household name in Malaysia as it has more than 2 hospitals in the country and been operating for over 3 years. KPJ plans to inject its fully-operational hospitals into its associate Al Aqar Healthcare REIT and rent back these assets through a lease-back agreement. This strategy will free up cash flow for capex to help finance future expansion. Weaknesses: Liquidity remains an issue as Johor Corp currently holds a 41% stake in ; this is an improvement from JCorp s previous stake of 81% in 22. KPJ is operating close to its optimal utilization rate at 65 7%; any delay in expansion plans could affect growth prospects. Opportunities: 1% of KPJ s revenue is from the medical tourism segment; KPJ aims to increase this to 25% by working with the government to further promote medical tourism aboard. Despite having a network of 21 hospitals in Malaysia, KPJ is not part of the 12 hospitals in Malaysia that are approved by the Singapore government to use CPF Medisave in Malaysia. Threats: As part of the liberalisation of the private healthcare sector in Malaysia, the government has started to allow foreign equity participation in the set-up of new hospitals. The new foreign hospitals may be seen as a threat as they have better branding and stronger balance sheets. Apart from the entry of foreign competitors, Malaysia could also have an additional 17 new private hospitals by 215, with licence to operate some 4,5 beds (incl. KPJ s new hospitals). Source: Macquarie Research, September September 212 5

6 Valuation, recommendation, risks TP RM7.1 with upside of 13%, and pays quarterly dividend We value KPJ based on sum-of-parts methodology and arrive at our target price of RM7.1 with an implied upside of 13%. 85% of the target price value is derived from KPJ s hospital operation business based on DCF methodology with 8.4% WACC and 1x EV/EBITDA for the terminal value, and we also add the value of Al-Aqar Healthcare REIT (Al-Aqar) at market price. KPJ s implied 213 P/E at 22x is higher than its historical average P/E of 1x as it reflects: 1. Improve trading liquidity x higher comparable valuation of IHH (KPJ s 23x FYE13 PER vs IHH s 33x FY13E PER) 3. Scale of the business vs competitors 4. Favourable legislation changes that have recently been implemented Our cash flow assumptions and sensitivity analysis are summarized below. Fig 5 Free cash flow assumptions Free Cash Flow (FCF) 213E 214E 215E 216E 217E EBITDA Dividend from associates (ex-al Aqar) Tax Capex Change in WC FCF NPV of 8.4% WACC 432 PV of terminal value 3,932 (Terminal Value of 4,977 based on 1x FY17 EBITDA) Sum of NPV at YE 4,364 DCF valuation estimates at YE Enterprise Value 4,364 Less: Net Debt 127 Less: Minority 115 Add: Al-Aqar REIT market value ~ 49% 495 (Mark to RM1.45/shr) Equity Value 4,617 Value per share 7.1 (Assuming all outstanding warrants are converted) Source: Macquarie Research, September 212 We calculate KPJ s terminal value at 1x FY17E EBITDA (one standard deviation above the two-year historical EV/EBITDA average), which we think better reflects the defensiveness of the business post the implementation of the Private Healthcare Facilities and Services Act 1998, which came into effect in May 26. Despite forecasting EBITDA to double by 217, we are estimating flat capex estimates at RM2m as KPJ should continue to maintain its asset light business model and will likely dispose the newly built hospital buildings to Al-Aqar Healthcare REIT once they are operational. Fig 6 Implied valuation multiples 212E 213E 214E Implied valuation Implied P/ E (x) Implied P/ BV (x) Implied EV/ EBITDA (x) Implied Dividend yield (%) Source: Company data, Macquarie Research, September 212; priced as of market close 5 September September 212 6

7 WACC (%) Macquarie Research Fig 7 Cost of equity and cost of debt assumption for WACC of 8.4% Cost of equity Cost of debt Risk-free rate 4.% Pretax cost of debt 4.% Market risk premium 6.% Marginal tax rate 25.% Stock Beta.85x Cost of equity, Ke 9.1% Net cost of debt, Kd 3.% Weight applied 89% Weight applied 11% Source: Macquarie Research, September 212 Our risk-free rate estimate for WACC is based on the current 2-year Malaysia government bond yield. There could be more upside potential to our target price as our risk-free rate assumption at 4.% could lower further, as the Malaysia 2-year government bond yield has fallen from 4.7% to 3.92% since the beginning of the year. Fig 8 DCF sensitivity analysis: WACC and terminal value EV/EBITDA multiples Terminal EV/EBITDA DCF Value sensitivity 8.5x 9.x 9.5x 1.x 1.5x 11.x 11.5x Source: Macquarie Research, September % % % % % % % Undemanding valuation (at first glance) Valuation seems demanding compared to its historical average, at first glance, but the higher valuation multiples reflect the changes KPJ has experienced compared to five years ago. Fig 9 KPJ P/E trading-band chart Fig 1 KPJ EV/EBITDA trading-band chart (x) 25 (x) Stdev +1 Stdev Stdev +1 Stdev 1 Average: 11x forward PER 6 Average: 6.3x EV/EBITDA 5-1 Stdev -2 Stdev Jan-7 Jan-8 Jan-9 Jan-1 Jan-11 Jan Stdev 2-2 Stdev Jan-7 Jan-8 Jan-9 Jan-1 Jan-11 Jan-12 Source: Bloomberg, Macquarie Research, September 212 Source: Bloomberg, Macquarie Research, September 212 1) Improved trading liquidity We believe the improved liquidity in KPJ shares is due to JCorp lowering its stake in KPJ from 81% in 22 to 41% today. With JCorp s ongoing debt issue, there is a possibility that JCorp could further divest its stake by disposing the warrant it currently owns. The outstanding warrants would increase KPJ s share base by 3.7%, as they are already in the money (strike price at RM1.7) with an expiration date in January September 212 7

8 Fig 11 JCorp s paring down has improved KPJ s liquidity Fig 12 JCorp is looking to trim down its debt (RM mn) ADTV (LHS) JCorp stake (RHS) (%) 4% % 3% 25% 2% 15% 1% net debt to equity ratio.5 1 5% % Source: Bloomberg, JCorp, Macquarie Research, September 212 Source: Company Data, Macquarie Research, September 212 We believe it is highly unlikely JCorp would increase its KPJ stake in the short to mid term. We do not think that JCorp would look to raise its KPJ stake, despite recently getting help from the federal government to help guarantee JCorp s newly issued debt, intended to refinance its outstanding bonds worth RM3.2bn, which matured in July 212. During the process, JCorp sold RM7m of assets to help close the difference. With JCorp looking to close the privatisation deal in QSR Brands (QSR MK, Not Rated) and KFC Holdings (M) (KFC MK, Not Rated), we believe it is highly unlikely JCorp would increase its stake in KPJ. 2) Improved returns through the listing of Al-Aqar Healthcare REIT To improve the KPJ s cash flow, starting from 26 KPJ decided to operate under an asset light business model by disposing its hospital assets to its associate Al-Aqar Healthcare REIT. So far, KPJ has sold off 24 hospital buildings to Al-Aqar. We believe the move is beneficial to shareholders as it unlocks the value of the building while freeing up more cash flow to help fund KPJ new expansions. with room for a further re-rating The listing of IHH (IHH MK, Not Rated) in Bursa Malaysia and the Singapore Stock Exchange has raised investor interest in healthcare-related stocks in Malaysia (Fig 14). We believe the reason for the increase in KPJ interest can be attributed to its similarity to IHH in the Malaysia healthcare business, with KPJ trading at a discount to IHH. IHH is currently valued at double the PER multiple of KPJ; although IHH is significantly larger with its international reach, KPJ is more profitable with a better expected return on asset and equity (Fig 13). Fig 13 KPJ is expected to be more profitable than IHH Fig 14 Interest in KPJ picked up post listing of IHH ROE (%) IHH KPJ (RM mn) Average 5-day value traded is on its new high post listing of IHH FY12 FY13 FY14. Jan-1 Jul-1 Jan-11 Jul-11 Jan-12 Jul-12 *IHH numbers based on Bloomberg consensus estimates Source: Company Data, Macquarie Research, September 212 Source: Bloomberg, Macquarie Research, September September 212 8

9 KPJ has made an offer to acquire the remaining 49% stake in SMC We are assuming KPJ will maintain a 5% payout ratio moving forward New REIT injection (of two hospitals)? We expect KPJ to inject Pasir Gudang hospital building and the New Sabah Medical Centre (SMC) building into Al-Aqar REIT once they are both operational by the end of the year. KPJ could also recognise a gain from the revaluation of these assets upon transfer/sale to Al-Aqar REIT, as it is currently being valued at cost on its balance sheet. An official dividend policy Currently KPJ does not have an official dividend policy, which could potentially be a concern for yield-searching investors. An official dividend policy should ease investor concerns on whether management will continue paying 5% of their profits through dividends. Based on its historical trend, we do expect KPJ to maintain a 5% payout ratio for the full year with quarterly dividends. We have observed that companies that pay quarterly dividend are favoured, as investors are willing to pay a premium for the certainty of payment. Fig 15 in 21 KPJ started paying a quarterly dividend Fig 16 KPJ has one of the highest dividend yields among peers for FY12E DPS (sen/shr) Q 3Q 2Q 1Q Div Yield (%) Bangkok Chain Opto Circuits KPJ BH Bangkok Dusit Apollo *IHH Fortis DPS from are adjusted to reflect bonus issue DPS for incl. dividend-in-specie for Al-Aqar share *IHH div yield is based on Bloomberg consensus estimates Source: Bloomberg, Macquarie Research, September 212 Source: Bloomberg, Macquarie Research, September 212 KPJ s div yield at 2.2% is 8bps above industry average Despite growing at a slower pace than its peers, KPJ is trading at sector-average multiples. We think there is limited downside, as at 2.2%, KPJ yield is 8bps above the sector average of 1.4%. We expect KPJ to continue paying a quarterly dividend as opposed to the industry norm of a semi or annual dividend. Fig 17 KPJ trades at 22x FY13 earnings with a quarterly dividend payment Bbg ticker Up/(Down) Market Div Yield 3-year EPS Price Target side Rec cap PER (x) EV/EBITDA (x) (%) CAGR (lcy) (lcy) (%) (US$m) FY12E FY13E FY14E FY12E FY13E FY14E FY13E (%) Malaysia KPJ MK OP 1, IHH Healthcare IHH MK 3.11 NR 8, Thailand (Jitima Ratanatam) Bangkok Dusit BGH TB OP 5, Bumrungrad BH TB UP 1, Bangkok Chain BCH TB N India (Abhishek Singhal) Apollo Hospitals* APHS IN OP 1, Fortis Healthcare* FORH IN UP 68 nmf nmf Opto Circuits* OPTC IN OP Simple Average Mkt Weighted Average Priced as of market close 5 September 212 *APHS IN, FOTH IN and OPTC IN are based on 3/FY13 3/FY15 Source: Bloomberg, Macquarie Research, September 212. Price as of 5 September September 212 9

10 Why not invest in Thai hospital operators? The biggest difference between Thai operators and KPJ is their reliance on international patients (medical tourism patients). Based on the latest annual numbers, revenue contribution from international patients for Thai operators is between 26-59%, compared to 1% for KPJ. We think given the uncertainty looming in the macro environment, investors may prefer investing in KPJ as its revenue is relatively stable compared to Thai operators. Fig 18 KPJ s foreign-patient revenue is less than its Thai peers Fig 19 Bumrungrad Hospital (BH TB) saw an 8% drop in international patients admissions during the GFC (%) , 45, 4, # of patients , KPJ Bangkok Dusit Bumrungrad Domestic International 3, 25, 2, 15, 1, 5, Based on 211 numbers Source: Company Data, Macquarie Research, September 212 Source: Company Data, Macquarie Research, September 212 Comparing us to consensus Fig 2 Our estimates are slightly above the street but we still think they are undervaluing KPJ shares Net profit (RM mn) EBITDA (RM mn) Depreciation (RM mn) Target price FY12 FY13 FY14 FY12 FY13 FY14 FY12 FY13 FY14 (RM) Macquarie Consensus Source: Bloomberg, Macquarie Research, September 212 Despite having slightly higher net profit FY12-FY14 (1-3%) estimates compared to the Street, our EBITDA estimates are 6-8% below consensus. We think this is because the company will receive a bigger contribution from its associate and lower interest expenses in future years. The street may be underestimating the value of KPJ, as we believe it is no longer the company it was several years ago we have seen KPJ s liquidity significantly improve with a steady quarterly policy. Risks to our investment thesis Risks to our target price and earnings forecasts come in the form of external and internal financial market shocks or issues affecting our assumptions, such as: Timing of new hospital openings. Our estimates are based on the hospital expansion plan timeline provided by KPJ management. Execution risk of overseas expansion. KPJ is still keen to expand overseas despite hitting roadblocks in Dhaka and Bangladesh. There are execution risks in venturing aboard from operation, valuation (i.e., over-paying) to regulatory risks. Recruiting the right medical professionals. KPJ s success lies in its ability to attract the right medical professionals. KPJ s inroads in smaller cities are making it tougher to retain/attract specialists in smaller cities as most specialists prefer working in bigger cities. 1 September 212 1

11 Legislative changes. There is a possible change to the current two-tier healthcare system such as the 1Care for 1Malaysia plan with the possibility of introducing a British-like National Health Service (NHS) system in the next two to three years. The implementation of a new healthcare system could change the risk profile of the stock. Ability to sell its assets to Al-Aqar REIT. The ability to sell its assets to Al-Aqar REIT is a key funding source for KPJ, as it enables them to continue their acquisition trail without further leveraging their balance sheet. Ability to continue paying dividends. There is a risk that management may deviate from its current informal system, including lowering the payout ratio or the frequency of the dividend payments, as the current KPJ management does not have an official dividend policy. 1 September

12 Benefiting from the public to private switch KPJ benefiting from the system KPJ, with the widest hospital network in Malaysia, is poised to benefit from patients opting for private hospital care instead of cheaper-but-congested public hospitals. If the government s focus remains on paying off medical bills and not building-up more hospitals, the congested public hospital scene is expected to continue. Fig 21 KPJ has one of the most extensive hospital networks in Malaysia Source: Company Data, Macquarie Research, September 212 The system : patients switching to private hospitals Malaysia has a two-tier healthcare system consisting of a government-run universal healthcare system and a private healthcare system. Under the two-tier system, all Malaysians are able to seek medical treatment at a minimal fee (outpatient medical treatment is RM2 per visit). 1 September

13 Fig 22 More money is spent on private healthcare Fig 23 but not from the government (% of GDP) 2.8 (RM'bn) 18 Health Budget (LHS) % of Health Budget Allocation to National Budget (RHS) (%) 9% % % % % % % % 1.2 Pirvate healthcare expenditure Public healthcare expenditure 2 1% % Source: World Databank, Macquarie Research, September 212 Source: MOH, Macquarie Research, September 212 Despite having a similar annual budget allocation for the healthcare sector, the recent focus has been on operating expenditures instead of investing in new hospitals. The Malaysian government has only allocated 2.5% of GDP towards public healthcare, which is less than the 5-6% of GDP recommended by WHO. Fig 24 Government needs to start spending on healthcare capex, in our view Fig 25 as only five government hospitals were build over the last five years (bn) Opex (RM 'bn) Capex (RM 'bn) public hospital (LHS) no. of beds (RHS) (') Source: MOH, Macquarie Research, September 212 Source: MOH, Macquarie Research, September 212 More than 6% of the funding through opex is used for medical care payments, while 41% of capex is used for either building or expanding hospitals. If we were to compare the absolute amount being spent on new hospital and facilities, it has drop by 35% from RM2.2bn in 23 to RM1.45bn in 21. With fewer hospitals being built, more patients have opted to seek treatment in private hospitals. We expect this situation to worsen as government has significantly cut its spending on building new hospitals. Malaysia s bed per population is low compared to other countries. 1 September

14 Fig 26 Beds per 1, population across the region Fig 27 as the government has significantly cut spending on new hospitals # of bed Japan Korea China Singapore Vietnam United States Brunei Thailand Malaysia Indonesia Philipines (RM 'bn) Total spending on new hospitals Source: WHO, Macquarie Research, September 212 Source: MOH, Macquarie Research, September 212 Given life expectancy expansion and the increasing acceptance of medical, demand for private healthcare is expected to continue growing. However, for those who can t afford private care, government aid is the only option. The problem is, without the government stepping up their investment in public healthcare the system will be stretched even further. Malaysia s ageing population (15% of people aged above or expected to reach the age of 6 by 235) could also provide further opportunity for KPJ to enter into elderly-care services. KPJ is transferring the knowledge from its elderly-care operations at its recently acquired Jeta Gardens in Australia, which specialises in this field. Fig 28 Medical premium contribution is on the rise, supporting affordability Fig 29 Malaysia s population is aging RM'mn (RHS) growth (LHS) 3% 25% 2% ('mn) Population (LHS) >65 years old (RHS) (%) % 1% 5% % Source: BNM, Macquarie Research, September 212 Source: MOH, Macquarie Research, September 212 We believe there is still room for growth in the private healthcare sector, as only 25% of Malaysian hospital beds are currently operated by private operators. KPJ is the market leader in the private healthcare segment with 19% market share, followed by IHH (ParkwayPantai) with 14% market share. 1 September

15 Fig 3 Private beds account for only 25% of total beds available Fig 31 KPJ is Malaysia s leading private healthcare provider 6, # of beds 5, 4, 11,637 11,291 11,689 12,216 13,186 13,568 KPJ 19% 3, 2, 38,625 4,57 41,249 41,58 41,483 41,716 IHH 14% 1, Public Private Others 67% Source: MOH, Macquarie Research, September 212 Source: MOH, Company Data, Macquarie Research, September September

16 Growing edge in a captive market Hospital operators like KPJ are the main beneficiaries of the Private Healthcare Facilities and Services Act 1998 KPJ has been acquiring two hospitals per year for the past five years KPJ is not only benefiting from the change in patients preference, but also, from the Private Healthcare Facilities and Services Act Under the Act, the expansion and building of new hospitals are required to adhere to zoning requirements (with the exception of specialist hospitals), which limits the total hospital bed to population ratio within a 14km radius to 1: 5. Existing players like KPJ benefited from the Act as it served as a barrier to entry. In addition, it appears, with the help of it Al-Aqar REIT, KPJ is able to acquire smaller hospitals around the country while simultaneously denying its competitors market access. KPJ: The only Malaysia hospital operator with a REIT Given the Act was effective from May 26, the availability of suitable locations for new hospitals are limited due to zoning constraints. To maintain KPJ s growth while strengthening its portfolio as the leading Malaysian private hospital operator, KPJ has been actively looking to acquire smaller hospitals (<9 beds) around Malaysia. On average, over the past five years, KPJ has acquired two hospitals per annum and we expect its acquisition momentum to continue. Lowering investment cost through Al-Aqar REIT We believe that KPJ has an edge over its peers in penetrating new markets, as KPJ has the ability to acquire smaller hospitals to gain access while being protected against other competitors with the help of Al-Aqar REIT. The REIT enables KPJ to lower its investment cost while maintaining control of the asset Although the allocation of RM1-25m for hospital acquisitions seems small, the cash outflow for these acquisitions is usually lower. Upon completion of the acquisitions, KPJ then disposes the hospital asset to its REIT and in return KPJ is compensated with cash and units in the REIT, while maintaining control over the hospital operation. By doing so, KPJ is able to recoup part of its investment upfront, and potentially reward its shareholders by distributing the accumulated REIT units. Fig 32 Preferable acquisition structure of KPJ Source: Company data, Macquarie Research, September 212 We believe that the advantage cannot be easily mimicked by its peers, as it requires a reasonable size of building assets to set up a REIT. The only competitor that could possibly follow suit would be Parkway Pantai (PPL) which has 11 hospitals with 2,1 beds in Malaysia, as it recently decided to sell it Gleneagles Medical Centre, Malaysia to its parent company associate Parkway Life REIT (PREIT SP, Not Rated). With the backing of the REIT, KPJ should be able to continue with its acquisitions and could possible outbid its competitors if needed. 1 September

17 Do these acquisitions make sense? The zoning requirement acts as a barrier to entry against new private hospitals, while forming a captive market for private hospitals within a 14km radius. Without new competition entering the market, we believe the key question to ask is whether these acquisitions make sense. Fig 33 Recent acquisition detail (26-212) Est Valuation Acquired Hospital Bed Count Date Stake Acq. Value PER (x) P/BV (x) Damai Specialist Centre Jan-6 97% KPJ Selangor Specialist Hospital Feb-6 6% Sentosa Medical Centre Dec-6 1% Taiping Medical Centre 48 2-Jan-8 1% Kluang Utama Specialist Hospital 5 31-Dec-8 1% KPJ Seremban Specialist Hospital 13 5-Aug-9 1% Sabah Medical Centre Jun-1 51% 51. NA.7 Sibu Specialist Medical Centre 35 6-Apr-11 1% Jeta Gardens 18 3-Nov-11 51% 19. NA.5 RS Medika Permata Hijau 7-May-12 8% Average (Malaysia acq. only) Average (Global) Source: Company data, Macquarie Research, September 212 Some of the recent acquisitions were done at a hefty valuation, which was due to its strategic location purposes. For example, the Damai Specialist Centre was acquired at 85x PER, but provided KPJ with a foothold into the Kota Kinabalu (capital of Sabah state) market which only has three private hospitals and also limits more established competitors from entering the market. It is hard to quantify the new referral business arising from these acquisitions Excluding strategic investments, the valuation for these assets looks reasonable at 14x PER. But it is hard to quantify the synergy arising from these acquisitions, as we are unable to break down the increase in revenues which are due to the new referral business. We view management s ability to take advantage of the valuation differences between KPJ assets and the acquired assets as a plus. Fig 34 Sentosa Medical Centre recent revenue growth trends (mn) 7 Post acqusition 12% 6 Revenue (LHS) Growth (RHS) 1% 5 1% 8% 4 3 2% 3% 3% 4% 5% 6% 4% 2 1 % 2% % % Source: Company data, Macquarie Research, September 212 Overall some investors might not be comfortable with these acquisitions, but we believe that management has the execution ability to at least maintain the growth rate of these newly acquired assets. As scarcity of new hospital land increases, acquisitions will likely be the key to KPJ s future. 1 September

18 Organic growth insufficient Organic growth can be obtained by either investing in new equipment or building new hospitals Of KPJ hospitals, 71% are established hospitals with more than 1 years of operation. These hospitals provide relatively stable income but lack strong growth momentum given their mature client base. To improve the return on these mature hospitals, KPJ is investing in new equipment to offer new services at a competitive rate to their current patients. While building a new hospital can extract a higher return, the availability of suitable locations remains a key concern. To tackle this problem, KPJ seeks to acquire partially built hospitals or partner with township developers to build a new hospital within a new township. Fig 35 Strong growth momentum New # of Beds Est. Completion Eff. Stake Sabah Medical Centre % Pasir Gudang Specialist Hospital % Muar Specialist Hospital % Bandar Dato Onn, JB % Pahang Specialist Hospital % Perlis Specialist Hospital % Source: Company data, Macquarie Research, September 212 KPJ aims to increase its hospital count to 3 from 22 by 215 Specialists partner with KPJ (not employees) The Act limits the fee a doctor can charge to his patient Based on KPJ management experience, new hospital within a city area would likely take at least one to three years before it is able to break even. Despite higher returns on the greenfield projects, management is inclined to grow through M&A as it provides them with a steady client base and doctors. KPJ aims to increase its hospital count to 3 from 22 by 215. Is the doctor shortage a problem to KPJ s growth strategy? With recent news articles pointing out that Malaysia currently lacks many specialist doctors, we think KPJ is somewhat shielded from the problem. The key for the hospital growth lies in its ability to attract and retain doctors. In the KPJ hospital network, doctors/specialists rent a clinic to practise while KPJ maintains the hospital facilities. With the specialist taking home most of the consultation fee (KPJ takes 5-7% of it as a management fee), they are more likely to stay with KPJ as they are not employed by KPJ and are free to refer their patients to any facilities for further treatment. KPJ need not to worry about doctors over-charging patients and in turn damaging its reputation, as all medical procedure and consultation fees have a price ceiling which is regulated by the government. While getting the right doctors to serve in smaller city hospitals is a challenge, acquiring existing hospitals would come with existing specialists & staff. KPJ would then bring in new equipment that was no longer being used in their bigger hospitals to diversify its service offering in the newly acquired hospital. 1 September

19 Unsuspected derivative play on interest rate Al-Aqar has the potential to add 5% to our target price Emil Wolter, our Asia strategist believe that investors should stay focused on the return of capital, hence investors should be looking into yield stocks with growth (link). If yield is all that matters, we believe Al-Aqar Healthcare REIT (Al-Aqar) could trade up to RM2.2 (which would add an additional 5% to our target price) on the assumption that investors bid up to sovereign yield. Based on Al-Aqar s current market value, it constitutes c.1% of our target market value. Fig 36 If yield is all that matters, moves in Al-Aqar s stock price could have a positive impact on our target price Sovereign Debt Yield Spread to Sovereign 3.% 3.25% 3.5% 3.75% 4.% 4.25% 4.5%.% % % % % % Calculation are formulated based on FY11 net distribution Source: Macquarie Research, September 212 We have seen yield compression across high-yield consumer names and the telco sector. Assuming a more realistic assumption at a 75bps spread to sovereign debt, there would still be an additional 2% (RM.11) upside to our current target price. In Malaysia, we have seen some yield compression from high-yield consumer names and the telco sector. We believe that the same yield compression scenario could also positively impact Al-Aqar s stock price as it has a similarly stable defensive cash flow. Fig 37 Telco yield is on the move Fig 38 same for the consumer sector 7.5% 7.5% 7.% 6.5% 6.% 7.% 6.5% 6.% 5.5% 4.8% 5.5% 5.8% Div Yield 5.% Nov-9 May-1 Nov-1 May-11 Nov-11 May-12 5.% 4.5% div yield 4.% Jan-9 Jul-9 Jan-1 Jul-1 Jan-11 Jul-11 Jan-12 Jul-12 Source: Bloomberg, Macquarie Research, September 212 Source: Bloomberg, Macquarie Research, September September

20 Kuala Lumpur Putrajaya Pulau Pinang Perak Melaka Negeri Sembilan Johor Perlis Selangor Sarawak Kedah Pahang Sabah Terengganu Labuan Kelantan Macquarie Research Malaysia Healthcare and its future Two federal territory and three states are below the suggested zoning requirement Malaysia private healthcare services are regulated by the Private Healthcare Facilities and Services Act 1998, which became effective in May 26. The Act covers issues from zoning requirements to the fees that a doctor can charge for their consultation. In this segment, we will examine how the Act has changed the landscape of the business and the impact of the new government policies (ETP & 1Care for 1Malaysia) Zoning requirement for new private hospitals The Private Healthcare Facilities and Services Act 1998 regulates the private healthcare and hospital business in Malaysia. Under the Act, the expansion and the setting up of new hospital are required to adhere to zoning requirements (with the exception of specialist hospital), which limits the total hospital bed to population ratio within a 14km radius at 1:5. Fig 39 Bed to population ratio in various states and federal territories Source: MOH, Macquarie Research, September 212 New hospitals can only be built 2km away from the nearest hospital It is highly unlikely for any new hospitals to be approved in Kuala Lumpur and Pulau Pinang as their bed to population ratio is above the zoning requirement and there aren t many new township development projects that are 2km distance away from an existing hospital. Where to build? Affluent states Preferably private hospital operators would want to set up at locations where the surrounding population is affluent. 67% of the total current private hospital beds are located in the top 4 richest states in Malaysia (KL, Pulau Pinang, Sarawak & Selangor) while Kuala Lumpur alone has 23% of the total capacity. 1 September 212 2

21 Selangor Johor Sabah Sarawak Perak Kedah Kuala Lumpur Pulau Pinang Kelantan Pahang Terengganu Negeri Sembilan Melaka Perlis Putrajaya Labuan Kuala Lumpur Pulau Pinang Sarawak Selangor Labuan Negeri Sembilan Melaka Pahang Johor Terengganu Sabah Perak Perlis Kedah Kelantan Macquarie Research Fig 4 67% of private hospital beds are located in the top 4 richest state (RM) 6, 5, 4, 3, 2, 1, # of beds 3,5 3, 2,5 2, 1,5 1, 5 GDP Hospital Source: Department of Statistic 21, MOH, Macquarie Research, September 212 Acquisition or expansion of old hospital seems to be the only viable way to enter KL and Pulau Pinang Major hospital players will have new hospital operating in KV or IDR within the next 3 years Within the 4 states mentioned, we don t think any private operators will be able to set up new hospitals in Kuala Lumpur and Pulau Pinang due to the zoning requirements. The only possibility to increase market leadership in these 2 states would be either through acquisition. Based on the Associate of Private Hospital of Malaysia (APHM) member list, the number of privately owned and managed hospital in Kuala Lumpur is 26 and Pulau Pinang is 14. States with sizable population By 22, the Malaysia government hopes to raise the GNI (gross national income) per capita to RM48,. If the plan succeeds, affordability for private healthcare system should improve. We expect more private healthcare groups to take advantage of it by setting up more hospitals in the greater Klang Valley (KV) in Selangor and Kuala Lumpur and Iskandar Development Region (IDR) in Southern Johor. Fig 41 Bigger population = bigger opportunity for private hospital operators (') 6, Population (LHS) # of hospitals (RHS) 7 5, 6 4, 3, 2, 1, Source: Department of Statistic 21, Macquarie Research, September 212 Pantai Parkway, KPJ and Thomson Medical Centre each has a hospital opening within the next 3 years in either KV or IDR to take advantage of the rising population in those area. 1 September

22 JV with township developers Township developers might opt to own the hospital instead of partnering with hospital operators To obtain a strategic located land at a reasonable pricing, private hospital owners will have to work with township developers to jointly develop hospitals land. The developers will help secure the land within its newly develop township, while hospital operators will be in charge of building and operating the hospital. The partnership resulted in lower initial capital investment by hospital operators, but might be problematic for independent hospital operator as they might not have full control planning the hospital future development. Developers might also opt to own the hospital and outsource the operation of the hospital through hospital management agreements (HMA). Sunway Medical Center (link to Sunway Group) and Sime Darby Healthcare (link to Sime Darby) are some of the successful hospital own by township developers. HMAs might be another growth option for independent hospital operators as its getting harder for them to secure land for new hospitals. ETP: Medical Tourism is a long-term project To transform Malaysia into a high-income economy by 22, Malaysia Prime Minister Najib Razak unveiled the Economic Transformation Programme (ETP) which focuses on 12 National Key Economic Areas (NKEA). Under the private healthcare NKEA, the government identified medical tourism as one of the potential growth segments. We agree with the government that there is considerable market potential in the medical tourism segment, but we believe it has a long way to go before Malaysia is able to monetise it. Fig 42 Malaysia medical tourism market in small compare to its regional peer (US$ mn) 1,4 1,2 1,145 1, Malaysia Singapore Thailand *Singapore is based on 21 numbers, Thailand is based on 29 numbers Source: IHH s prospectus, Macquarie Research, September 212 We believe that Malaysia s hospitals are less competitive in this segment due to: Accreditation Branding Accreditation The main consideration for most patients when they are seeking treatment abroad is better affordability without compromising on quality and care standards. Despite having a similar pricing structure with Thailand, Malaysia hospitals are not competitive in attracting medical tourists. We believe this is due to the lack of accredited hospitals and branding. 1 September