KPJ Healthcare. Company Update. A Fresh Start BUY. MALAYSIA EQUITY Investment Research Daily News

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1 PP10551/10/2010(025682) 07 January 2010 Norfauzi Nasron +60 (3) Company Update KPJ Healthcare MALAYSIA EQUITY Investment Research Daily News BUY Target Previous Price RM2.95 RM2.39 RM2.60 HEALTHCARE KPJ is the largest private hospital provider in Malaysia with a network of 19 hospitals across the country Stock Statistics Bloomberg Ticker KPJ MK Share Capital (m) Market Cap (RMm) week H L Price (RM) mth Avg Vol ( 000) YTD Returns 0.0 Beta (x) 0.69 Major Shareholders (%) Johor Corp 50.2 Al-Waqaf 8.8 EPF 5.2 Share Performance (%) Month Absolute Relative 1m m m m month Share Price Performance Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 A Fresh Start Following the sharp price appreciation, some might wonder whether is there any more upside on KPJ s share price and whether the potential upside been priced in. Although KPJ s valuation appears to be relatively expensive on a historical basis, we believe there is more upside to the share price as the stock is still trading at a discount to its regional peer average PER of 18.5x. At 18.5x PER on the fully diluted FY10 EPS, we arrive at a TP of RM2.95 and maintain our BUY recommendation. We reiterate our view that KPJ is an excellent choice for long term investment and portfolio balancing in view of its resilient business and steady dividend payout as well growth potential in a defensive sector. Closing the valuation gap. Following the strong price appreciation, there has been a significant upward rerating for KPJ s valuation, which is currently trading at around 16x PER on FY10 EPS. We believe the upward rerating on the valuation is justifiable given that despite the significant price appreciation, KPJ remains a cheaper alternative to its regional peers. We believe the improvement in liquidity, coupled with its position as the only pure private hospital provider listed in Malaysia and the inclusion of KPJ as a member of FBM100 Index, should further justify the higher valuations for the stock Raising its expansion game. Under its previous business expansion strategy, KPJ was aiming to add at least one new hospital each year either through acquisitions or building greenfield hospitals. As its existing hospitals have matured and stabilised, KPJ is ready to embark on a more aggressive expansion strategy by targeting to add at least two new hospitals every year from 2010 onwards, which is in line with its goal to achieve RM2bn revenue by 2012, which we believe is reasonable. Yesterday, KPJ announced its first acquisition for 2010 via the proposed acquisition of a 51% stake in SMC Healthcare SB (SMCH), which owns of Sabah Medical Centre for RM51m. Maintain BUY. We maintain our forecast but have adjusted our EPS based on an enlarged number of shares following the 1-into-2 share split, 1-for-4 bonus issue and 1-for-4 free warrants issue. We have imputed an enlarged number of shares from 211.1m previously to 659.5m, which takes into account full exercise of the free warrants. We value KPJ at 18.5x PER on FY10 EPS, which is based on its regional peer average, as we believe KPJ deserves a higher valuation as it offers comparable earnings performance as well as future growth potential. At 18.5x PER, we arrive at a TP of RM2.95 and maintain our BUY recommendation. Despite the strong rally leading up to the ex-date of the entitlements, the track record of similar corporate exercises by mid-cap peers is inconclusive and KPJ could well continue its strong rally. KPJ s should resume trading the latest by next week on completion of the bonus issue and share split exercise. FYE Dec (RMm) FY06 FY07 FY08 FY09f FY10f Revenue Net Profit % chg y-o-y Consensus EPS (sen) DPS (sen) Dividend yield (%) ROE (%) ROA (%) PER (x) BV/share (RM) P/BV (x) EV/ EBITDA (x) Notes: Share base is adjusted for 1-into-2 share split, 1-for-4 bonus issue and 1-for-4 free warrants OSK Research See important disclosures at the end of this report 1

2 KEY HIGHLIGHTS Improved liquidity. Back in August when KPJ s 1HFY09 results were released, KPJ s share price was trading at less than 7x PER on FY10 EPS. As its low share liquidity was among the issues raised by investors leading to the low PER, KPJ subsequently announced proposals for a 1-into-2 share split, 1-for- 4 bonus issue and 1-for-4 free warrants issue as a step to improve the liquidity and marketability of the stock. Judging from the significant jump in the average daily volume and value traded post the announcement of the proposals, it appeared that the proposals are highly welcomed by the investors. The improved liquidity and increase in investors interest has indirectly supported the upward rerating on the stock price which has appreciated by around 50% since the announcement of the proposals. Nevertheless, we believe the strong price appreciation is not solely attributed to the excitement over the proposals as there are also strong fundamental reasons for the upward rerating in valuation. Figure 1: Increase in KPJ s share price and volume traded post announcement Shares 2,500,000 Post announcement 2,000,000 1,500,000 1,000, ,000 0 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 RM Average daily volume traded Share Price (RHS) Source: OSK, Bloomberg Closing the valuations gap. Following the strong price appreciation, there has been a significant upward rerating for KPJ valuation, which is currently trading at around 16x PER on FY10 EPS. We believe the upward rerating is justifiable despite the significant price appreciation because KPJ remains a cheaper alternative to its regional peers. We believe the improvement in liquidity, coupled with its position as the only pure private hospital provider listed in Malaysia and the inclusion of KPJ as a member of FBM100 Index, should further justify the stock s higher valuations. Although its dividend yield at around 4% has become less attractive as compared to before the sharp price appreciation, we believe the yield is still decent and remains attractive as compared to its regional peers. Supported by its steady dividend payout, we believe KPJ should remain as an excellent choice for long term dividend yield seeking investors. Figure 2: Comparison of KPJ s regional peers (as at 30 Dec 2009) Mkt Cap (RM m) Current P/E 5-Year Average P/E P/E FY10 ROE (%) ROA (%) P/B (x) EV/EBITDA FY10 Dividend Yield (%) Parkway Bangkok Dusit Fortis Healthcare N/A Apollo Hospitals Bumrungrad Bangkok Chain Raffles Medical Thomson Medical KPJ Healthcare Source: OSK, Bloomberg OSK Research See important disclosures at the end of this report 2

3 Raising its game. Previously under its business expansion strategy, KPJ was aiming to add at least one new hospital every year either through acquisition or building greenfield hospitals. However, as its existing hospitals have become more mature and stable, KPJ is ready to embark on a more aggressive expansion strategy by aiming to add at least two new hospitals every year from 2010 onwards which is inline with its goal to achieve RM2bn revenue by To recap, for 2009 alone, KPJ has announced three additional hospitals which be operational by end 2011 or early 2012 comprising of a JV project in Kuantan and acquisitions of two abandoned hospital projects in Klang and Muar respectively. Upon the completion of all these projects in 2012, KPJ will increase its bed capacity by around 400 beds. Acquisition of SMCH. As mentioned earlier, yesterday KPJ has announced its first acquisition in 2010 via the proposed acquisition of 51% stakes in SMCH for RM51m which will be funded internally. SMCH is the business owner of a private hospital known as Sabah Medical Centre (SMC) located in Kota Kinabalu. SMC was established in 1986 and currently it has a capacity of around 150 beds. Following the purchase of the hospital building by the Ministry Of Health in Sept 2009, SMC is still continuing its operations in same building at a rental rate of not more than RM5m p.a. pending the completion of its new premises which currently under planning. SMCH via its interest in Amity Development SB also owned a piece of land measuring around 1.7ha which will be used as the relocation sites for the new premises of SMC. As stated in the agreement, KPJ will be appointed to manage the existing hospital as well as the new hospital with a management fee of 3% of the total hospital s annual revenue. Fair valuation for the acquisition. The acquisition price of RM51m for the 51% stake implied a valuation of 1.25x of SMCH s net assets value (NAV). We view the 25% premium on the NAV (which is mostly likely arising from goodwill) as fair based on SMC strong brand name as the largest and leading private hospital that offers the most comprehensive and advanced healthcare services in Sabah. We are positive with the acquisition as there is strong untapped growth opportunity in Sabah and further supported by the over utilization of public healthcare services there which has resulted in overcrowded problem. We believe Kota Kinabalu is an underserved market based on the fact that there are only 3 private hospitals with total bed capacity of less than 180 beds supporting a population of 900,000 people. This acquisition marked the KPJ s second footprint in Sabah following the acquisition of Damai Specialist Hospital in Although the acquisition is expected to be completed in 1QFY10, we have not factored in the latest acquisition into our current forecasts pending more details from management. Figure 3: KPJ s hospital network across 4 countries Source: OSK, Annual Report Allocating RM150m for capex. In order to fulfill its expansion ambition, KPJ has allocated around RM150m p.a. for capex for Given that there are still several of its hospital buildings that have not been injected to Al-Aqar REIT coupled with the proceeds arising from the issuance of m free warrants, we believe KPJ has the flexibility and capacity for expansion without heavily stretching its balance sheet. With the exercise price of RM1.70 for the free warrants, logically we believe that the warrants will most likely be exercised as they are in-the-money. Based on the exercise price, KPJ could potentially raise about RM224m of proceeds from the full exercise of the free warrants which we believe will be used to repay borrowings as well as for future expansion. OSK Research See important disclosures at the end of this report 3

4 Internal expansion. Apart from expanding its capacity externally either via acquisitions or building its own new hospitals, KPJ is also expanding capacity at its existing hospitals. In August last year, KPJ started operations at its replacement Penang Specialist hospital, which has more than double the capacity of the old facility, which will in turn be converted into a nursing college for the northern region. After some delays, KPJ is expected to start operations of its replacement Tawakal Specialist hospital in 1Q10, which has a capacity of around 200 beds with the old premises being used as a day care centre. It is also expanding capacity at its two renowned hospitals, Ampang Puteri and Damansara Specialist hospital, by adding an extra 100 and 60 beds, which are expected to be ready by 2012 and 2011 respectively. We gather that the extensions will mostly comprise premium wards with special focus on medical tourism. Expansion will also be undertaken in several other hospitals across the country. Tapping the medical tourism market. Although KPJ is known as a community based healthcare provider, it is progressively increasing its presence in the medical tourism segment which offers sizeable growth potential for KPJ given that medical tourism currently contributes only around 3% of group revenue. KPJ s move is in line with Government efforts to boost medical tourism and encourage private hospitals to be export-driven. Apart from the tax incentive announced during Budget 2010, the government has outlined several other incentives to boost the medical tourism industry such as tax exemptions equivalent to 100% of qualifying capex incurred for a period of 5 years for the construction of new hospitals or for expansion, modernization or refurbishment of existing hospitals. The Government would also review existing advertising regulations and guidelines to meet the changing role of private hospitals in medical tourism. Is the celebration over? As we mentioned earlier, KPJ s share price has appreciated sharply over the last few months, which made KPJ one of the biggest gainers in Following the sharp gains, some might wonder whether is there any more upside in the share price and whether the potential upside been fully priced in. Some might also wonder whether the price movements experienced by KPJ shares are common with other companies that have undergone bonus issues and share splits. On comparing KPJ s share price movement with several small and mid cap companies (QL, KNM, UMW) which have undergone bonus issues or/and share split exercises over the last two years, we came to the conclusion that there is no common trend on the movement of share prices post announcement and ex-dates, as shown in Figure 4. No particular pattern. Based on the observation, it is fair to say that a bonus issue or share split may not have a particular impact on share price movement as we believe the overall market conditions and business fundamentals are still strong determinants of share price movements. See Figure 4 for the price data on UMW (1 to 2 share split), KNM (1 for 1 bonus issue & 1 to 2 share split) and QL Resources (1 for 2 bonus issue). We observe that KNM s share price was on an upward trend before the announcement and even after having gone ex- as it was largely driven by favorable crude oil prices at that time. As for UMW, the share price was on a downward trend before the announcement as well as after going ex-, which was in line with the KLCI s downtrend as UMW has a relatively high beta to the index. As for QL, the share price was trading range bound after the announcement and the share was on a downtrend after going ex-, which we believe was attributed to negative market sentiment then as the KLCI was on a downward trend at that time. As such KPJ s share price might continue its uptrend post ex-date as the stock has solid fundamentals, and this will be aided by the favorable market conditions. Historically expensive but regionally attractive. Although KPJ s valuation appears to be relatively expensive on a historical basis, we believe there is more upside on the share price as KPJ is still trading at a discount to its regional peer average PER of 18.5x. Supported by the fact that KPJ s yield, ROE and ROA are comparable to other listed healthcare services providers in the region, we believe the stock should trade on par with its regional peers. With its status as the only pure private healthcare provider listed in Malaysia, moving forward we would not be surprised if KPJ does trade at a premium to its regional peers as it is the best proxy to the fast-growing local private healthcare sector. Maintain BUY with fully diluted EPS. We maintain our earnings forecast. However, we have adjusted our EPS based on an enlarged number of shares following the proposals for the 1-into-2 share split, 1-for- 4 bonus issue and 1-for-4 free warrants issue. We have imputed an enlarged number of shares from 211.1m previously to 659.5m, which takes into account the full exercise of the free warrants. We value KPJ at 18.5x PER on FY10 EPS, which is based on its regional peer average as we believe KPJ deserves a higher valuation after being undervalued for years despite the fact that the group offers comparable earnings performance and balance sheet strength as well as growth potential. The improvement in OSK Research See important disclosures at the end of this report 4

5 liquidity should also further support and justify the higher valuation for the stock. At 18.5x PER, we derive a TP of RM2.95 and supported by the upside, we maintain our BUY recommendation. Although the potential price upside might be smaller than before, we reiterate our view that KPJ is an excellent choice for long term investment and portfolio balancing given its resilient business, steady dividend payout and growth potential in a defensive sector. Figure 4: No particular pattern in share price movement post announcement and ex-date 9 UMW /12/07 03/01/08 03/02/08 03/03/08 PX_LAST EX date Announced KNM /03/07 26/04/07 26/05/07 26/06/07 26/07/07 PX_LAST EX date Announced 3 QL /03/08 03/04/08 03/05/08 03/06/08 03/07/08 PX_LAST EX date Announced Source: OSK, Bloomberg OSK Research See important disclosures at the end of this report 5

6 EARNINGS FORECAST FYE Dec (RMm) FY06 FY07 FY08 FY09f FY10f Turnover EBITDA PBT Net Profit EPS (sen) DPS (sen) Margin EBITDA (%) PBT (%) Net Profit (%) ROE (%) ROA (%) Balance Sheet Fixed Assets Current Assets Total Assets Current Liabilities Net Current Assets LT Liabilities Shareholders Funds Net Gearing (%) OSK Research See important disclosures at the end of this report 6

7 OSK Research Guide to Investment Ratings Buy: Share price may exceed 10% over the next 12 months Trading Buy: Share price may exceed 15% over the next 3 months, however longer-term outlook remains uncertain Neutral: Share price may fall within the range of +/- 10% over the next 12 months Take Profit: Target price has been attained. Look to accumulate at lower levels Sell: Share price may fall by more than 10% over the next 12 months Not Rated (NR): Stock is not within regular research coverage All research is based on material compiled from data considered to be reliable at the time of writing. However, information and opinions expressed will be subject to change at short notice, and no part of this report is to be construed as an offer or solicitation of an offer to transact any securities or financial instruments whether referred to herein or otherwise. We do not accept any liability directly or indirectly that may arise from investment decision-making based on this report. The company, its directors, officers, employees and/or connected persons may periodically hold an interest and/or underwriting commitments in the securities mentioned. Distribution in Singapore This research report produced by OSK Research Sdn Bhd is distributed in Singapore only to Institutional Investors, Expert Investors or Accredited Investors as defined in the Securities and Futures Act, CAP. 289 of Singapore. If you are not an Institutional Investor, Expert Investor or Accredited Investor, this research report is not intended for you and you should disregard this research report in its entirety. In respect of any matters arising from, or in connection with, this research report, you are to contact our Singapore Office, DMG & Partners Pte Ltd ( DMG ). All Rights Reserved. No part of this publication may be used or re-produced without expressed permission from OSK Research. Published and printed by :- OSK RESEARCH SDN. BHD. ( V) (A wholly-owned subsidiary of OSK Investment Bank Berhad) Chris Eng Kuala Lumpur Hong Kong Singapore Jakarta Shanghai Malaysia Research Office OSK Research Sdn. Bhd. 6 th Floor, Plaza OSK Jalan Ampang Kuala Lumpur Malaysia Tel : +(60) Fax : +(60) Hong Kong Office OSK Securities Hong Kong Ltd. 12 th Floor, World-Wide House 19 Des Voeux Road Central, Hong Kong Tel : +(852) Fax : +(852) Singapore Office DMG & Partners Securities Pte. Ltd. 20 Raffles Place #22-01 Ocean Towers Singapore Tel : +(65) Fax : +(65) Jakarta Office PT OSK Nusadana Securities Indonesia Plaza Lippo, 14 th Floor, Jln. Jend. Sudirman Kav 25, Jakarta Indonesia Tel : +(6221) Fax : +(6221) Shanghai Office OSK (China) Investment Advisory Co. Ltd. Room 6506, Plaza 66 No.1266, West Nan Jing Road Shanghai China Tel : +(8621) Fax : +(8621) OSK Research See important disclosures at the end of this report 7