China Healthcare Sector

Transcription

1 China / Hong Kong Industry Focus China Healthcare Sector Refer to important disclosures at the end of this report DBS Group Research. Equity 29 February 2016 The rise of small/mid-sized and private medical service providers Demand for medical services in urban areas will surge faster than rural areas in next five years Lower-tier medical institutes and private hospitals are emerging to satisfy the demand Private hospitals focusing on areas with supply shortage will benefit, such as Wenzhou Kangning (2120 HK) Device providers that help lower-tier medical institutes to upgrade service ability will benefit, like Yestar (2393 HK) Surging demand for medical services in urban areas. The total expenditure on health in urban areas had been growing at a faster CAGR in than rural areas (18% vs 11%). We believe this will continue in the next five years as: 1) The population in urban areas is expected to increase by 100m/13% by 2020 relative to 2014 for expansion of urban areas, floating population from rural to urban areas and the Two Child Policy; 2) Around 162m of urban population are floating population from rural areas without any coverage of public medical insurance programs. The central government wants to provide medical insurance coverage to them. Lower-tier medical institutes and private hospitals are emerging to satisfy the demand. Based on State Council s guidance on promoting tiered diagnosis & treatment system issued in Sep 2015, China will satisfy the surging demand for medical service in urban areas by directing patient flow to medical institutes at lower tiers as their facilities are not fully utilised (e.g bed utilisation of third-tier hospitals was just 60%). Further utilising the facilities is more cost effective than relying on top-tier hospitals which are already crowded (2014 bed utilisation: 102%). China also encourages the development of private hospitals to satisfy the demand for medical services, such as the exemption from business tax (3-20% of sales). Beneficiaries of the trend. In view of the increasing number of patients, the government will upgrade the service ability of lower-tier medical institutes by increasing their medical staffs and equipment. Yestar (BUY, TP: HK$4.00) will benefit from this as it is a distributor of Roche (ROG VX) in-vitro diagnostic devices (the No.1 brand in China with 18% market share in 2014). Driven by the penetration into lower-tier medical institutes, we project its earnings to grow at a 37% CAGR (15F- 17F). Private hospitals is another area of growth, particularly in areas with supply shortage such as psychiatric healthcare. There were c.20m patients suffering from serious psychiatric disorders who needs inpatient care but only 300k beds available for psychiatric healthcare. Wenzhou Kangning (BUY, TP: HK$46.00) is the largest private psychiatric healthcare hospital in China. By expanding scale to capture the unmet demand, we project its earnings to grow at a 43% CAGR in 2015F-17F. HSI: 19,112 ANALYST Mark KONG CFA mark_kong@hk.dbsvickers.com Recommendation & valuation Compa ny Yestar (2393 HK) Wenzhou Kangning (2120 HK) Source: Thomson Reuters, DBS Vickers Ta rge t Mkt FY16F Pric e Price Rec Ca p PE HK$ HK$ HK$m x BUY 6, BUY 2, ed-th / sa- DL

2 Industry Focus China Healthcare Sector Table of Contents Surging demand for medical services in urban areas 3 Fully utilising lower-tiered medical institutes and developing private hospitals to satisfy the demand 3 Private hospitals to benefit 4 Service/device suppliers that directly help to upgrade the services of lower-tier medical institutes will benefit 5 Medical IT companies stand to benefit 6 Stock Profiles 7 (2120 HK) 7 Yestar International (2393 HK) 37 Aier Eye Hospital ( CH) 44 B-Soft Co. ( CH) 46 Phoenix Healthcare (1515 HK) 48 Topchoice Medical ( CH) 50 Universal Medical (2666 HK) 52 Winning Health Technology ( CH) 54 Page 2

3 Industry Focus China Healthcare Sector Surging demand for medical services in urban areas In , the total expenditure on health in urban areas had been growing at a faster CAGR than rural areas (18% vs 11%) (see the following chart). Total expenditure on health (Rmb bn) 1,125 1,354 1,551 1,857 2,128 2, CAGR Urban: 19% Rural: 9% Urban CAGR Urban: 18% Rural: 11% Rural Source: 2015 China Health & Family Planning Statistic We believe the growth in urban areas will be stronger in the next five years because: 1) According to the State Council of China, the population in urban areas is expected to increase by c.100m by 2020 compared to 2014 (up 13%), thanks to expansion of urban areas, migration of floating population from rural areas to urban, and the Two Child Policy. 2) There was a floating population of 253m in urban areas in 2014, of which 200m are included in the calculation of population in urban areas. Only c.19% of them are covered by medical insurance programmes run by local governments in urban areas, according to an estimate by Peking University. For the rest, they are unable to enjoy the same level of medical services as residents in the household register of urban areas. The Central government is aiming towards increasing the portion of them enjoying the same medical services like other residents so as to avoid social discontent Fully utilising lower-tiered medical institutes and developing private hospitals to satisfy the demand China has been heavily reliant on top-tier hospitals (class 3) to satisfy medical needs, and top-tier hospitals contributed 46% of total revenue of all medical institutes in Beds in these hospitals were already over-utilised (see the following table). Utilisation of beds (2014) 2014 Number of beds (m) % of total Utilization Top tier hospitals (class 3)* % 102% Mid level hospitals (class 2)* % 88% Basic level hospitals (class 1)* % 60% Healthcare institutions at grassroot level (including community health service % 60% centers, v illage clinics) Specialized public health institutions (Centers for disease control & % 75% prevention, Women & children care agencies) Others % 53% Source: 2015 China Health & Family Planning Statistic *Number of bed: in most cases, Top tier (class 3) is above 500, Mid level (class 2) is between , Basic level is below 100 In view of increasing demand for medical services in urban areas, suggestions have been made to increase/expand top-tier hospitals. But the Central government will not do so and has instead decided to tighten the control on top-tier hospitals expansion, according to Emergent notice to curb the overexpansion of public hospitals ( 關於控制公立醫院規模過快擴張的緊急通知 ) issued in Jun 2014 and State Council s guidance on promoting tiered diagnosis & treatment system ( 國務院辦公室關於推進分級診療制度建設的指導意見 ) issued in Sep 2015: We believe the reasons behind this are: 1) Medical institutes at lower tiers are not fully utilised (see the table above). Increasing utilisation of those institutes to meet the surging medical needs is more cost-effective than increasing/expanding top-tier hospitals. Furthermore, c.50% of patients visit top-tier hospitals for the treatment of minor diseases, common diseases/chronic diseases, according to News of the Communist Party of China ( 中國共產黨新聞網 ). Those diseases can be treated at lowertier medical institutes. Redirecting part of top-tier Page 3

4 Industry Focus China Healthcare Sector hospitals patients to medical institutes at lower levels will not only increase the utilisation of idle facilities, but also allows top-tier hospitals to spare more medical resources (for example, medical staffs, equipment, beds, etc) to treat patients with serious diseases. This is also a goal which the policy State Council s guidance on promoting tiered diagnosis & treatment system is aiming for. 2) Expansion & construction of top-tier public hospitals will impose bigger financial burden on local government than increasing medical equipments & staffs for medical institutes at lower tiers. This is because we believe the investment of top-tier hospital is bigger. Meanwhile, the future income of local governments is very uncertain. According to the Ministry of Finance, in 2013 and 2014, 34-35% of the income generated by local governments was from transfer income from state-owned land use rights. This income dropped by 32% y-o-y in Jan-Oct A further decline is possible. With an uncertain revenue outlook, local governments are very careful in infrastructure investment; To achieve the goal mentioned above, the Central government is implementing various measures as follows: - Improving the medical service capability of medical institutes at lower tiers, to help attract patients. So, in Jan 2015, the National Health & Family Planning Commission (NHFPC) announced that it will upgrade the medical ability of 500 assigned hospitals at the county level. Investments in medical staff and equipment there will increase. This is the first batch of hospitals and we believe there will be more to come; - Adjusting patients reimbursement ratio (governmentrun medical insurance programmes) in different levels of medical institutes to direct patient flow. Many local governments are doing so. For example, in Dongguan, Guangdong province, patients will not be reimbursed for medical expenses if they visit top-tier hospitals directly without going to medical institutes at lower levels first; - At this stage, focus to direct patients with diseases widely suffered, including hypertension, diabetes, cancer, and cardiovascular diseases. That involves a huge group of patients. Successfully directing them could effectively increase the utilisation of medical institutes at lower tiers. Patients with those diseases at early/non-critical stages will be directed to medical institutes at lower tiers for diagnosis and treatment, according to State Council s guidance on promoting tiered diagnosis & treatment system. Besides increasing the utilisation of medical institutes at lower tiers, development of private hospitals is another way to satisfy the surging demand for medical services in urban areas. According to National healthcare service system planning ( 全國醫療衛生服務體系規劃綱要 ) issued in Mar 2015, China is targeting to expand the scale of private/social organisations' hospitals at a faster pace than public hospitals, and we use the number of beds to illustrate this (see the following table). We think this is reasonable as private hospitals are more efficiently run generally and can alleviate the financial burden of the government. The market share of private hospitals in the hospital industry is still small. In 2014, total revenue of the hospital industry in China was Rmb2tn, and only 8% was contributed by private hospitals. In terms of total number of hospital inpatients in 2014, private hospitals account for 13% in mainland China, while the ratio in Hong Kong is 20%. So, there is plenty of room to grow. Increase in beds in hospitals Number of bed per 1000 of permanaent residents ( 每千常住人口醫療衛生機構床位數 ) 2013 actual 2020 target CA G R ( ) Hospital % Public hospital % Prov incial lev el % Municipal level % County level % Others % Private / Social organization % Source: National healthcare service system planning Private hospitals to benefit China is encouraging the development of private hospitals. We are particularly optimistic of hospitals providing medical services for which there is a shortage. Companies like Wenzhou Kangning (2120 HK), Aier Eye Hostpital ( CH), and Top Choice Medical ( CH) will benefit. Page 4

5 Industry Focus China Healthcare Sector Wenzhou Kangning (2120 HK) (BUY, TP: 50.00) Business: Wenzhou Kangning is a private psychiatric hospital group. It is the second largest psychiatric hospital group in China with 0.99% market share (in terms of revenue) in Growth prospect: Among 20 categories of specialty hospitals in China (categorized by NHFPC), only 5 categories have bed utilization of over 95% in Psychiatric hospitals are one of them. We believe the supply of this service is not sufficient. Hence, Wenzhou Kangning's expansion is actually helping the government to alleviate the supply shortage. We project its number of beds will increase from c.1900 in 2014 to over 3700 in With the enlarged scale, we estimates its earnings will grow by 4% / 55% / 32% in 15F / 16F / 17F. Aier Eye Hospital ( CH) (Non-rated) Business: Aier is a private ophthalmological hospital group. It is the largest ophthalmological hospital group in China with 5% market share (in terms of revenue) in Growth prospect: Around 70% of ophthalmological diseases patients are located in 2nd & 3rd tier cities but the majority of top tier hospitals with an ophthalmology department are located in 1st tier cities. These patients would need to travel long distances to visit top tier hospitals for treatment. This creates opportunities for Aier. By the end of 2015, Aier had around 95 hospitals covering many 2nd & 3rd cities which would help it to capture the unmet demand. Riding on the expansion of its network, its earnings is projected to increase by 39% / 34% / 34% in 15F / 16F / 17F, according to Bloomberg consensus. Top Choice Medical ( CH) (Non-rated) Business: Top Choice is a private dental hospital group. It is a leader in the dental hospital industry with close to 5% market share in Growth prospects: The room for development of dental hospitals in China is huge. For the population aged 35-44, around 88% of them suffer from tooth decay and only 8.4% of patients have received treatment. For the population aged 65-74, around 98% suffer from tooth decay and only 1.9% patients have received treatment. In terms of per capita dental expenditure in 2014, mainland China's was HK$189 and Hong Kong's was HK$578. Therefore, we believe there is huge room for growth. By expansion of network, the earnings of Top Choice is projected to grow by 35%/35%/36% in 15F/16F/17F, according to Bloomberg consensus. Service/device suppliers that directly help to upgrade the services of lower-tier medical institutes will benefit As discussed above, China is determined to strengthen the healthcare servicing ability of medical institutes at lower tiers. Companies which can help to achieve this will benefit, including Phoenix Healthcare (1515 HK), Yestar (2393 HK), and Universal Medical (2666 HK). Yestar (2393 HK) (BUY, TP HK$4.00) Business: Yestar is a distributor of Roche's (ROG VX) in-vitro diagnostic (IVD) devices in Shanghai, Jiangsu province, and Anhui province. It also produces and distributes colour photographic paper and medical films for Fujifilm (4901 JP) in China. Growth prospects: We project Roche's related businesses to contribute c.46% earnings in This is the major growth driver for Yestar. IVD devices are necessary in providing medical services. Therefore, when medical institutes at lower levels increase and improve their medical services, they will need more IVD devices. Yestar will grow this segment by penetrating into 2nd/3rd tier cities and providing mainly Roche IVD devices to them. Roche is the largest IVD brand in the world and China with market shares of 20% and 18% respectively. Driven by the IVD distribution business, we project Yestar's earnings to grow by 52%/52%/23% in 15F/16F/17F. Universal Medical (2666 HK) (Non-rated) Business: Universal Medical is the largest medical equipment leasing company in China with 20.9% market share in It mainly serves mid/basic level hospitals in 2nd/3rd tier cities. Its leasing services allow mid/basic level hospitals with limited financial resources to install proper medical equipment, so as to improve their medical services directly. Growth prospects: In 2013 and 2014, the hospital customers of Universal Medical had increased by 131 and 118 respectively. By further penetration into 2nd/3rd tier cities, the number of hospital customers should grow at a similar pace in the next three years. Bloomberg consensus projects its earnings to grow by 43%/38%/31% in 15F/16F/17F. Page 5

6 Industry Focus China Healthcare Sector Phoenix Healthcare (1515 HK) (Non-rated) Business: In terms of beds in operation and patient visits, Phoenix Healthcare is the largest private hospital group in China. Phoenix Healthcare generates over 70% of its earnings by helping loss-making mid/basic level public hospitals to reach breakeven. These public hospitals compensate Phoenix Healthcare by 1) management fees; 2) allowing it to procure drugs & medical consumables for them and charge a commission. Due to its reputation, more and more local governments are seeking help from Phoenix Healthcare to optimise the operations of their hospitals. It is a service provider directly helping medical institutes at lower levels to strengthen their medical services. Growth prospects: With an increase in the number of beds in hospitals under Phoenix Healthcare's management, more and more local governments are also seeking help from Phoenix Healthcare. The company's earnings are projected to increase by 2%/28%/19% in 15F/16F/17F, according to Bloomberg consensus. Medical IT companies stand to benefit and also the communication with medical institutes at various levels. Therefore, the State Council s guidance on promoting tiered diagnosis & treatment system targets to upgrade the information system of medical institutes. Hence, medical IT companies will benefit, for example B-Soft ( CH) and Shanghai Kingstar ( CH). B-Soft ( CH) (Non-rated) Business: B-soft is an information system solution provider. It generates over 85% of its revenue by serving hospitals and medical institutes at grassroot level. Growth prospects: Thanks to penetration into 2nd/3rd tier cities, its earnings is projected to grow by 15%/12%/33% in 15F/16F/17F, according to Bloomberg consensus. Winning Health Technology ( CH) (Non-rated) Business: Shanghai Kingstar is an information system solution provider. It generates nearly 100% of its revenue by serving medical institutes. Growth prospects: Thanks to penetration into 2nd/3rd tier cities, its earnings is projected to grow by 39%/57%/53% in 15F/16F/17F, according to Bloomberg consensus. Optimising the information system of medical institutes at lower levels could help them to improve internal operations Beneficiaries in thriving of small/mid size medical & private medical service providers Segments Priv ate hospitals Services/devices suppliers directly help to upgrade lower lev el institutes' medical serv ices Medical IT companies Companies Wenzhou Kanning (2120 HK) Aier Ey e Hospital ( CH) Top Choice ( CH) Yestar (2393 HK) Univ ersal Medical (2666 HK) Phoenix Healthcare (1515 HK) B-Soft ( CH) Winning Health Technology ( CH) Source: DBS Vickers Page 6

7 Bloomberg: 2120 HK Equity Reuters: 2120.HK Refer to important disclosures at the end of this report DBS Group Research. Equity 29 February 2016 BUY (Initiating Coverage) Last Traded Price: HK$40.70 (HSI : 19,112) Price Target : HK$50.00 (23% upside) Potential Catalyst: Acceleration of network expansion Where we differ: Earnings are lower than consensus due to lower revenue growth assumption Analyst Mark Kong CFA, mark_kong@hk.dbsvickers.com Price Relative HK$ 34.7 Nov-15 Wenzhou Kang ning Hospital (LHS) Relative Index Feb-16 Relative HSI INDEX (RHS) Forecasts and Valuation FY Dec (RMB m) 2014A 2015F 2016F 2017F Turnover EBITDA Pre-tax Profit Net Profit Net Pft (Pre Ex) EPS (RMB) EPS (HK$) Core EPS (HK$) Core EPS (RMB) EPS Gth (%) Core EPS Gth (%) Diluted EPS (HK$) DPS (HK$) BV Per Share (HK$) PE (X) Core PE (X) P/Cash Flow (X) P/Free CF (X) nm nm nm nm EV/EBITDA (X) Net Div Yield (%) P/Book Value (X) Net Debt/Equity (X) CASH CASH CASH CASH ROAE (%) Earnings Rev (%): New New New Consensus EPS (RMB) Other Broker Recs: B: 0 S: 0 H: 0 ICB Industry: Health Care ICB Sector: Health Care Equipment & Services Principal Business: Healthcare Source of all data: Company, DBSV, Thomson Reuters, HKEX Rapid expansion in a market with severe supply shortage Second largest psychiatric healthcare hospital group in China. With 0.99% market share based on 2014 revenue, Wenzhou Kangning is the 2 nd largest player in the China psychiatric healthcare industry. The group has been operating since 1996 and is the only private hospital designated as Key National Hospital for Specialized Clinical Psychiatry by National Health & Family Planning Commission. This is a recognition of its psychiatric healthcare service capabilities from the Central government. Supply shortage of psychiatric healthcare services in China.The shortage of psychiatric healthcare services is evidenced by: 1) There are c.20m patients suffering from serious psychiatric disorders in China but there are only 300k beds available for psychiatric healthcare as at end-2014; 2) Bed utilisation at psychiatric healthcare hospitals in 2014 was already close to 100%, leaving hardly any room to take care of more patients. The reason for the shortage is insufficient supply of psychiatric doctors as their income is typically lower than other kinds of doctors. The lower income is because, relative to general hospitals, operations and usage of drugs in psychiatric hospitals are fewer, and this flows to lower related income. Rapidly expanding team of doctors and hospital network to capture unmet demand. Despite the insufficient supply of psychiatric doctors, by attracting talents from public players, the group is able to expand its team of doctors at a faster pace than the industry ( CAGR: 10% vs 5%). This is thanks to its reputation and higher remuneration package than public players (20-30% higher). The group plans to increase the number of doctors from 175 (Jun 2015) to 240 (Dec 2016). Meanwhile, it will expand its number of beds from 2268 (2015) to 3798 (2017). The increase of doctors and beds should drive its earnings CAGR to 28% in F. Thus, we initiate coverage with BUY. Valuation: Based on Bloomberg, there are 97 healthcare services providers listed in the Asia Pacific as at 17 Feb. The stocks are trading at 45x FY16F PE on average. We believe the group should trade at a 15% discount to the average given its short listing history (IPO in Nov 2015), and concentration risk (one hospital contributes >55% of revenue). Hence, we derive a TP of HK$50.00 based on 38x FY16F PE. The groups ability to accelerate its expansion and thereby diversify its revenue base should help to improve its valuation. Key Risks to Our View: Losses incurred by newly opened hospitals create uncertainty on future earnings. Possibility of medical accidents may tarnish the group s reputation and income. At A Glance Issued Capital (m shrs) 73 Mkt. Cap (HK$m/US$m) 2,973 / 382 Major Shareholders Weili Guan (%) 32.3 Defu Fund (%) 21.1 Wang Hongyue (%) 9.4 Beijing CDH Weixin (%) 8.3 Free Float (%) m Avg. Daily Val. (US$m) 0.6 ed- JS / sa- DL

8 INVESTMENT THESIS Profile The 2nd largest psychiatric healthcare hospital group in China (in terms of 2014 revenue) with close to 20 years history in the field. It is the only private hospital designated as a Key National Hospital for Specialised Clinical Psychiatry by National Health & Family Planning Commission (as of Nov 2015). This is a recognition of its psychiatric healthcare services by the Central government. Rationale Supply shortage of psychiatric healthcare services in China. There are 180m people suffering from psychiatric disorders in China. Out of the 180m people, we estimate that c.20m are suffering from schizophrenia which requires inpatient care. However, there only 300k beds available for psychiatric healthcare as of Network expansion to capture unmet demand. To capture the unmet demand, the group will expand its number of beds from 2,268 in 2015 to 3,798 in It is expanding from Zhejiang province to Beijing and Shenzhen, two cities which are facing a severe shortage in the supply of psychiatric services. Valuation BUY, TP: HK$ Based on Bloomberg, there were 97 healthcare services providers listed in Asia Pacific emerging stock markets as of 17th Feb On a market cap weighted average basis, they are trading at 45x 16F PE. The TP of Wenzhou Kangning should be set in reference to this. Due to its short listing history (just listed in Nov 2015), concentration risk on one hospital (we estimate that Wenzhou Kangning will contribute 56-59% of the group s revenue in ), price control on medical services & products paid by public medical insurance programmes (making up 49% of the group s revenue in 1H15), we believe the counter should trade at a 15% discount relative to the average PE of healthcare service providers in Asia Pacific emerging markets. That derives our TP PE (16F) of 38x and TP of HK$ Risks Losses incurred by newly opened hospitals. In the first year of operations, the newly opened hospitals may not generate sufficient revenue to cover their rental and staff costs. The losses create uncertainty to the group s future earnings. Price cuts on drugs. The segment of pharmaceutical sales made up 26% of the group s revenue in The continuous price pressure on drugs exerted by the government may squeeze the gross margin of this segment. Possibility of medical accidents may tarnish the group s reputation. In 2012/13/14, there were 7/8/6 material medical incidents for the group. Medical accidents could happen in the future which may hurt the group s reputation and income. Concentration risk. Wenzhou Kangning hospital is expected to make up 56-59% of the group s revenue. Any setbacks faced by this hospital could impact the group s financial performance significantly. Source: DBS Vickers Page 8

9 Table of Contents SWOT Analysis 10 Key company information 11 Competitive edges 14 Growth drivers 16 Risks & concerns 20 Valuation 21 Financial analysis 29 Page 9

10 SWOT Analysis Strengths Weaknesses 2 nd largest psychiatric healthcare hospital group in China (in terms of 2014 revenue) with close to 20 years of experience The only private hospital designated as a Key National Hospital for Specialised Clinical Psychiatry by National Health & Family Planning Commission as of Nov This is a recognition of its psychiatric healthcare services by the Central government Heavily reliant on one hospital which is Wenzhou Kangning (expected to contribute 56-59% of revenue in 2015F-17F) Heavily reliant on a single type of medical service which is psychiatric healthcare Well established in private psychiatric healthcare services market which enjoys patient spending 60% higher than the public segment Opportunities Threats Shortage of psychiatric healthcare services in China Plans to expand network from Zhejiang province to Beijing and Shenzhen, both of which are in severe shortage of psychiatric healthcare services Gross margin squeeze of pharmaceutical sales (making up 26% of revenue in 2014) due to price cuts on drugs Possibility of medical accidents may impact the group s reputation Source: DBS Vickers Page 10

11 Key company information Key company information Number of beds (Dec 2016F) Major shareholders Wenzhou Kangning 溫州康寧 (100% stake, in Zhejiang province) Qingtian Kangning 青田康寧 (100% stake, in Zhejiang province) Cangnan Kangning 蒼南康寧 (100% stake, in Zhejiang province) Yongjia Kangning 永嘉康寧 (100% stake, in Zhejiang province) Yueqing Kangning 樂清康寧 (100% stake, in Zhejiang province) Pingyang Changgeng Ward 平陽長庚 (operates under management agreement with third party hospital, in Zhejiang province) 37 - Chengdu Renyi Ward 成都仁一 (operates under management agreement with third party hospital, in Sichuan province) Yanjiao Furen 燕郊輔仁 (operates under management agreement with third party hospital, in Beijing) 38 - Beijing Yining 北京怡寧 (49% stake, in Beijing) 80 - Linhai Kangning 臨海康寧 (80% stake, in Zhejiang province) Hangzhou Yining 杭州怡寧 (100% stake, in Zhejiang province) Shenzhen Yining 深圳怡寧 (52% stake, in Guangdong province) Total Right after IPO in Nov 2015: 27.12% (domestic shares*) - Mr. Guan Weili, Chairman of the group 5.2% (domestic shares*) - Ms. Wang Lianyue, General manager of the group 7.26% (domestic shares*) - Ms. Wang Hongyue, CFO of the group 2.73% (domestic shares*) - Xinshi Kangning, Enci Kangning, Renai Kangning ** 21.06% (domestic shares*) - Defu Fund (estimated cost: Rmb195.6m, lock-up: 1 year) 8.91% (domestic shares*) - Beijing CDH (estimated cost: Rmb82.7m, lock-up: 1 year) 4.94% (H shares***) - OrbiMed (estimated cost: HK$139.5m, lock-up: 6 months) 3.84% (H shares***) - Dragon Billion China (estimated cost: HK$108.5m, lock-up: 6 months) 18.94% (H shares***) - Public *Domestic shares: unlisted shares which are not listed or traded on any stock exchange **Xinshi Kangning, Enci Kangning, Renai Kangning: held by 27 individuals, 41 individuals, 38 individuals, respectively, consisting of one director, two supervisors, three external consultants, senior management and employees of the group. ***H shares: tradable shares Headquater No of staffs (as of J un 2015) Auditor Wenzhou (Zhejiang province) Management : 10 (include 6 mgmt members who also serve as doctors and other medical staff) Admin staff : 107 Doctors : 171 Other medical staff : 507 Others : 343 Total : 1138 PricewaterhouseCoopers Source: Company, DBS Vickers Page 11

12 1H15 revenue breakdown by segments 1H15 revenue breakdown by hospitals Ancillary hospital services*** 1% Mgmt service fees**** 3% Yongjia Kangning 永嘉康寧 7% Yueqing Kangning 樂清康寧 4% Pingyang Changgeng ward 平陽長庚 3% Pharmaceutical sales** 26% Cangnan Kangning 蒼南康寧 12% Treatment & general healthcare services* 70% Qingtian Kangning 青田康寧 5% Wenzhou Kangning 溫州康寧 69% Source: Company Source: Company * Providing medical services to inpatients & outpatients. Much of the revenue is attributable to inpatients. Daily expense for inpatient bed: low-end c.rmb240, mid-end c.rmb1050, high-end c.rmb2750 ** Sales of pharmaceutical products and medical consumables *** Miscellaneous services provided in support of medical treatment services, e.g. revenue from the group's Judicial Appraisal Institution **** Income attributable to psychiatric wards that the group manage under management agreements with 3rd party private hospitals 1H15 revenue breakdown by payers 1H15 gross margin by segments Others* 12% 75.1% Public medical insurance 49% 47.3% 34.5% 18.3% Patient outof-pocket 39% Treatment & general healthcare services Pharmaceutical sales Ancillary hospital services Mgmt service fees Source: Company Source: Company * Others (including supplemental civil administration funds for lowincome patients, commercial medical insurance and charities) Page 12

13 1H15 gross margin by hospitals 1H15 COGS breakdown 35.4% 42.9% Wenzhou Kangning 溫州康寧 Qingtian Kangning 青田康寧 55.0% 57.6% Cangnan Kangning 蒼南康寧 Yongjia Kangning 永嘉康寧 24.7% Yueqing Kangning 樂清康寧 75.1% Pingyang Changgeng ward 平陽長庚 Canteen expenses 5% Depreciation & amortization 7% Leasing expenses 3% Testing fees 2% Employee benefits & expenses 35% Others 5% Pharmaceuticals & consumables used 43% Source: Company Source: Company Page 13

14 Competitive edges The group has been in psychiatric healthcare service industry for nearly 20 years. It is now the second largest player in this industry and is the only private player among the top ten (see the following table). The strong recognition is the biggest competitive edge of the group. The recognition is evidenced by: 1) (this hospital contributed 62-68% of the group s revenue in ) was designated as a Key National Hospital for Specialised Clinical Psychiatry by the National Health & Family Planning Commission (NHFPC). In 2014, there were 831 psychiatric healthcare hospitals in China (public: 620, private: 211). There are some public players which have gained the recognition (e.g. Beijing Anding Hospital). But among private players, the group is the only one which has gained this recognition. This qualification implies recognition of its psychiatric healthcare services by the Central government. It is difficult to gain this recognition because: A) One of the requirements is that the nominee must be a top-tier hospital (total number of beds must be at least 300). We estimate less than 38% of psychiatric healthcare hospitals are top-tier hospitals; B) Another requirement to gain this recognition is the diagnostic & treatment ability of the hospital must be up to international standards. In 2014 and 2015, Wenzhou Kangning gained TÜV SÜD certification for excellence in quality and strength of its standardisation procedures. Founded in 1866, TÜV SÜD is an international technical service company based in Munich, Germany with over 22,000 employees all over the world. Its services include certification, consultancy, inspection, test and expert reports. It made revenue of EUR2.06bn in The certification gained from TÜV SÜD helps the Wenzhou Kangning to prove that its service quality is up to international standards; 2) Wenzhou Kangning is rated as Grade A Class III hospital by NHFPC, the highest grade attainable by hospitals in China. In 2014, there were 25,860 hospitals in China. Only 1158 of them gained this recognition. This grade implies strong recognition of the quality of its hospital operations by the Central government. Top 10 psychiatric hospital groups in China Market share Group Public/ Priv ate (based on 2014 rev enue) Shanghai Mental Health Center Public 1.90% Wenzhou Kangning Private 0.99% Beijing Anding Hospital Public 0.95% Guangzhou Psychiatric Hospital Public 0.83% Beijing Huilongguan Hospital Public 0.80% Peking University Sixth Hospital Public 0.80% Nanjing Brain Hospital Public 0.65% Chengdu 4th Hospital Public 0.50% Suzhou Guangji Hospital Public 0.44% Mental Health Center of West China Hospital of Sichuan Univ ersity Public 0.34% *Total market size in 2014: Rmb29.9bn Source: Frost & Sullivan The above recognition brings four advantages to the group: 1. Attract talented doctors. The number of doctors within the group has increased from 124 (Dec 2012) to 150 (Dec 2014), up 21%, and 10ppts above the increase in the psychiatric healthcare service industry during the same period based on data from the NHFPC. The group targets to raise the number of doctors to 240 by the end of This advantage is very important in the psychiatric healthcare service industry as there is shortage of doctors in this field and it is not easy to recruit the doctors, according to a survey conducted by Frost & Sullivan. The shortage is because the income of psychiatric doctors is not very attractive compared to doctors in other fields. There are two reasons for this: a) The treatment of psychiatric disorders does not involve many operations. Therefore, the income related to operations is low; and b) in terms of drugs expenditure as a percentage of total inpatient expense, this is lower in psychiatric hospitals than the hospital industry on average (c.15% vs 38% in 2014) This implies lower related income. Leveraging on its reputation and better remuneration package (monthly income 20-30% higher than public hospitals), we believe the group can continue to expand its team of doctors at a pace faster than the industry by attracting doctors from public hospitals. 2. Able to maintain a safety level higher than the industry. Sufficient medical staff allows the group to maintain a better safety level. Thanks to of its ability to attract talented doctors, the group is able to allocate more doctors to patients on average. The group s doctor per 10,000 patients in 2014 averaged 11.3, 8% above public Page 14

15 psychiatric hospitals, and 35% above private psychiatric hospitals, according to Frost & Sullivan. This has enabled the group to maintain a higher safety level. In terms of inpatient deaths / total admitted inpatients, the group s ratio was 0.05% / 0.08% / 0.05% in 2012 / 13 / 14, while the death rate of psychiatric specialty hospitals on average was higher (0.32% / 0.33% / 0.3%), according to Frost & Sullivan. 3. Able to access high-end psychiatric healthcare services market. The strong recognition enables the group to attract patients with deeper pockets. As a result, in terms of average outpatient spending per visit in 2014, the group s was Rmb482, 93% higher than public players. 4. Attracting JV opportunities to expand at a lower cost. Apart from running a hospital on a wholly owned basis, the group also co-operates with others to grow. For example, two new hospitals will commence operations this year, namely, Linhai Kangning (in Zhejiang province) and Shenzhen Yining (in Guangdong province), in which the group owns stakes of 80% and 52% respectively. The group s reputation attracts third parties to form joint ventures which would allow it to expand its network with less capital requirements compared to operating the hospitals on a wholly owned basis. Page 15

16 Growth drivers Shortage of psychiatric healthcare services in China. We believe there is a shortage for psychiatric healthcare services in China, as evidenced by: 1) According to Frost & Sullivan, there are 180m people suffering from psychiatric disorders in China. Out of the 180m people, we estimate that c.20m are suffering from schizophrenia which requires inpatient care. However, there only 300k beds available for psychiatric healthcare as of 2014; 2) The bed utilisation in psychiatric healthcare hospitals is high. It was 98% in 2014, according to NHFPC. There is almost no room for those hospitals to serve more patients; 3) In terms of total psychiatric beds per 10,000 people, China s is very low from a global perspective (see the following chart). Total psychiatric beds per 10,000 population (2011) psychiatric beds per population Japan Russia France Germ Source: Frost & Sullivan UK Italy The supply shortage in the psychiatric healthcare service sector is mainly due to shortage of doctors in this field, according to a survey conducted by Frost & Sullivan. The shortage of doctors is because the income of psychiatric doctors is not very attractive compared to doctors in other fields. There are two reasons for this: US Spain Canada Brazil China India The shortage provides opportunities for psychiatric healthcare hospitals that are able to attract talented doctors to grow. Frost & Sullivan projects that the market size of psychiatric healthcare services will grow at CAGR of 16.7% in (see the following chart). China psychiatric healthcare market size Rmb bn 2015F-19F 70 CAGR: 16.7% CAGR: % Source: Frost & Sullivan China psychiatric healthcare market size Public players 2015F 2016F 2017F 2018F 2019F Rmb bn F-19F CAGR: 15.5% CAGR: 19.5% Source: Frost & Sullivan F 2016F 2017F 2018F 2019F 1) The treatment of psychiatric disorders does not involve many operations. Therefore, the income related to operations is low; 2) In terms of drugs expenditure as a percentage of total inpatient expense, this is lower in psychiatric hospitals than the hospital industry on average (c.15% vs 38% in 2014). This implies lower related income. Page 16

17 China psychiatric healthcare market size Private players Rmb bn CAGR: 23.8% Source: Frost & Sullivan F-19F CAGR: 21.8% 2015F F F F 13.6 Expanding teams of doctors and hospital network to capture unmet demand. Despite insufficient supply of psychiatric healthcare doctors, we believe the group is able to expand its team of doctors by attracting talents from competitors, particularly public players, thanks to: 1) Better remuneration packages offered to doctors (monthly income 20-30% higher than public hospitals); 2) Reputation in psychiatric healthcare industry. In 2014, there were 831 psychiatric healthcare hospitals in China (public: 620, private: 211). The group is the only private player designated as a Key National Hospital for Specialised Clinical Psychiatry by the National Health & Family Planning Commission (NHFPC). This qualification implies recognition of its psychiatric healthcare services by the Central government. The number of doctors within the group has increased from 124 (Dec 2012) to 150 (Dec 2014), up 21%, which is 10ppts above the increase in the psychiatric healthcare service industry during the same period based on data from the NHFPC. The group targets to raise the number of doctors to 240 by the end of Apart from expanding the team of doctors, the group is also expanding its scale and network to capture unmet demand (see the following table). 2019F Wenzhou Kangning total number of beds Province Wenzhou Kangning 溫州康寧 (100% stake) Zhejiang 1,025 1,175 1,875 Qingtian Kangning 青田康寧 (100% stake) Zhejiang Cangnan Kangning 蒼南康寧 (100% stake) Zhejiang Yongjia Kangning 永嘉康寧 (100% stake) Zhejiang Yueqing Kangning 樂清康寧 (100% stake) Zhejiang Pingyang Changgeng ward 平陽長庚 (management Zhejiang contract*) Chengdu Renyi ward 成都仁一 (management Sichuan contract*) Yanjiao Furen 燕郊輔仁 (management Beijing contract*) Beijing Yining 北京怡寧 (49% stake) Beijing Linhai Kangning 臨海康寧 (80% stake) Zhejiang Hangzhou Yining 杭州怡寧 (100% stake) Zhejiang Shenzhen Yining 深圳怡寧 (52% stake) Guangdong Total 2,268 2,878 3,798 Source: the company, DBS Vickers *The group does not own the hospitals. It is operating the hospitals under management contracts. As seen in the table above, most of the group s hospitals are based in Zhejiang province where the group founded its business in 1996 and it is well established there. Other than Zhejiang province, the group is expanding its reach into two regions: Guangdong province (Shenzhen in this stage) and Beijing. Shenzhen: This is a city with population of close to 11m. There is a shortage of psychiatric healthcare services in this city. According to NHFPC and Shenzhen government, in terms of average bed numbers for psychiatric healthcare / population in 2013, China as a whole was 1.9, Zhejiang province was 2.4, but Shenzhen was only 0.5! As the population grows in Shenzhen, the shortage could become more severe. Leveraging on its reputation, we believe the group s expansion in this city will enable it to effectively capture the huge unmet demand. Beijing: There is also a shortage of psychiatric healthcare services in Beijing. According to estimations from the Beijing Municipal Health Bureau, there were 15,000 psychiatric patients that required psychiatric inpatient beds in 2013 but Page 17

18 there were less than 9000 beds in the city. The shortage was over 6000 beds. In 2014, the number of beds increased by only 1% or 83 y-o-y, according to NHFPC. Thus, we believe the supply shortage is still there. Hence, the group s expansion can also capture the huge unmet demand. Increase in prices of medical services. Medical services contributed 70% of the group s revenue in Prices have been increasing over the years and we believe this trend will continue (see the following table) driven by: 1) Increasing contribution from high-end services. In terms of daily expense per inpatient bed: low-end c.rmb240, mid-end c.rmb1050, high-end c.rmb2750. The portion of beds allocated on high-end services should increase from c.10% in 2015 to c.18% in 2017; 2) Increase in prices of services for hospitals in Zhejiang province (makes up >90% bed numbers of the group in 2015). In that province, as long as the hospitals elect to sell pharmaceuticals at the procurement bidding price for public hospitals without any mark-up, they are permitted to implement up to a 30% price increase on certain medical services that are covered by public medical insurance. More and more of the group s hospitals are joining this scheme Prices of medical services for major hospitals of the group F 2016F 2017F Inpatient's spending per bed-day* (Rmb) Wenzhou Kangning 溫州康寧 Cangnan Kangning 蒼南康寧 Yongjia Kangning 永嘉康寧 Outpatient's spending per visit (Rmb) Wenzhou Kangning 溫州康寧 Cangnan Kangning 蒼南康寧 Yongjia Kangning 永嘉康寧 Change of inpatient's spending per bed-day Wenzhou Kangning 溫州康寧 32% 32% 3% 6% 10% Cangnan Kangning 蒼南康寧 17% 4% 13% 5% 5% Yongjia Kangning 永嘉康寧 5% 26% 5% 5% Change of outpatient's spending per visit Wenzhou Kangning 溫州康寧 4% 6% 9% 5% 5% Cangnan Kangning 蒼南康寧 25% 15% 4% 5% 5% Yongjia Kangning 永嘉康寧 -21% 27% 5% 5% Source: the company *Bed-day: number of beds occupied multiplied by the number of days in the period. **Medical services revenue contributed by the hospitals above made up 63% of 2014 group revenue Page 18

19 Revenue breakdown by hospitals (Rmb m) F 2016F 2017F Wenzhou Kangning 溫州康寧 Qingtian Kangning 青田康寧 Cangnan Kangning 蒼南康寧 Yongjia Kangning 永嘉康寧 Yueqing Kangning 樂清康寧 Linhai Kangning 臨海康寧 Hangzhou Yining 杭州怡寧 Shenzhen Yining 深圳怡寧 Pingyang Changgeng ward 平陽長庚 Yanjiao Furen 燕郊輔仁 Chengdu Renyi 成都仁一 Total Source: the company, DBS Vickers Revenue breakdown by segments (Rmb m) F 2016F 2017F Treantment & general healthcare services Pharmaceutical sales Ancillary hospital serv ices Management service fees Total Source: the company, DBS Vickers Page 19

20 Risks & concerns Newly opened hospitals may lose money in the first year of operations which could drag the group s profit. In the first year of operations, the newly opened hospitals may not generate sufficient revenue to cover their rental and staff costs. For example, there were three hospitals which commenced operations in 2015 (Yanjiao Furen, Beijing Yining, Chengdu Renyi ward). We estimate that they aggregately incurred a net loss of c.rmb12m in Without the loss and the IPO expenses of Rmb5.1m, the group could have earned c.rmb70m in As the number of patient visits and revenue improve, we believe they are able to break even or be slightly profitable in Our earnings projection for 2016F is Rmb82m, and relative to the earnings it could have made in 2015F (c.rmb70m), the increase is 17%, 9ppt below the projected revenue growth in the period. This is because we believe the earnings growth could be dragged by the loss incurred from the three new hospitals commencing operations in 2016F (Linhai Kangning, Hangzhou Yining, Shenzhen Yining). Going forward, the opening of new hospitals will create uncertainty to earnings growth. of medical accidents is still there and could hurt the group s reputation and also its future income. Price control on medical services & products paid by public medical insurance programme. In 2012/13/14/1H15, 31%/36%/45%/49% of the group s revenue were from services and products provided to patients covered in part by public medical insurance. The prices of those services and products are subject to the government's control. Even if there is cost surge in those businesses, the group has to negotiate with the government for a price increase. Failure to increase prices given the cost surge may cause gross margins to be squeezed. Concentration risk. Wenzhou Kangning hospital contributed 62-68% of the group s revenue in In , we expect it to contribute 56-59% of the group s revenue. The group is highly dependent on the performance of this hospital. If any medical accidents or revenue growth decelerates or revenue decreases occur in this hospital, the financial performance of the group will be impacted significantly. More and more drugs being sold at procurement bidding price will impact the segment of pharmaceutical sales. Geographically, we estimate Zhejiang province to contribute over 85% of the group s revenue. In that province, as long as the hospitals elect to sell pharmaceuticals at the procurement bidding price for public hospitals without any mark-up, they are permitted to implement up to a 30% price increase on certain of their medical services covered by public medical insurance. In 2015, six out of nine hospitals under the group s management were located in Zhejiang province. Three of them have joined the scheme mentioned above, while another three should do so this year. The group could open two more hospitals in Zhejiang this year and we believe they will join the scheme in the future. As a result, more and more pharmaceuticals will be sold at procurement bidding prices without being marked up. The selling price will be lower, and so will the gross margin. The segment of pharmaceutical sales made up 26% of revenue in We project the gross margin of this segment to drop from 17.1% in 2014 to 13% in Possibility of medical accident may impact the group s reputation. In 2012/13/14, there were 7/8/6 material medical incidents for the group. The total compensation paid were Rmb1.415m/Rmb0.946m/Rmb0.848m, implying compensation paid for each incident were Rmb0.2m / Rmb0.12m / Rmb0.14m. To reduce the potential financial loss, the group has purchased medical liability insurance for all of their owned hospitals. The amount of coverage per incident is Rmb0.2m to Rmb0.5m. Although there is insurance coverage, the possibility Page 20