M&A Research. Company Visit. M&A Securities. KPJ Healthcare Bhd. Prepared For Next Phase of Growth. Tuesday, June 28, 2016 HOLD (TP: RM4.

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1 M&A Research M&A Securities Company Visit PP14767/09/2012(030761) Tuesday, June 28, 2016 KPJ Healthcare Bhd HOLD (TP: RM4.27) Prepared For Next Phase of Growth We made a visit to KPJ Healthcare Berhad (KPJ) recently and came back feeling positive after we were told of encouraging inpatient growth that neared 4.5% and consistent improvement of 2% in outpatient volume in 1H16. The management is confident to achieve similar growth in 2H16, which we opine could hit our earnings target of RM147 million for FY16 or 3.5% higher than in FY15. We maintain our target price of RM4.27on KPJ. The stock is a HOLD. Extended Construction Time for Perlis & Penang Project. The 90-bedded Perlis project has been delayed from the initial estimated completion of 1H2015 to 1Q2017 as the appointed building contractor failed to meet deadlines due to labour shortage. The project is currently 80% completed. Note that KPJ Penang s brownfield expansion has also been delayed by the same contractor. We understand that the Board is currently reviewing new contractor for Perlis project while the Penang brownfield project will be re-initiated by open tender and the project is expected to complete by 3Q2017. Current Price (RM) RM4.20 New Fair Value (RM) RM4.27 Previous Fair Value (RM) RM3.92 Previous Recomm. HOLD Upside To Fair Value -0.2% Dividend Yield (FY15F) 2% Stock Code Bloomberg KPJ MK Stock & Market Data Listing MAIN MARKET Sector Healthcare Shariah Compliance Yes Issued Shares (mn) 1,042.4 Market Cap (RM mn) 4,384mn YTD Chg In Share Price -0.5% Beta (x) week Hi/Lo (RM) RM4.41 RM3.96 6M Average Volume (mn shares) 1.2mn Estimated Free Float 30% Major Shareholders Johor Corp 44.5% EPF 12.2% Waqaf An-Nur Corp 7.3% Steady Patient Growth in 1H16. We learned from the management that KPJ has achieved approximately 5% inpatient growth for 1H16 and 2% for outpatient growth. The group is confident to register similar growth for 2H16, achieving >290,000 inpatients and >2.5 million outpatients for The ASP/inpatient and ASP/outpatient for 2015 touched RM6,700 (+13% y-o-y) and RM313 (+9% y-o-y) respectively. With an estimated population growth of 1.5% in Malaysia, there will be >450,000 new-born babies every year which will be a strong support for patient growth in private healthcare ext:257, 229, 221, 249, 258 1

2 due to rising middle class and space limitation in public hospitals. Bed Revenue & Capacity. In 1Q16, there were 2,903 operational beds serving 707,355 patients, achieving occupancy rate of 71.5% (+1.6% y-o-y), higher than 68% rate in Average revenue per bed rose from RM600 in 2014 to RM646 (+7.7% y-o-y) in 2015, mostly driven by sound improvement in the Northern region (+14% y-o-y) and Klang Valley (+9% y-o-y). We expect bed capacity to grow from the current 2,912 beds to 3,156/4,142/4,392 in FY16/17/18 after factoring in the group s pipeline expansion projects. Asset to be injected to REIT. We learned from the Management that upon the completion of brownfield projects, these assets will be injected to Al- Aqar Healthcare REIT. KPJ Selangor and KPJ Puteri would be the first two projects (120 bed capacity) to be sold to REIT for some RM200 million. This alone could pare down the gearing from 0.77x to 0.64x. To date, there are a total of 8 brownfield projects with 545 beds in the pipeline, slated to complete by Hence, we reckon that debt gearing would stay below 1.0x moving forward, considered as a reasonable level for a long gestation business model like KPJ. Targeting 2 New Hospitals Every Year. KPJ will allocate RM million capex from now up to 2020 for both the greenfield and brownfield expansion, aiming for 2 new hospitals construction per annum. There are currently 7 hospitals under construction slated to complete by 2019, including the 2 projects (Melaka & Bayu Emas) which are yet to be submitted to the Ministry of Health (MOH). Of note, it would take years to set up a new hospital. Sharpen Its Focus On Medical Tourism. Although medical tourist made up less than 5% of KPJ s total revenue or <RM150 million/annum, the average bill spent by medical tourist is 20% higher than average local spending. This can be deduced as medical tourists tend to spend more on medical services or under taking more value added services such as complete body check-up and other health screening. Weakening Ringgit and the price ceiling of consultation fees in Malaysia will boost patient volume for local private healthcare providers which provide identical medical services with relatively cheaper price as compared to the neighbouring countries. To further boost revenue from medical tourism, KPJ is eyeing to build 3 new hospitals to fetch demand from the target market namely for Bandar Dato Onn Specialist Hospital (BDO), Melaka Specialist Hospital and Port Dickson International Specialist Hospital. We understand that BDO is currently under construction and slated to open by 2017 while the plan for another two is still pending and yet to be submitted to MOH. These three hospitals are expected to accommodate 420 beds capacity, catering for patients in Johor, Melaka and Klang Valley. 2

3 Number of medical tourist Fig.1 Medical Tourist 1,000, , , , , , , , , , Source: Company, M&A Securities Outlook. Malaysia s economy is expected to grow by 5-6 percent with growing middle class population and various mega infrastructure projects initiated by the Economic Transformation Programme. This will translate into higher domestic demand for private healthcare services and propel the growth of KPJ which is the largest private healthcare provider with >20% market share and growing. Note that doctor fees are regulated by law in Malaysia and patients cannot be charged more than the 100% of price ceiling. Coupled with weakening RM, Malaysia is expected to hail medical tourists from neighbouring countries such as Thailand and Singapore, further grow from current <5% market share in Asia-Pacific, as compared to Thailand s of 50%-share. Besides being cost competitive, Malaysia has 12 private hospitals nationwide (of which 4 are KPJ hospitals) accredited by US-based accreditation body Joint Commission International (JCI) and is also ranked the 28 th in the world s medical device markets. The wide availability of halal food and prayer spaces gives Malaysia an edge when it comes to targeting the Middle Eastern markets. Key challenges. 1) Limited pool of specialists; 2) Long gestation period before a new hospital reaps recurring income; 3) Difficulty in keeping new hospital development on track; 4) Potential structural/policy changes including AEC, AFTA, TPPA, etc; 5) Competition from other big players such as Pantai, Gleneagles, government hospitals as well as other foreign hospitals in neighbouring countries Valuation. We maintain the target price at RM4.27 on KPJ based on our target PER of 27x pegged to FY17 EPS forecast, suggesting a HOLD call. We are cautiously optimistic on the current domestic patient growth, not expecting big improvement in the near term due to lacklustre consumer spending. However, as the economy and per capita GDP are expected to improve over the years, demand for private healthcare consumption is expected to rise in tandem. As part of the 11th Malaysia Plan, the government is aiming to promote the development of three health care hubs in Penang, Melaka and Johor Bahru where KPJ has already set its footprint. 3

4 Figure 2: Peers Comparison Source: Bloomberg, M&A Securities Figure 3: Financial Forecast FYE Dec (RM million) FY14A FY15A FY16F FY17F FY18F Revenue 2,639 2,818 3,224 3,583 3,943 COGS (1,865) (1,994) (2,299) (2,529) (2,783) Gross Profit ,054 1,160 EBITDA Depreciation (93) (108) (121) (137) (154) EBIT Net interest income (30) (52) (55) (59) (64) Profits from associates PBT Tax & Zakat (71) (63) (66) (80) (86) PAT Non-controlling interest PATMI EPS EBITDA margin 4% 4% 3% 4% 4% EBIT margin 8% 8% 7% 8% 8% PBT margin 8% 7% 7% 7% 7% Net profit margin 5% 5% 4% 5% 4% Source: Bloomberg, M&A Securities 4

5 M&A Securities STOCK RECOMMENDATIONS BUY Share price is expected to be +15% over the next 12 months. TRADING BUY Share price is expected to be +10% within 3-months due to positive newsflow. HOLD Share price is expected to be between -10% and +10% over the next 12 months. SELL Share price is expected to be -15% over the next 12 months. SECTOR RECOMMENDATIONS OVERWEIGHT The sector is expected to outperform the FBM KLCI over the next 12 months. NEUTRAL The sector is expected to perform in line with the FBM KLCI over the next 12 months. UNDERWEIGHT The sector is expected to underperform the FBM KLCI over the next 12 months. DISCLOSURES AND DISCLAIMER This report has been prepared by M&A SECURITIES SDN BHD. Readers should be fully aware that this report is for informational purposes only and no representation or warranty, expressed or implied is made as to the accuracy, completeness or reliability of the information or opinion contained herein. The recommendation and opinion are based on information obtained or derived from sources believed to be reliable. This report contains financial forecast/projection based on our assumptions which may defer from the actual financial results announced by the companies under coverage. All opinions, estimates and assumptions are subject to change without notice. Analysts will initiate, update and cease coverage solely at the discretion of M&A SECURITIES SDN BHD. Investors are to be cautioned that value of any securities invested may fluctuate from time to time. We advise investors to seek financial, legal and other advice for investing based on the recommendation of our report as we have not taken into account each investors specific investment objectives, risk tolerance and financial position. This report is not, and should not be construed as, an offer to buy or sell any securities or other financial instruments. M&A SECURITIES SDN BHD can accept no liability for any consequential loss or damage whether direct or indirect. Investment should be made at investors own risks. M&A SECURITIES SDN BHD and INSAS GROUP of companies, their respective directors, officers, employees and connected parties may have interest in any of the securities mentioned and may benefit from the information herein. M&A SECURITIES SDN BHD and INSAS GROUP of companies and their affiliates may provide services to any company and affiliates of such companies whose securities are mentioned herein. This report may not be reproduced, distributed or published in any form or for any purpose. M & A Securities SdnBhd (15017-H) (A wholly-owned subsidiary of INSAS BERHAD) A Participating Organisation of Bursa Malaysia Securities Berhad Principal Office: Level 1,2,3 No.45 & 47, 43-6 The Boulevard, Mid Valley City, Lingkaran Syed Putra, Kuala Lumpur Tel: Fax: Website: 5