Far East Horizon (3360 HK)

Equity Research Financials Far East Horizon (3360 HK) Buy (upgraded) Target price: HK$9.30 Wang Wen SFC CE No. BGL298 wangwen@gfgroup.com.hk +86 755 8826 1286 GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong Stock performance 9.00 8.50 8.00 7.50 7.00 Rising contribution from hospital operations; upgrade to Buy Upgrade from Accumulate to Buy and raise TP to HK$9.30 Far East Horizon has had a relatively stable P/B valuation due to its asset-heavy leasing model. However, hospital operations have become a significant source of income and profit, which we expect to account for 10% of revenue and 5% of net profit in 2018. Hospital operators have higher P/E valuations, for example CR Phoenix (1515 HK, NR) (including not-forprofit public hospital management and for-profit private hospital operation) which is trading at 22x 2018E P/E, and Guangdong Kanghua Healthcare (3689 HK, NR) (forprofit private hospitals) at 15x 2018E P/E. Assuming an average of 18.5x P/E for 5% of the company s business and 8.1x P/E for 95% (corresponding to 1.05x P/B, its historical average), we roll over our valuation basis to 2018 and raise our target price from HK$7.80 to HK$9.30, representing 8.6x 2018E P/E and 1.13x 2018E P/B. Ambitious plans for the future Broad market space for investment in private hospitals The number of private hospitals in China has grown rapidly over the past few years and has exceeded the number of public hospitals since 2015. However, the scale of investment, operational beds and technical personnel for each private hospital is still far below the public hospital average. The government has been encouraging private investment in hospitals. Take the number of beds for example; public hospitals had 3.9 beds per thousand people in 2015 while private hospitals had just 0.52 beds. According to the medical and health system reform plan for the 13th Five Year Plan period, the number of beds per thousand people should increase to 4.8 by 2020, of which 1.5 will be in private hospitals. This means the number of beds in private hospitals could triple over the next three years. Key operating data and long-term goals As of end-june 2017, the company had acquired 26 hospitals, mostly in county-level cities across China. All are for-profit private hospitals that qualify for basic medical insurance reimbursement, and have more than 10,000 beds combined, 2m annual outpatient visits, 160,000 annual inpatient visits and 40,000 annual surgeries. Overall utilization of hospital beds was over 80%, compared to an average of 63% for other private hospitals in China. Most acquired hospitals have seen a significant improvement in gross margins to 40-45% and net profit margins of over 10%, following the adoption of a comprehensive supply chain management system. Over the long term, the company plans to operate over 100 hospitals and have over 50,000 beds available, 27m annual outpatient visits, 1.6m annual inpatient visits and 500,000 annual surgeries, indicating a four-fold increase in total investment and a more than ten-fold rise in operational capacity. 6.50 6.00 Far East Horizon HSI(comparable) Source: Bloomberg Key data Oct 13 close (HK$) 7.59 Shares in issue (m) 3951 Major shareholders Sinochem (23.29%) Market cap (HK$ 100m) 298 3M avg. vol. (m) 3 52W high/low (HK$) 7.75/6.28 Source: Bloomberg Stock valuation Revenue Net profit EPS EPS P/E BPS P/B ROE (Rmb m) (Rmb m) (Rmb) YoY (Rmb) 2015 11796 2503 0.63-9% 10.1 5.41 1.2 13.35% 2016 13928 2882 0.73 15% 8.8 5.81 1.1 13.00% 2017E 17334 3170 0.80 10% 8.0 6.37 1.0 13.18% 2018E 20610 3627 0.92 14% 7.0 6.99 0.9 13.74% 2019E 23849 4260 1.08 17% 6.0 7.73 0.8 14.64%

Figure 1: Key operating data and long term goals 2H16-1H17 2050E Hospitals: 26 Number of beds: 10,000 Outpatient visits: 2m+ Inpatient visits: 0.16m+ Surgeries: 40,000+ Hospitals: 100+ Number of beds: 50,000+ Annual outpatient visits: 27m+ Annual inpatient visits: 1.6m+ Annual surgeries: 500,000+ Unique geographic operation In contrast to other hospital operators that concentrate on first, second and third-tier cities that have more dense populations, Far East Horizon has acquired hospitals in county-level cities, for two main reasons: 1) There is considerable demand for healthcare but a shortage of high-quality hospitals and doctors in these rural areas, despite them having 65% of China s population (~900m people). 2) It is difficult for for-profit private hospitals to compete with public hospitals in first/second/third-tier cities given the local authorities greater financial strength and public hospital resources. Figure 2: Comparison of areas of operation Areas of operation First and second-tier cities + prefecture-level cities CR Phoenix (1515 HK, NR) Beijing, Shenzhen, Wuhan, Kunming, Baoding, Xuzhou, Huaibei and others Beijing + second and third-tier cities PKU Healthcare (000788 CH) Beijing, Zibo, Zaozhuang, Zhuzhou, Changzhi and others High-end healthcare in first-tier cities: Beijing, Shanghai, Guangzhou Fosun Pharma (600196 CH, 2196 HK NR) Comprehensive hospitals in second and third-tier cities: Hefei, Foshan, Wenzhou, Taizhou, Yueyang, Suqian and others Core second and third-tier cities: CITIC Medical & Health Group Hangzhou, Chengdu, Chongqing, Changsha, Huizhou, Shanwei and others Core second and third-tier cities, supplemented by some county-level cities: Hengkang Medical Group (002219 CH) Chengdu, Dalian, Ziyang, Pingxiang, Guang'an, Xuyi, etc. Four major areas - most are county level cities Northeast: Anda, Siping, Wuchang; East China: Weihai, Siyang, Binghai etc; Far East Horizon (3360 HK, Buy) SouthChina: Huizhou, Shenzhen, Meizhou; Southwest: Chongqing, Deyang, Guizhou, Nayong etc. Overall enhancement in medical technologies and operational efficiency After acquiring hospitals, Far East Horizon has taken measures to improve purchasing, operations and management in accordance with its company-wide standards for its hospitals, improve medical techniques used as well as operational efficiency. Standardized organization, systems, quality and supervision The company has established a standardized organizational structure so that it has a three-level medical quality control system for each hospital. It has also issued standardized manuals for areas such as infection control, patient safety, medical quality, and nursing. Standardized quality improvements have been adopted, including the 6S and QCC standards as well as international standards such as the TUV and CCI. In addition, all hospitals are included in the company s comprehensive data management system for standardized supervision. Well-respected experts enhancing its key disciplines The company s four key disciplines are orthopedics, gynecology, nephrology and oncology. Using orthopedics as an example, as of end-june, three nationally-respected orthopedics experts from the military hospital system had joined Far East Horizon. With professors Pei Guoxian and Zhang 2

Chuncai as its chief experts in orthopedics, the company has established a physician team of over 250 doctors to serve 1,400 beds nationwide, covering over 95% of orthopedics techniques. Comprehensive supply chain management The company has accumulated solid professional skills in medical equipment purchasing through its leasing business. Thanks to its good relationships with major global equipment suppliers and group purchasing, the company purchased over Rmb50m worth of equipment during 7M17 at prices 5-10% lower than individual private hospitals and 50-60% lower than public hospitals. The company also unifies its medical supplies program and negotiates better prices for commonly used medical supplies. The company has conducted group purchasing for more than 200 commonly used drugs, resulting in a typical drug procurement cost reduction of more than 10%. Valuation for hospital operations Earnings forecasts Management estimates that the total number of beds available will be 15,000 by end-2017, contributing Rmb1.4-1.5bn in consolidated revenue (vs Rmb0.63bn in 2016), equivalent to about 10% of the company s total revenue in 2016. Its long-term goal is to acquire 20,000-30,000 beds over the next 2-3 years. We have brought our assumptions for bed acquisitions broadly in line with management guidance and further assume that 56% of beds acquired can be put into use with annual revenue per bed of Rmb330k/337k/343k in 2017/18/19, respectively. We estimate hospital revenue of Rmb2,402m/3581m/4807m and net profit of Rmb168m/287m/409m during the same years. Given an equity stake of 60%, we estimate revenue from hospital operations for Far East Horizon of Rmb1,441m/2,149m/2,884m in 2017/18/19, accounting for 8%/10%/12% of total revenue. Management has indicated that gross profit margin may increase to 40-45% and net profit margin could rise above 10% following its planned enhancements. However, we have made conservative estimates for net profit given that this will take time and a substantial amount of ongoing investment, giving us a net profit contribution from the segment of 3%/5%/6% in 2017/18/19, respectively. Figure 3: Earnings forecasts for hospitals Figure 4: Peer valuations Rmb m 2016 1H17 2017E 2018E 2019E Beds acquired 7000 10000 13000 19000 25000 Operational rate 63% 56% 56% 56% 56% Beds in operation 4400 5600 7280 10640 14000 Hospital revenue 1415 925 2402 3581 4807 Annual revenue per bed ('000) 322 330 330 337 343 Gross profit margin 32% 30% 32% 35% 40% Gross profit 455 281 769 1253 1923 Net profit margin 8.3% 6.3% 7.0% 8.0% 8.5% Net profit 118 58 168 287 409 Shareholding % 60% 60% 60% 60% 60% Revenue from hospital operation 626 591 1441 2149 2884 Net profit from hospital operation 52 37 101 172 245 Revenue % in Group 4% 7% 8% 10% 12% Net profit % in Group 2% 2% 3% 5% 6% Market cap Total P/E P/B ROE (%) (Rmb100m) Net assets Revenue Net profit (HK$ bn) assets 2017E 2018E 2017E 2018E 2016 2017E 2666 HK Universal Medical 11 319 69 16.5 5.8 8.5 6.7 1.3 1.1 14 16 3360 HK Far East Horizon 30 1970 235 89.7 16.2 7.6 6.5 1.0 0.9 13 14 1606 HK CDB Leasing 24 1728 228 58.0 12.9 9.7 8.3 0.8 0.8 8 9 1515 HK CR Phoenix 14 68 54 8.6 3.2 24 22 1.9 1.8-43 8 3689 HK Guangdong Kanghua Healthcare 4 16 12 6.4 0.7 18 15 2.3 2.1 20 14 3

Figure 5: P/E and P/B valuation 10.5 10 9.5 9 8.5 8 7.5 7 6.5 6 2 1.8 1.6 1.4 1.2 1 0.8 P/E (TTM) P/B (MRQ) (RHS) Figure 6: Financial statements Balance Sheet Income Statement Year ended Dec 31 (Rmb m) 2015 2016 2017E 2018E 2019E Year ended 31 Dec (Rmb m) 2015 2016 2017E 2018E 2019E Cash and cash equivalents 2,501 2,051 2,503 2,828 3,196 Revenue 11,796 13,928 17,334 20,610 23,849 Loans and accounts receivables 120,566 138,801 169,338 191,352 216,227 Finance leasing and factoring 6,849 8,139 10,086 11,985 13,747 Restricted deposits 2,641 2,461 3,003 3,393 3,834 Advisory servicies 3,851 3,820 4,470 5,140 5,912 Prepayments, deposits and other receivables 3,637 7,592 9,263 10,467 11,827 Revenue from business operation 1,207 2,114 2,959 3,699 4,439 Deffered tax assets 1,301 1,907 2,327 2,629 2,971 Business tax and surcharges -111-145 -181-215 -249 PPE 3,358 4,996 6,095 6,887 7,782 Cost of sales 4,772 5,736 7,577 9,229 10,750 Prepaid land lease payments 1,150 1,216 1,483 1,676 1,894 Borrowing costs 3,963 4,132 5,357 6,455 7,510 Investment in joint ventures 1,188 1,405 1,714 1,937 2,189 Cost for industrial operation 808 1,604 2,219 2,774 3,240 Investment in associates 0 264 322 364 411 Gross profit 7,024 8,193 9,758 11,381 13,099 Available-for-sale investment 427 290 354 400 452 Operating cost -3,133-3,340-4,420-5,152-5,962 Equity investments at fair value through profit or loss 244 721 880 994 1,124 Other income and gains 510 477 347 412 477 Derivative financial instruments 1,117 1,383 1,687 1,906 2,154 Impairment losses recognised in the income statement -821-1,259-1,164-1,362-1,455 Inventories 115 246 300 339 383 Profit before tax 3,580 4,072 4,520 5,278 6,159 Construction contracts 42 44 54 61 69 Tax -1,000-1,131-1,255-1,466-1,710 Goodwill 359 749 914 1,032 1,167 Profit attributable to non-controlling interests 77 60 95 186 189 Others 666 2,434 2,970 3,356 3,792 Profit attributable to holders of ordinary shares 2,503 2,882 3,170 3,627 4,260 Total assets 139,313 166,561 203,204 229,621 259,472 Net profit 2,580 2,942 3,265 3,813 4,448 Liabilities Interest-bearing bank and other borrowings 41,700 53,546 66,020 75,880 86,902 Long term borrowings 41,729 53,392 65,138 73,606 83,175 Other payables and accruals 22,694 28,107 34,291 38,749 43,786 Cash Flow Statement Trade and bills payables 8,338 2,887 4,064 4,592 5,189 Year ended Dec 31 (Rmb m) 2015 2016 2017E 2018E 2019E Taxes payable 644 1,003 1,223 1,382 1,562 Cash flow from operating activities Derivative financial intruments 288 92 113 127 144 Net income 2,503 2,882 3,265 3,813 4,448 Deffered tax liablities 129 71 86 98 110 Add: Depreciation of PPE 276 407 609 689 778 Deferred revenue 261 148 181 204 231 Net working capital changes -13,609-25,201-30,085-23,374-26,459 Other liabilities 569 2,469 3,012 3,404 3,846 Others 541 902 1,079 777 874 Total liabilities 116,351 141,715 174,128 198,042 224,946 Cash generated from operations -10,290-21,009-25,131-18,095-20,358 Equity 0 0 0 0 0 Cash flow from investing Equity attributable to holders of ordinary shares 21,391 22,959 25,150 27,633 30,559 Net purchase of PPE -906-1,862-1,718-1,693-1,048 Share capital 10,211 10,213 10,213 10,213 10,213 Net investment 1,209 1,158 431 311 351 Other reserves 11,180 12,746 14,937 17,420 20,346 Others -137-226 -54-39 -44 Holders of perpetual securities 1,227 1,232 3,255 3,255 3,255 Net cash flows used in investing -3,208-2,534-2,276-1,531-1,730 Non controlling interests 343 655 671 690 713 Cash flow from financing Total equity 22,961 24,846 29,076 31,579 34,526 Net changes of debt 10,394 6,595 24,764 18,720 21,034 Total equity and liabilities 139,313 166,561 203,204 229,621 259,472 Changes in shares 3,411-631 2,027 0 0 Minus: dividend paid 697 843 1,068 1,232 1,423 Financial Ratios Others -369 1,762 0 0 0 Year ended Dec 31 2015 2016 2017E 2018E 2019E Net cash flows from financing 12,739 23,179 27,858 19,952 22,456 Drivers Net cash flows: NIM (Recalculated) 2.6% 3.1% 3.0% 3.0% 3.0% FX adjustment -59-85 0 0 0 NIS (Recalculated) 1.0% 1.9% 2.0% 2.0% 2.0% Net (decrease)/increase in cash and cash equivalents -817-449 451 325 368 Non interest revenue ratio 42.5% 42.2% 42.4% 42.4% 43.0% Cash and cash equivalents at beginning of year 3,318 2,501 2,051 2,503 2,828 Credit cost 0.7% 1.0% 0.8% 0.8% 0.7% Cash and cash equivalents at end of year 2,501 2,051 2,503 2,828 3,196 Asset quality Non Performing assets ratio 0.97% 0.99% 0.96% 0.95% 0.95% Provision coverage ratio 201.24% 212.13% 213.00% 213.00% 213.00% Provision/Interest-bearing asset 1.95% 2.14% 2.02% 2.00% 2.00% Profitability ROE 13.35% 13.00% 13.18% 13.74% 14.64% ROA 2.06% 1.92% 1.77% 1.76% 1.82% Leverage (A/E) 6.07 6.70 6.99 7.27 7.52 Valuation P/E 10.1 8.8 8.0 7.0 6.0 P/B 1.2 1.1 1.0 0.9 0.8 Dividend yield (%) 3.0 3.1 3.9 4.5 5.3 4

Rating definitions Benchmark: Hong Kong Hang Seng Index Time horizon: 12 months Company ratings Buy Stock expected to outperform benchmark by more than 15% Accumulate Stock expected to outperform benchmark by more than 5% but not more than 15% Hold Expected stock relative performance ranges between -5% and 5% Underperform Stock expected to underperform benchmark by more than 5% Sector ratings Positive Sector expected to outperform benchmark by more than 10% Neutral Expected sector relative performance ranges between -10% and 10% Cautious Sector expected to underperform benchmark by more than 10% Analyst Certification The research analyst(s) primarily responsible for the content of this research report, in whole or in part, certifies that with respect to the company or relevant securities that the analyst(s) covered in this report: (1) all of the views expressed accurately reflect his or her personal views on the company or relevant securities mentioned herein; and (2) no part of his or her remuneration was, is, or will be, directly or indirectly, in connection with his or her specific recommendations or views expressed in this research report. 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