This article first appeared in The Edge Financial Daily on May 23, 2017

IHH Healthcare Bhd
(May 22, RM5.97)
Reiterate add call with a target price (TP) of RM6.90: IHH Healthcare Bhd’s first quarter ended March 31, 2017 (1QFY17) results missed on start-up costs. The 1QFY17 core net profit declined 15.3% year-on-year (y-o-y), missing our estimate by 17% and missing the consensus estimate by 24%. 1QFY17 formed only 21% of our FY17 forecast.

However, 1QFY17 was bogged down by the opening of two large flagship hospitals in March 2017 — the Gleneagles Hong Kong (GHK) and Acibadem Altunizade. A weaker lira did not help either. Notwithstanding, core operations remained strong with both growth in volumes and average inpatient revenue, which deserves a big credit taking into account competitors are actually struggling in today’s environment.

Hence, GHK’s widening 1QFY17 earnings before interest, taxes, depreciation and amortisation (Ebitda) loss (about RM85 million) were not unexpected (4QFY16: about RM40 million; 3QFY16: about RM20 million). We remain “positive” on GHK and expect losses to gradually narrow in the second half of FY17 (2HFY17) before hitting Ebitda break-even by 1HFY18.

Management also shared that costs came in lower than internally budgeted for, which we attribute to the group intentionally offering more “bread and butter” services which help with utilisation before allocating resources towards higher-intensity specialisations.

Looking past start-up costs from new hospitals, we continue to see strong underlying performance in IHH’s core markets in both the top line and Ebitda, driven by better volumes and revenue intensity.

Meanwhile, Singapore’s 1Q Ebitda were +12% y-o-y and Malaysia’s Ebitda were +14% y-o-y. Acibadem’s Ebitda were -6% y-o-y, but would have been +10% in constant currency terms.

The other positive is that the group’s biggest profit contributor Singapore (47% of group Ebitda) continues to do well with higher margins, driven by better operating leverage from Mount Elizabeth Novena in Singapore. There is also further upside from Novena, with full bed capacity expected in 2HFY17 (currently about 85% opened).

In addition, Singapore’s 4.1% inpatient volume growth was also robust, with management even reporting growth in foreign patient volumes. We read this as very strong given that competitors saw declining trends in 1QFY17.

We trim our margin assumptions to factor in higher start-up costs. This lowers our FY17 to FY19 earnings per share forecasts by 5% to 6%. Accordingly, our sum-of-parts-based TP falls to RM6.90.

We suspect near-term share price movement could be hindered by gestation costs, but remain confident that management can successfully navigate the gestation phase, and we see any share price weakness as a buying opportunity. In our view, longer-term prospects remain very strong.

Risks include profit erosion from slower-than-expected ramp-up. — CIMB Research, May 19