This article first appeared in The Edge Financial Daily on September 18, 2018
KPJ Healthcare Bhd
(Sept 14, RM1.12)
Reiterate outperform with a target price of RM1.35: KPJ Healthcare Bhd’s management explained that core profit after tax and minority interests for first half of financial year 2018 (1HFY18) rose 5% due to: i) a better cost optimisation (1HFY18 earnings before interest, taxes, depreciation and amortisation margin rose two percentage points to 15% from 13% in 1HFY17); ii) higher complex surgical cases in KPJ Rawang, KPJ Pasir Gudang, and KPJ Bandar Maharani; and iii) higher volumes of outpatient (+1%) and inpatient (+1.6%). Specifically over the past few years, the group has undertaken cost optimisation measures including better inventory and billing systems and cost management of administrative expenses. Elsewhere, in order to enhance efficiency, the group is planning to phase out or convert four-bedded rooms into twin-bedded ones for better rates. We expect a strong showing in 2HFY18, underpinned by a ramp-up of existing hospitals following the slower second quarter of FY18 (2QFY18) due to: i) festivals; ii) continuing benefits from cost optimisation initiatives; iii) profitability from hospitals which were previously in a gestation phase (KPJ Klang, Pasir Gudang, Rawang and Muar); and iv) slower new greenfield development.
KPJ’s earnings growth is expected to come from narrower losses and profitability from hospitals built two to three years ago including KPJ Klang, Rawang, Maharani, Pasir Gudang, and Pahang. KPJ Perlis (greenfield, 90 beds) commenced operations in 2QFY18. Beyond FY18, we expect brownfield development, including KPJ Ampang (149 new beds), KPJ Johor (40 new beds), and KPJ Seremban (90 new beds) to drive earnings beyond FY18, of which gestation period is much shorter than that of greenfield development. Elsewhere, greenfield expansions include Kuching, Sri Manjung, and KPJ Johor Bandar Dato Onn, which are expected to start operating by 2QFY19. The group is confident that start-up costs from new openings will be absorbed by incremental ramp-ups from earlier openings and steady contributions from matured hospitals.
The new sales and services tax regime is seen to be net positive for hospital operators like KPJ with exemptions for: i) doctors’ consultation fees; ii) most or all medications likely to be exempted; and iii) equipment. Any saving is expected to pass through in FY19.
We understand that KPJ is in the midst of drafting an agreement with interested parties to sell its 57% stake in its aged-care business in Jeta Gardens, and the deal is targeted to be completed by end-FY18. Given that this non-core segment has been making losses over the years, the divestment is expected to be positive. Since the investment was written down in FY16, any gain arising from the divestment is only expected to be reflected in the balance sheet. — Kenanga Research, Sept 14