This article first appeared in The Edge Financial Daily on November 1, 2019

KPJ Healthcare Bhd
(Oct 31, 92 sen)
Upgrade to buy with a higher target price (TP) of RM1.08: KPJ Healthcare Bhd’s share price has fallen 12% year-to-date due to imminent drug price control, we believe, with it now trading at 12-month forward price-earnings ratio (PER) of 21 times (below its -1 standard deviation to five-year mean). However, we believe KPJ should be able to raise other charges to mitigate for potential lower drug revenue. We raise our financial year 2019 to 2021 forecast (FY19-21F) earnings per share (EPS) by 6% to 8% and our discounted cash flow-based TP is also raised by 8%, to RM1.08 (weighted average cost of capital: 7%, long-term growth: 2%) as we roll forward our valuation base. With the selling looking overdone, we upgrade KPJ to “buy” (from “hold”). At our revised TP, the implied 12-month forward PER is 26 times, its five-year mean.

The third quarter of financial year 2019 (3QFY19) results are scheduled to be released on Nov 28 or 29 and we expect its core net profit to be stronger quarter-on-quarter (q-o-q) and year-on-year (y-o-y) (2QFY19: RM43 million, 3QFY18: RM42 million). Traditionally, earnings are backloaded with the second half (2H) stronger than 1H, in the absence of major festivities. We also expect the incremental earnings from younger hospitals (about nine of its total 29 hospitals) to offset the initial losses from the three new hospitals (KPJ Batu Pahat: opened in September 2019, KPJ Miri and KPJ Kuching: to open by November 2019 and January 2020).

Given the congestion at public hospitals, the ministry of health plans to shift some of its outpatients to the private hospitals, at prices that are agreeable to both parties. Though margins for this business could be lower, KPJ would still benefit as this will increase its outpatient volume (about 25% of the group’s total revenue) and lead to higher utilisation of its equipment during off-peak hours. We think this shifting could be implemented in 2020-21, as it is not overly complicated to work out the referral or pricing framework.

We raise our FY19-21F EPS by 7%/8%/6% as we raise our total patient volume growth to 3% per annum (from 2%; 1H19: +3%) and revenue growth per inpatient to 5% per annum (from 2%; 1H19: +9%). The earnings upward revision is to reflect the outperformance in 1H19 and our expectation that the volume growth will sustain into 2020-21 given the spillover of patients from the public sector and growing medical tourism. — Maybank IB Research, Oct 31