Raffles Medical Group - Post analyst briefing update ~ Margins could yet worsen
- We think it is still too premature to start turning positive on RFMD. Both 4Q16 topline and bottomline were weak, and costs could yet intensify.
- Weak medical tourism, limited domestic growth and expansion costs are hitting the group’s hospital segment. Hospital saw its first ever PBT decline in FY16 (-3% yoy).
- Losses at ISOS are also widening and route to profitability could take longer than expected.
- We cut our EPS on slower sales growth and lower margins. Accordingly, our SOP-based TP falls to S$1.36. Maintain Reduce.
Topline missed amid weak demand
- 4Q16 topline growth was weak amid slowing demand. As 4Q is typically its strongest quarter, the 1% qoq sales decline in 4Q16 was especially poor.
- Management attributed the weakness to medical tourism (declining Indonesian patients) and an uncertain macro environment which would have led patients to either postpone procedures or switch to the public sector.
- We do not expect demand to recover soon and lower our FY17F hospital revenue growth forecast to 5% (prev. 8%).
Still seeing a drop in Indo patients
- The miss in medical tourism mostly came from Indonesian patients (single-digit decline). Indo patients now form less than 20% of RFMD’s total foreign patients (prev. 20+%).
- Even as management cited growth from other markets (Malaysia, Vietnam, Myanmar and China), the tone was that medical tourism growth (if any) will likely be subdued.
- Key deterrents include
- a strong S$,
- rising private healthcare costs, and
- competition from regional hospitals.
Hospital extension likely to be accompanied by higher costs
- Common investor concerns include the timing of its Singapore hospital extension (scheduled completion: 2H17) amidst slowing demand and associated cost pressures.
- However, management guided that it operates a demand-led model and will ramp up in phases according to demand; cost concerns are, therefore, manageable. However, we remain cautious and note that margins are already being squeezed.
- FY16 hospital PBT was down 2.8% yoy even as revenue grew 4.8% yoy.
Where does ISOS fit in?
- Widening losses at 55%-owned ISOS have not helped the group’s cost pressures.
- We understand the drag is mostly at the manpower level. Staff cost/revenue was 60+% upon acquisition but has been brought down to c.56%. Using RFMD’s existing operations as a benchmark, we think an optimal level will be 50%.
- Management highlighted that it has taken an active role in managing this business and has a new management for ISOS. However, we still expect transition costs and view a turnaround in FY17 as unlikely.
Not yet time for a turnaround, maintain Reduce
- Overall, we cut our FY17-18F EPS by 8-12% on the back of slower hospital segment growth and continued margin pressure. Accordingly, our SOP-based TP falls to S$1.36.
- With valuations still rich at 26.7x CY17F EV/EBITDA and accompanied only by a 5% EPS CAGR over FY17-18F, we keep our Reduce rating.
- The stock continues to trade above peers (23x CY17F EV/EBITDA) and its historical 5-year mean (also 23x).
- Upside risks to our call could come from further greenfield hospital plans in China.