Health Management Int’l (HMI SP) - Maybank Kim Eng 2017-06-05: Unique Hospital Operator

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HEALTH MANAGEMENT INTL LTD 588.SI

Health Management Int’l (HMI SP) - Unique Hospital Operator

Malaysia hospital operator set for a new growth era 

• Listed on the SGX since 1998, Health Management International HMI operates two tertiary hospitals in Malaysia and is the only group in Singapore that offers an independent practice model. 
• After building a firm foundation by turning around two loss-making hospitals, HMI is set to enter a new growth phase. It will scale up via: 
  1. fully acquired stakes in two hospitals; 
  2. more than doubling the capacity of Regency Hospital; and 
  3. potential M&A of synergistic businesses. 
• The market has not priced in HMI’s growth opportunities, in our view. Our 3-year EPS CAGR of 20% for FY16-19E has not included points 2 and 3. 
• Initiate at BUY with TP of SGD0.84.

Positive outlook for Malaysia market 

• The positive industry outlook, which could boost demand for private healthcare, is being driven by: 
  1. rising importance of private hospitals due to Malaysia’s inadequate public healthcare system; 
  2. positive structural factors, including rising affluence, increasing availability of private insurance and high prevalence of lifestyle diseases; 
  3. undersupply of hospital beds; and 
  4. rising demand for medical tourism.

Strategically located hospitals with good prospects 

• Both HMI’s hospitals stand to gain more patients from the surrounding mega-development projects, which will create many new jobs and healthcare demand. 
• Mahkota, a mature hospital located in Malacca, should benefit from the MYR43b Malacca Gateway project, which could create 45,000 new jobs and 2.5m new visitors in 2025 (vs 300,000 patient visits pa.). The 1st phase will be completed in 2019. 
• Regency, a young hospital in Johor which turned profitable only in FY14, is the closest tertiary hospital to Pasir Gudang Industrial Area and the new MYR60b Petronas RAPID Project. With completion in 2019, RAPID will add 54,000 new jobs from c.110,000 patient visits pa.).

Discount to peers, but comparable growth/margins 

• Our DCF-based TP of SGD0.84 (WACC 7.4%, LTG 2.0%) implies 35x FY18E P/E, on par with the peer group average. This does not include future expansion in Mahkota and potential M&A. 
• HMI’s current 26x FY18E P/E is a 19% discount to peers, despite having a comparable 3-year EPS CAGR of 20%. 
• Risks are competition, regulation, and execution of business plan.

INVESTMENTS THESIS

Unique and well -managed hospital group in Malaysia 

• HMI operates two tertiary hospitals in Malaysia and is the only hospital group in Malaysia that offers Singapore’s independent practice model.
• This has worked well in attracting and retaining top doctors. HMI has been able to attract highly specialised doctors that focus on niche sub - specialties such as neurologist and it has a zero turnover rate for doctors who own a medical suite in Mahkota. 
• After building a firm foundation in its two hospitals, the second -generation management is now set to scale up the business. Mahkota Medical Centre in the Malacca state was acquired in 1998. HMI turned around this loss-making hospital in three years. Key initiatives included: 
  1. cutting excess capacity at first; 
  2. recruiting more doctors ; and 
  3. increase marketing across Indonesia.
• Seeing potential in the Johor state, HMI acquired Regency Specialist Hospital in 2009. Similar to its first hospital, patient load grew rapidly and Regency achieved profitability in 2014, five years after it started operations.

Positive outlook for Malaysia’s private hospital segment 

• The positive industry outlook is driven by: 
  1. rising importance of private hospitals due to Malaysia’s inadequate public healthcare system; 
  2. positive structural factors including rising affluence, increasing availability of private insurance and high prevalence of lifestyle diseases; 
  3. undersupply of hospital beds; and 
  4. rising demand for medical tourism.

Mahkota – good potential from booming Malacca 

• Mahkota is a mature hospital located in the city centre of Malacca, which could benefit from the MYR43b Malacca Gateway Project, potentially creating 45,000 new jobs and 2.5m new visitors in 2025 (vs 15.4m tourists in 2014 and c.1m population in 2015), based on estimation by the master developer . This could significantly increase its patient numbers, which stood at 300,000 visit s pa and revenue per patient, as foreign patients typically spend 50% more than the local patients due to higher case intensity. The first phase, consisting of a deep sea port, is expected to be complete d in 2019. 
• Mahkota stands out for its: 
  1. unique independent practice model , which allows doctor s to own a medical suite; 
  2. pioneer and leadership position of Malaysia’s medical tourism with c.10% market share of Malaysia’s medical tourists. It has secured an early mover advantage in this space, started since 1999, where c.30% of its patients are medical tourists; 
  3. it is one of only two hospital groups approved by Singapore MOH for usage of Medisave in Malaysia.
• The growth plan is to build higher value medical sub-specialties, to improve case intensity. It has an option for future organic expansion, as it owns a plot of land opposite to the hospital .

Regency – low base in underserved Johor 

• Started in 1999, Regency is a young hospital that turned profitable only in FY14. It is located strategically as it’s only a 15 -minute drive from the Singapore-Woodlands Checkpoint and Johor Bahru City Centre. It is also the closest tertiary hospital to the Pasir Gudang Industrial Area and the new MYR60b Petronas RAPID Project, which could create 54,000 new jobs in 2019. This will boost demand for Regency’s corporate patients and significantly increase its patient numbers, which stood at 110,000 patient visit s pa. 
• Johor’s hospital segment is underserved. It has only a 1.6 bed-per-1,000-population ratio, which is below Malaysia’s average of 1.9 and 2.1 in Singapore. In addition, there is potential for more medical tourism from regional markets such as Singapore and Indonesia, as HMI increases marketing and leverages on the brand name of Mahkota among the medical tourists. 
• Regency aims to more than double its existing capacity from a major expansion. Construction is expected to commence in mid- 2017 and is expected to be completed in end-2019. Based on the estimated capex of MYR160m for the expansion, the investment per room is MYR0.73m.

Valuation

• Our DCF-based TP of SGD0.84 (WACC 7.4%, LTG 2.0%) implies 35x FY18E P/E, on par with peers’ average. This does not include future expansion in Mahkota and potential M&As. HMI’s current 26x FY18E P/E is at a 19% discount to peers, despite having a comparable 3-year EPS CAGR of 20%.
• The hospital consolidation exercise has raised its market cap by c.40% to c.SGD500m via the issuance of 236m new shares. Risks are competition, regulation and execution of the business plan.

COMPANY BACKGROUND

Unique Malaysia hospital operator 

• HMI is an SGX-listed company but it operates two renowned hospitals in Malaysia: Regency in the state of Johor and Mahkota in Malacca. Both hospitals have around 200 practicing consultants (140 full-time), serving more than 400,000 patients annually. 
• HMI aims to provide patients with a “one-stop” treatment centre and attract referrals of complex cases. In addition, it is an early mover in medical tourism, started since 1999, as c.30% of its patients are medical tourists and it is one of only two hospital groups approved by Singapore MOH for usage of Medisave in Malaysia.
• HMI’s unique independent practice model sets it apart from other hospitals in Malaysia, including those operated by IHH (IHH MK; HOLD) and KPJ (KPJ MK; HOLD). Similar to most of Singapore’s private hospitals, this model allows specialist doctors to own and operate their clinics within HMI’s hospitals. It has worked well in attracting, retaining and motivating top specialist doctors, which are the key success factors in Malaysia’s hospital industry. We note that not a single doctor who has purchased a medical suite in HMI’s Mahkota hospital has left and older doctors remain motivated compared to peers in other hospitals that operate under the employee-based model. 
• About half of the medical suites in Mahkota were sold to practicing doctors, while the remaining are rented out. The more established Mahkota provides more specialties compared to Regency, as the former has been branching out deeper into various sub-specialties for treating more complicated cases.
• The second-generation management stepped up to the top executive roles since 2015. HMI now plans to pursue more expansion. Its new hospital building next to Regency could more than double the hospital’s capacity, by end-2019. At the same time, management is exploring more M&A activities in Malaysia and Indonesia. Also, HMI has raised its stake in the two existing hospitals to boost EPS immediately. 

POSITIVE OUTLOOK FOR MALAYSIA'S PRIVATE HOSPITALS

Larger role for the private sector 

• Malaysia’s public healthcare system is under the purview of the Ministry of Health (MoH) and it’s funded by the tax system, whilst the private system is user-charged. Despite the improvement of Malaysia’s public healthcare system over the years, it has been strained by the rising demand for healthcare services. Long waiting times and high bed occupancy rates are some of the problems plaguing the system. As a result, we see middle-high income earners shifting to private healthcare as an alternative.
• Statistics from Malaysia National Health Account (MNHA) show that the proportion of private sector spending on healthcare has increased from 43% in 2009 to 48% in 2013. The number of public hospitals nationwide has also fallen short, with only 142 public hospitals in 2014 in comparison to 184 private hospitals. However, public hospitals still made up the majority of the inpatient and outpatient admissions at 69% and 83%, respectively in 2014, largely due to the almost free public healthcare provided by the Malaysian government. Public hospitals generally operate out of bigger establishments relative to private hospital players. But the shortcomings of public hospitals include: 
  1. long waiting time in an overcrowded environment; 
  2. risk of getting inexperienced doctors as cases could be handled by young doctors; 
  3. and poor service quality.
• Two major players in the private sector command about two-third market share, in terms of the number of hospitals. The largest player is KPJ healthcare (25 hospitals), followed by Parkway Pantai, under IHH (14 hospitals). These two players are also expanding continuously to cater to rising demand. To distinguish themselves, smaller players such as HMI use a niche operating model and unique overseas branding by practicing based on Singapore’s independent model. HMI’s independent practice model allows great autonomy, in enabling doctors to run their own clinic within its hospitals. This enables HMI to attract and retain top doctors. 
• HMI positions itself as a high-quality provider, at affordable pricing. It aims to grow largely by increasing its patient volume. Over the years, HMI’s hospitals have built up a strong brand name among the local community and medical tourists in Mahkota. Today, Mahkota is the leader in Malaysia’s medical tourism industry with c.10% market share. The bulk of the patients in Regency are residents from the nearby area, in the Southern part of Johor. It also has a strong base of corporate patients from the Pasir Gudang Industrial Park.

Structural boost: aging, affluence, insurance, diseases 

• Malaysia had a population of almost 31m in 2014. Close to 6% of the population were aged 65 and above, according to the Department of Statistics (DoS) Malaysia. Longer life spans have resulted in an increase in the number of aged people (65 and above) in Malaysia. The aged population increased by an average of 5.1% from 2011-2014, exceeding the average population growth rate in Malaysia of 1.7% over the same period. This demographic shift will continue to help fuel the increasing demand for healthcare services. Aged-care facilities and services are another segment that the government is hoping to promote amongst the elderly.
• In addition, rising income levels will help boost healthcare spending. Wealthier citizens have access to better education and the Internet has helped them to realize the importance of healthcare. As evidence, per capita expenditure on healthcare has increased along with rising income levels over the years.
• Increasing availability of medical insurance packages in Malaysia has also reduced the reliance on out-of-pocket spending for private healthcare services and encourages transition from overcrowded public to private healthcare services, particularly for the middle-income earners. Thanks private insurance, people can now use private hospitals and be reimbursed by their insurance. Written premiums for general medical insurance in 2013 were MYR920m and it’s expected to have grown by 63%, reaching MYR1.5b by 2016. Growth in the insurance market indicates the public is accepting the benefits of subscribing to private insurance.
• Other supporting factors for Malaysia healthcare include high diabetes prevalence due to unhealthy lifestyles and unhealthy diets. Also, the share of population with HIV is relatively higher compared to other countries due to gender inequity, silence, denial and ignorance. Unicef reported that urban and rural children and adolescents' vulnerability to HIV further increases due to sexual and physical violence, incest, sex work, human trafficking, and underage and unprotected sex.

An undersupplied market with upside potential 

• The Malaysian healthcare market is underserved due to the lack of beds; bed shortages as of 2015 amounted to about 27,000. Also, Malaysia has only 1.9 beds per 1,000 people, much lower than most Asia Pacific nations.
• In addition, there is more room for Malaysians to increase their healthcare spending, as indicated by the relatively low total health expenditure as a % of GDP compared to regional peers.

Good potential for medical tourism market 

• There is still plenty of room to grow Malaysia’s medical tourism industry as it contributes less than 10% of revenue for most of the major private hospitals in Malaysia. Most of the medical tourists are from Indonesia, Bangladesh, China, India, Japan, the UK, the Middle East and Africa.
• Malaysia Healthcare Travel Council (MHTC) sees Thailand and Singapore as its main competitors. The government spends MYR20m a year to promote and develop medical tourism, and it wants the private sector to take over this role in the future.
• The medical tourism industry in Malaysia is expected to achieve its target revenue of MYR1.3b or 30% YoY growth in 2017, according to the MHTC. On average, medical travellers' contributions to the economy were double that of the regular tourists; a foreign patient would spend about RM1,000 per visit, excluding other expenditures while staying in the country. Malaysia Airlines has signed an agreement with MHTC for joint marketing to position Malaysia as an international medical tourism destination.
• In 2016, more than 860,000 medical travellers sought treatment in Malaysia. The number is expected to grow as more private hospitals are able to cater to foreign patients. Private hospitals nationwide currently have an estimated 15,000 beds, with the top five treatments sought by medical travellers being cardiology, oncology, orthopaedics, IVF (in-vitro fertilisation), dental and cosmetics.
• Key drivers for medical tourism: 
  1. Encouraging government initiatives 
     • Tax benefits for medical-tourism-focused hospitals 
     • Government agencies such as MHTC working with providers to promote medical tourism.
  2. Competitive edge of the Malaysian healthcare market 
     • Lower costs with improving quality offerings 
     • Large English-speaking and multi-lingual population 
     • Regional accessibility and transport infrastructure 
• From the macro perspective, Malaysia’s tourism industry is booming and we are bullish going into 2017 given the weaker MYR and on-going promotional efforts by the government and airlines. In 2016, tourist arrivals grew 4% YoY and more importantly tourism receipts rose by a strong 19% YoY to MYR82b. This is on the back of a strong 27% YoY growth in Chinese tourists and 11% increase in Indonesian travellers.

ACQUISITIONS TO BOOST GROWTH

Second-generation management ready for growth 

• After the second-generation management stepped up to the top executive roles of CEO and CFO in 2015 and 2016, HMI started more aggressive inorganic expansion. This could lead to a better growth profile, backed by a good foundation and M&A track record.
• In Mar 2017, HMI fully acquired the minority stakes in its two hospitals, up from 49% stake in Mahkota and 61% stake in Regency. We expect this to lift FY18E EPS by 39%, assuming full-year contribution in FY18. The acquisition cost MYR557m (MYR211m will be paid in cash and the rest in the form of shares and rights issue at SGD0.57 per share). 
• The sellers of the minority stakes consist of a Malaysia businessman and a group of more than 20 Singapore doctors in various specialties including ophthalmology, general surgery, dental, cardiology and etc. The P/E multiple for the acquisition is 19x FY16 core earnings or MYR2.2m per bed (MYR557m / 254 beds), this is below HMI’s current market cap per bed of MYR2.9m. The deal should be highly EPS accretive and has completed in Mar 2017.
• Beyond the low-hanging fruit, HMI is exploring several M&A opportunities in Malaysia and other Southeast Asia countries. Outside Malaysia, HMI has operational experience in Singapore and Indonesia. It has built a strong base and good brand name in Malaysia. This has placed it on the radar of other healthcare players. 
• HMI has been in talks with a few profitable medical centres in different states in Malaysia. It targets to enhance its network and feed patients into its hospitals via smaller medical centres.

Good M&A track record 

• We believe HMI’s M&A strategy should work well based on its good M&A execution track record. HMI’s management successfully turned around two loss-making hospitals. 
• After acquiring the loss-making Mahkota hospital in 1999, management took two years to turn around this business. For Regency, management took five years to achieve profitability. 
• The success of its M&A strategy will depend on a few factors: 
  1. the quality and potential synergies of the assets acquired; 
  2. the ability to integrate and grow the acquired entities; and 
  3. paying a reasonable price. 
• From the track record since 1999, the management team has acquired and turned around two loss-making hospitals into highly profitable entities. They are also flexible enough to divert their attention away from the unsuccessful Singapore-based Balestier Hospital, which has ceased operation. 
• In addition, we understand that the new CFO will be spearheading the M&A strategy. He has eight years of experience in private equity and investment banking in Southeast Asia. 
• In addition, management will continue to be supported by its strong base of shareholders, which are made up of a large group of experienced specialist doctors.

FORECASTS & ASSUMPTIONS

High growth from Regency, Mahkota to remain robust 

• We forecast revenue will increase by 14%/11%/10% for FY17E/18E/19E, mainly driven by: 
  1. High revenue growth from Regency, on high patient volume growth of 13%/8%/7% and good revenue per patient growth of 9%/6%/6%. Growth should accelerate in FY20E, as its expansion project in Regency start to contribute.
  2. Stable revenue growth from Mahkota, on stable patient volume growth of 2% for FY17-19E and good revenue per patient growth of 6% for FY17-19E.
• Gross margin should remain stable with some room for improvement as Regency scales up and both hospitals continue to focus more on higher value sub-specialist areas.
• Flowing down to the bottom, we expect earnings growth to outperform revenue, due to the low-base effect from the recent turnaround of Regency and operating leverage. We estimate earnings will increase by 23%/76%/15% for FY17E/18E/19E. However, EPS for FY17E/18E will trail earnings growth, at 9%/39% YoY due to dilution from consolidation of hospitals. 
• Our forecasts have not included potential M&As and future expansion of Mahkota hospital.
• Summary and financial impact of hospitals consolidation exercise: 
  • In Nov 2016, HMI announced the plan to fully acquire the stakes in both of its existing hospitals, up from 49% in Mahkota and 61% in Regency. The exercise is expected to complete around Apr 2017. The total consideration is MYR556.5m, in a mix of: 
    1. MYR 210.5m cash; 
    2. new HMI share consideration of MY346.0m at issue price of SGD0.57 per share with 1 year lock-up; 
    3. Rights issue of up to MYR18.5m at issue price of SGD0.57 per share. Total no. of shares will increase by 40%, to 821m shares from 585m shares.
  • In our forecast, we assume the exercise to complete in Mar 2017.
  • FY18E EPS is expected to grow 39% YoY. Excluding the organic growth of 10% YoY, the consolidation is expected to lift EPS by 39% YoY.
  • HMI will assume a small net debt position of around MYR5m in FY18E; net gearing will be at a comfortable level of 14%.
  • HMI’s group structure will be clearer with no significant non-controlling interest and will also have increased scale.

Robust balance sheet and cash flow to fund growth 

• Due to its strong cash flow, HMI turned net cash and declared a dividend in FY16, the first time in five years. 
• As of FY16, HMI had a healthy balance sheet with net cash of MYR37m. In FY17E, it is expected to go into a net debt position, to finance the full consolidation of both hospitals. 
• It will have to incur an estimated total capex of MYR160m for the expansion of Regency from FY18E onwards. Also, its operating cash flow before tax and interest expense have been improving with earnings.

VALUATION - OPPORTUNITIES NOT PRICED IN

Initiate BUY with TP of SGD0.84; 36% upside 

• Our DCF TP of SGD0.85 (WACC 7.4%, LTG 2.0%) implies 35x FY18E EPS, on par with its peer average. 
• We believe current valuations have not priced in HMI’s growth plans and opportunities, including: 
  • EPS accretive from increasing stake in Regency and Mahkota; this could provide an immediate EPS boost of 52% in FY18E.
  • Future expansion of Mahkota hospital, on the wholly-owned plot of land opposite the hospital.
  • Various M&A opportunities in Malaysia and other Southeast Asia countries. We note that HMI is in discussion with several healthcare-related targets.
  • HMI fares better than KPJ and IHH in terms of average inpatient bill size, EBITDA margin and ROE. This could be due to more motivated doctors from HMI’s unique management strategy, which enables doctors to run their own clinics. Also, we note that higher bill size and better EBITDA margin in Mahkota are due to higher contribution from medical tourists. Medical tourists make up around 30% of Mahkota’s patients vs less than 10% of total patients for other hospitals. Medical tourists often travel to treat more complex cases with higher revenue intensity. Other factors include location and maturity of hospitals. KPJ and IHH have a much larger operation, which are spread across different geographical areas, including rural areas, which command lower bill size. Also, they have several new hospitals, which could be loss-making and drag down the group’s EBITDA margin. 

RISKS 

Intensifying competition 

• Being a relatively small player in the Malaysia healthcare industry, HMI faces competition from larger private healthcare groups such as IHH and KPJ, which also operate hospitals near HMI. In addition, new hospitals might also increase the intensity of competition. 
• HMI might face difficulties in recruiting doctors and attracting patients. To differentiate itself, HMI is the only hospital group in Malaysia that offers Singapore’s independent practice model. This has worked well in attracting and retaining top doctors. 
• It is also one of only two hospital groups approved by Singapore’s MOH to use Medisave in Malaysia.

Regulatory changes 

• Adverse changes in Malaysia’s healthcare regulations could impact HMI’s profitability. Capping the hospital-related charges and relaxing the requirements for foreign doctors to practice in Malaysia could impact private hospitals in the country. 
• Currently, there is no cap on hospital charges but on doctors’ fees. Also, foreign doctors have to undergo stringent requirements, including serving in public hospitals and pass local exams, before they are allowed to practice in Malaysia.

Expansion risks 

• Expanding too quickly might jeopardise service quality and divert management’s attention. More than doubling of capacity in Regency might cause HMI to incur high start-up costs and drag down earnings. 
• Also, M&A risks include inability to extract synergies, high integration costs and risk of overpaying. 
• Finally, increasing its stake in existing hospitals could be negative if HMI overpays for the minority stake or subjects itself to unfavourable terms.

Forex risks 

• Weakening of the MYR against other currencies such as USD,EUR and CNY will raise the procurement cost of medical supplies and equipment. 
• On the other hand, a strengthening MYR, specifically against the IDR, may affect medical tourists as healthcare costs in Malaysia will increase. 
• HMI’s financials are also subject to forex fluctuations, albeit non-cash, due to the company’s structure. HMI’s exposure to currency risk arises from MYR23m (2014: RM 27m) due from an associated company and MYR19m (2014: RM 20m) from a subsidiary as HMI’s functional currency is SGD. 
• In addition, with almost all of its earnings denominated in MYR and the shares being traded in SGD, depreciation of the MYR against the SGD would reduce our TP directly.

John Cheong CFA Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2017-06-05

Maybank Kim Eng SGX Stock Analyst Report BUY Initiate BUY 0.84 Same 0.84