Raffles Medical Group - CIMB Research 2016-04-01: Uncharted waters in China

RAFFLES MEDICAL GROUP LTD R01.SI

Raffles Medical Group - Uncharted waters in China

We downgrade RFMD from Hold to Reduce, as we think too much positivity has been priced into China.
At 25.8x CY16 EV/EBITDA, RFMD is currently trading above its 1 s.d. level. These are rich valuations given that FY15 core earnings growth was its lowest in a decade.

Cost pressures from expansion plans are already showing. We could see further pressure in mid-17 and FY18 when the hospital extension and Shanghai come onboard.

RFMD’s share price has rebounded (+6%) since its 4Q results and is currently trading at 25.8x CY16 EV/EBITDA, which we put down to its proposed 1:3 share split and a China premium.
The last time the stock traded at these levels was in 2007, when the group acquired full ownership of Raffles hospital and recorded earnings growth of 49%.
On the other hand, FY15 core earnings growth (+5% yoy) was the slowest growth in over a decade. We think the prospects of China have been overplayed.

Current valuations imply a premium is afforded to RFMD’s 400-bed Shanghai hospital (70% JV, completion mid-2018).
Beyond the well documented supportive regulatory reforms and talks of a large underserved private healthcare market, private healthcare in China is still in its infancy, and we think execution risks remains the biggest challenge.
Data points hint at operational difficulties in China
1. High-end private healthcare prices in China are, on average, some 30% below prices in Singapore, and
2. our peer comparison reveals that both average inpatient bill sizes and margins in China are lower than in Singapore.

We see pressure coming from:
1. higher average length of stay (ALOS); and
2. higher costs from employing foreign doctors.
Patient turnover in China is up to 2.6x lower than in Singapore, mostly due to the higher ALOS which is c.9 days vs. c.3 days in Singapore. This implies lower margins, as revenue generation is highest in the first days of admission.
We also think Raffles will need to employ a high proportion of foreign physicians and invest considerably in training up a local workforce.

Outside of China, the outlook for Raffles is not all rosy either:
1. declining medical tourism;
2. the general macro uncertainty which, in our view, will feed through to a decline in private patient admissions; and
3. cost pressures from the group’s oncoming expansion pipeline.
In each of the last three economic downturns (1998 Asian financial crisis, dot-com bust, and 2007-08), private admissions in Singapore declined 5-9% yoy.

RFMD is trading above its historical +1 s.d. level, and at a premium to regional peers (26x/24x CY16/17F EV/EBITDA vs. peers’ 22x/19x) despite its weaker earnings growth and declining ROICs.
Key upside risks are an economic rebound, the Singapore hospital extension achieving better-than-expected operational leverage, and outperformance in Shanghai.
We recommend investors switch to IHH.

Jonathan SEOW CIMB Securities | Kenneth NG CFA CIMB Securities | http://research.itradecimb.com/ 2016-04-01

CIMB Securities SGX Stock Analyst Report REDUCE Downgrade HOLD 4.23 Down 4.45