Q&M Dental Group - CIMB Research 2016-05-13: M&A still the main growth driver

Q&M Dental Group - CIMB Research 2016-05-13: M&A still the main growth driver Q & M DENTAL GROUP (S) LIMITED QC7.SI 

Q&M Dental Group - M&A still the main growth driver 

  • 1Q16 was above ours but in line with consensus primarily due to government grants, partly due to better Aidite margins. 1Q formed 29%/25% of ours/consensus. 
  • Earnings growth (+28% yoy) was driven by acquisitions. Ex-acquisitions, organic earnings were weak. 
  • Better gross margins from Aidite played a smaller part in the earnings beat. 
  • New debt drawdown hints at more M&A. Upgrade from reduce to Hold. 
  • Our TP rises as we factor in higher other income from government grants. 

Earnings beat mostly from other income 

  • 1Q16 revenue was +18% yoy as contributions from acquisitions kicked in. This was in line with expectations. 
  • The positive surprise was from other income, +165% yoy due to higher government grants related to wage and PIC credits. 
  • Higher gross margins at Aidite (1Q16: 78%; FY15: 61%) was also a positive but was a smaller reason for the earnings beat. 
  • Excluding government grants, 1Q would have formed 25% of our FY. 

Inorganic growth masks weak underlying earnings 

  • We remain cautious that growth from newly-acquired clinics could be masking weakness in the group’s organic operations. 
  • 1Q net profit growth of 28% yoy was no doubt commendable, but this was primarily driven by acquisitions completed in 3Q/4Q15. Excluding which, net profit would have been up a smaller 7% yoy. If we further exclude non-core government grants, 1Q earnings would have been down 4% yoy. 
  • Aidite sales lower due to downtime but margins improved Aidite was the main reason for 4Q’s earnings miss. Aidite’s 1Q revenue trend (-16% yoy) reflects this but gross margins improved to 78%, from 67% in 1Q15 and 20% in 4Q15. The shift to a new factory in Dec 15 explains the dip in sales, while we think the vast improvement in gross margins was due to one-off adjustments in FY15. 

Paring down its stake in Aidite 

  • Q&M marginally reduced its stake in Aidite to 48.256% (from 51%) effective 29 Apr as new shares were issued to a limited partnership entity held by Mr Li Hongwen (founder and Chairman of Aidite). 
  • We understand the rationale is to hold shares in trust for employees. 
  • Plans on its proposed spin-off are still in the works and expected to be completed towards the end of FY16. 

New debt drawdown hints at possible M&A activity 

  • The group took on a new S$10m (US$7.3m) term loan, rebuilding its cash after spending S$4.4m (US$3.2m) on acquisitions (Lee & Lee) and S$5.2m (US$3.8m) on share buybacks in 1Q. This increases net gearing to 0.26x (FY15: 0.14x). 
  • We think the move to take on more debt hints at possible M&A in the near future. 

Upgrade to Hold; Stock likely to be supported by possible M&A 

  • Our EPS upgrades come from higher other income. This lifts our target price to S$0.70 (still based on 34.5x CY17 P/E, -1 s.d.). 
  • We upgrade from reduce to Hold as we think share price will be supported by possible M&A activity. 
  • M&A is the key catalyst for the stock, but valuations are not compelling at 35x CY16 P/E vs. healthcare services peers 19x.

Jonathan SEOW CIMB Securities | Kenneth NG CFA CIMB Securities | http://research.itradecimb.com/ 2016-5-13
CIMB Securities SGX Stock Analyst Report HOLD Upgrade REDUCE 0.70 Up 0.64