Q&M Dental Group - CIMB Research 2016-06-07: Expanding footprint in China

Q&M Dental Group - CIMB Research 2016-06-07: Expanding footprint in China Q & M DENTAL GROUP (S) LIMITED QC7.SI 

Q&M Dental Group - Expanding footprint in China

  • Q&M proposes to acquire a dental laboratory group for Rmb66m. Implied valuation of 13x forward P/E undemanding and in line with its historical transactions (10-15x).
  • Deal signals Q&M’s growth strategy in China.
  • Acquisition lifts our FY17-18 EPS by 5%, edging our target price up.
  • Maintain Hold. Downside risks include failure to conclude the deal.

Overview of the deal

  • Q&M today announced the proposal to acquire a 33% stake in Shenzhen New Perfect Dental Research (SZNP) for a total consideration of Rmb66m (S$13.75m, US$10m), all cash. The deal, with an implied forward P/E is c.13x, comes with an annual profit guarantee for 12 years. Management guides for a year-end target completion.

Background of the acquisition

  • SZNP is a dental prosthetic devices provider, operating 16 dental laboratories across 15 cities in China. The deal will add to Q&M's value chain and complement its dental ceramics manufacturing business (Aidite). 
  • As SZNP is one of the larger laboratory groups in China, we suspect overseas exports form a substantial portion of its revenues. For reference, about 40% of Aidite’s revenues come from exports. 
  • The implied valuation of 13x P/E is undemanding and in line with Q&M’s historical transactions of 10-15x.

What we like about the acquisition

  • The acquisition is consistent with Q&M’s inorganic growth strategy and intention to build its franchise in China. It currently generates 40% of its earnings from China, with the balance 60% from Singapore, by our estimates. 
  • We think the longer-term strategy for the company will be to derive the majority of its earnings from China, which it sees as the engine for growth, especially given that Q&M is already the largest private dental chain in Singapore and is likely to see its domestic growth plateau.

Our near-term concerns

  1. Q&M already took on additional debt in 1Q16. After this acquisition, net gearing will rise to 0.39x from 0.26x as at end-1Q16. 
  2. We also note that unlike its usual 50/50 cash/shares consideration which would be EPS-accretive due to Q&M’s lofty valuations, this deal is all cash. 
  3. Completion of the deal could take longer than expected – Q&M has yet to conclude five deals announced in 2014-15 and has also terminated deals.

Read-through for healthcare players entering China

  • Our secondary takeaway is Q&M's broader strategy of tapping China’s growing healthcare market. 
  • We note that the trend among larger hospital operators is to employ a greenfield strategy, as opposed to Q&M’s brownfield strategy. 
  • We opine that hospital operators prefer a greenfield strategy as they are targeting the premium segment, for which there are few suitable potential targets. 
  • Meanwhile, Q&M targets the masses and the hardware market (crown manufacturing and dental labs).

Maintain Hold, limited upside given valuations

  • We lift our FY17-18 EPS forecasts by 5% and our target price to S$0.74 (34.5x CY17F P/E, -1 s.d.) but keep our Hold rating. 
  • Our target multiple represents a premium to healthcare services peers’ of 20x, which we think is fair given Q&M’s dominant domestic position and growing overseas presence, but at a slight discount to larger established hospital groups’ 37x. 
  • Upside risks include smooth M&A execution.

Jonathan SEOW CIMB Securities | Kenneth NG CFA CIMB Securities | http://research.itradecimb.com/ 2016-06-07
CIMB Securities SGX Stock Analyst Report HOLD Maintain HOLD 0.74 Up 0.70