Singapore Consumer & Healthcare - Maybank Kim Eng 2016-06-29: Taking Stock & Feeling The Pulse

Singapore Consumer & Healthcare - Maybank Kim Eng 2016-06-29: Taking Stock & Feeling The Pulse Healthcare Q & M DENTAL GROUP (S) LIMITED QC7.SI  IHH HEALTHCARE BERHAD Q0F.SI  RAFFLES MEDICAL GROUP LTD R01.SI  SHENG SIONG GROUP LTD OV8.SI  JUMBO GROUP LIMITED 42R.SI 

Singapore Consumer & Healthcare - Taking Stock & Feeling The Pulse

Go for the best in consumer & healthcare

  • In our Unmasking Singapore thematic note, we identified consumption as a sector which should benefit from any measures to alleviate high business costs or boost demand through income-related benefits. 
  • There is some urgency, as our analysis suggests vulnerabilities even for success stories like Jumbo, whose high staff costs are only ameliorated by low rental costs. Our sensitivity analysis suggests a 15-16% boost for Sheng Siong’s EPS and 25-28% boost for Jumbo if labour and rental costs fall by 10%. 
  • Elsewhere, healthcare companies are the poster boys of overseas expansion but the jury is still out on their returns. With their premium valuations, there could be risks for under-performers such as IHH. Q&M stands out for its high ROICs which should hit 11%, well ahead of a WACC of 8%.

  • Consumer Sector: POSITIVE. Top consumer BUYS: Sheng Siong (TP SGD1.12), Jumbo (TP SGD0.65)
  • Healthcare Sector: NEUTRAL. Top healthcare BUYs: Q&M (TP SGD1.08), Raffles Medical (TP SGD1.73)

1. Consumer Sector: big winner if something is done about business costs

1.1 Bedevilled by high business costs

  • Singapore’s listed consumer stocks fall into two camps: the ones successfully managing their labour and rental costs and those that are struggling. The latter far overwhelm the former. All are beset by rising business costs and manpower shortages.
  • We examined 10 consumer-staple companies in Singapore for their mix of most vexing business costs. 
  • Even though Sheng Siong and Jumbo have successfully dealt with the two biggest cost bugbears, salaries and rentals remain their biggest variable costs, after raw materials and other consumables. 
  • As Jumbo’s staff costs run as high as 28% of its revenue, even it cannot escape unscathed if its rentals are not generally lower. Its most successful seafood outlets are located outdoors where rents are lower than inside malls. 
  • Sheng Siong is the flag-bearer of cost management in Singapore but its wage cost is low at 13% of sales only because of high food costs. In absolute terms, its staff costs are the highest in the industry.
  • The pain of high business costs is more acute for companies not faring that well in revenue terms, such as the Tung Lok Group and Soup Restaurant. Unlike Sheng Siong, there is no relief, as both wages and rentals are equally high. 
  • The difference between the two camps appears to boil down to sales. The higher their revenue, the better they appear positioned to handle high costs. That’s just simple mathematics, but it brings up a troubling issue. If consumption ever dips so slightly, costs for even those which are doing well now could catch up. This makes it imperative for them to break into bigger external markets, such as what Jumbo has done and what Sheng Siong will soon be doing.
  • For those stuck in Singapore at the lower end of the margin curve, they appear to be treading a fine line between solvency and insolvency. That is a dire prospect.
  • The measures we called on wage relief and property measures should provide some breathing room, if they are forthcoming. Lower wage and property-rental bills could immediately provide reprieve for consumer companies, while subsidy-driven improvements in disposable income could boost demand. More pertinently, the margin impact should be disproportionately larger for the consumer sector, given their lower margin base.

1.2 Go for quality names

  • If operating costs can be cut, loss-making or low-margin companies such as Neo Group, Tung Lok or Soup Restaurant should benefit the most. Still, this does not make them investible stocks.
  • Sheng Siong (SSG SP, BUY, TP SGD1.12), the biggest cost winner. Although its absolute wage bill is high, it is the lowest at 13% of revenue. We are also expecting its topline to grow faster this year as core inflation picks up. Furthermore, at just 42 stores in Singapore vs 48 for Cold Storage and 122 for market leader, NTUC FairPrice, Sheng Siong has expansion potential. It is, moreover, exploring ways to use IT to boost productivity.

    Reflecting traction, the number of workers it required to run a supermarket by 2015 was just 71% of what it needed in 2008.

    Longer term, a successful break into China could provide another catalyst, in our view.
  • Jumbo (JUMBO SP, BUY, TP SGD0.65) another big winner, due to its high wage bill. Any wage relief should also benefit Jumbo as wages account for 28% of its revenue, on par with the rest of the consumer sector. If not for its low rental costs, Jumbo may not be doing so well today. This is a chink in its armour that needs addressing.

    Profits could be boosted by 15%/28% if costs are cut by 10%. 
  • Our sensitivity analysis suggests that if labour and rental costs are cut by 10%, Sheng Siong’s EPS could be bumped up by 15-16% in FY17-18 and Jumbo’s, by up to 28%.

2. Healthcare Sector: poster boys for overseas expansion but jury still out

2.1 Are overseas returns worth the risks?

  • We next explore the kind of returns that Singapore companies have been generating or expect to generate from their overseas investments. In our view, healthcare companies, especially general hospital operators Raffles Medical and IHH Healthcare and specialised groups such as Q&M Dental are the best case studies for this, given the market’s premium valuations for them.

2.2 Healthcare companies showing the way

  • Due to small markets at home, many Singapore and Malaysia healthcare companies have been expanding overseas. In doing so, they aim to generate higher growth and replicate their domestic business success abroad. In chronological order, the leading proponents of this model are:
    • IHH Healthcare (IHH MK, HOLD, TP SGD6.13) was formed in 2012 from a mega-merger of Singapore-based Parkway Group, Malaysia- based Pantai Group and Turkey-based Acibadem. Still managed mostly by Singaporeans and funded by strong cash flows from Singapore, it has expanded into India, Hong Kong and China. Being a market leader in premium services, IHH incurs huge upfront capex to build state-of- the-art hospital facilities. Also, with a legacy of high intangible assets from its mega-merger, ROIC and ROA have been low and declining.
    • Q&M Dental (QNM SP, BUY, TP SGD1.08) started its M&A spree in 2013 in China. It has discovered favourable M&A deals in third-tier cities, after initially running into limited success in first-tier cities. It tasted its first success in 2014, when in two blockbuster deals, it acquired majority stakes in a dental hospital group and a dental- supply manufacturer in China.
    • Raffles Medical (RFMD SP, BUY, TP SGD1.73) started to actively look overseas only in 2015. It has acquired a regional clinic group and will be developing a 400-bed tertiary hospital in Shanghai. ROIC and ROA have been declining due to high upfront development costs.

2.3 Market overlooking falling ROIC for now

  • To a man, all the healthcare companies we studied are seeing declining ROIC. Still in their early stages of expansion, ROICs have been declining due to huge upfront capex. That said, investors are obviously bullish given their premium valuations. It is still too early to judge their success as their overseas track record is still not long enough. However, we believe the market understands that their development models for new overseas investments involve a hockey-stick curve where business grows at a normal linear pace but once an inflection point is hit, growth starts to take off at an exponential rate.
  • Q&M stands out as the biggest success story so far. The standout appears to be Q&M Dental, which is easily the most active M&A player in China. So far, its overseas ROICs are comparable to, if not better than, its local ROICs. If not for debt that was taken on ahead of its actual need to facilitate faster conclusions of its M&A negotiations, its ROIC would have consistently exceeded WACC and not dipped below in FY15.

    In the long term, profit guarantees for its various deals provide some confidence that ROIC can hit as high as 11.2% relative to its historical WACC of 8.4%.
  • IHH’s ROIC has lagged WACC for years now. Management has told investors that it has different ROIC expectations for different countries due to their varying stages of development. It aims for 20+% ROICs for developing countries and 15+% for developed countries.

    So far, there are no indications that it is near the part of the hockey- stick curve where growth takes off. We see risks of a correction if this inflection point does not come soon.
  • Still early in the game. Raffles Medical, which will only start its first China hospital in 2019, expects higher ROICs than its local projects, from higher fees and lower costs in China. Its upcoming 400-bed Shanghai Hospital is expected to deliver a 15.9% ROIC vs the group’s 8.1% WACC.

    We expect the hospital to reach a steady state in 2023, its fifth year of operation. On the other hand, 55%-held International SOS (MC Holdings) is estimated to generate an ROIC of around 5%. Despite this low value accretion, its 10 clinics are necessary for Raffles Medical to gain a stronger foothold in China and penetrate new markets like Vietnam and Cambodia, before setting up more profitable hospitals. It could also complement its new Shanghai Hospital, by acting as a referral centre.

Gregory Yap Maybank Kim Eng | John Cheong CFA Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2016-06-29
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