Raffles Medical Group - CIMB Research 2016-10-24: 3Q16's post briefing notes

RAFFLES MEDICAL GROUP LTD BSL.SI

Raffles Medical Group - 3Q16's post briefing notes

ISOS’s quarterly losses are expanding and turnaround is taking longer than expected. Shaw continues to be loss-making.
Staff costs (increased recruitment for Holland V and higher cost structure at ISOS) accounted for the majority of 3Q’s 2.6%pt yoy OPM decline. We cut EPS on this.
Medical tourism was flat and hospital growth was driven by domestic patients.
Guidance for the hospital extension’s initial lease out lowered to 30-40% (from c.75%).

Our SOP-based target price rises as we roll forward our valuation. Maintain Reduce.

While ISOS has clearly lifted the group's topline growth (reported 9M16 +20% yoy; exISOS +9% yoy), it continues to be a drag on profitability and its quarterly run-rate has worsened (3Q16 operating profit: -S$0.8m, 2Q: -S$0.5m, 1Q: -S$0.3m).
Management attributed the losses to rebranding and transition costs, coupled with higher staff costs (staff cost/sales is 60+% for ISOS vs. RFMD's existing c.50%).
Guidance is for a better FY17 for ISOS as it grows its corporate client base and improves staff productivity.

Staff cost continues to be under pressure due to recruitment for Holland V, made worse by the higher cost structure at ISOS. 3Q’s staff cost/revenue was 51.5% (vs. 48-50% historically).
Taking a 3-year view, we think the staff/cost revenue ratio should remain at an elevated level as the larger magnitude of the hospital extension further adds to cost pressure, mitigated by a maturing Holland V and improved efficiency at ISOS. This accounted for the majority of our FY16F-18F EPS cuts.

Medical tourism is no longer a growth driver and management highlighted that absolute medical tourism has remained largely flat. Management blamed weak macro conditions, rising healthcare costs in Singapore and a strong S$ as factors for the lack of growth.

RFMD now intends to lease out 30-40% of the Raffles Hospital extension (vs. 75% initially). We are generally positive on the longer term prospects of utilising more space for own use as returns are better. However, this also translates to higher depreciation as leased-out space is recognised as investment property and not depreciated.
Management updated that the hospital extension is due for completion by end-CY17.
Management sounding more positive on Holland V relative to Shaw Shaw medical centre (17.5k sf, opened Jun 15) is still loss-making but management expects it to break even by end-FY16.
When asked about the breakeven timeline for its own Holland V medical centre (9k sf, opened Jun 16), management sounded more positive and expected breakeven within a year.
We attribute the better performance at Holland V to the smaller floor space (i.e. lower costs) and better location.

Valuations are rich at 25.5x CY17F EV/EBITDA with a 6% 3-year EPS (FY16F-18F) CAGR. Regional peers are trading at a cheaper 22x CY17F with a higher 16% EPS growth.
The stock is also trading above its historical mean of 21x.
At the same time, margins continue to decline on cost pressures which could worsen nearing the completion of the Raffles Hospital extension.
Our SOP-based TP only rises (to S$1.46) as we roll forward our valuation. Maintain Reduce.

Jonathan SEOW CIMB Research | http://research.itradecimb.com/ 2016-10-24

CIMB Research SGX Stock Analyst Report REDUCE Maintain REDUCE 1.46 Up 1.410