Raffles Medical Group - CIMB Research 2016-12-05: Likely to worsen before it gets better

Raffles Medical Group - CIMB Research 2016-12-05: Likely to worsen before it gets better RAFFLES MEDICAL GROUP LTD BSL.SI

Raffles Medical Group - Likely to worsen before it gets better

  • Raffles Medical Group (RFMD) is undergoing its heaviest capex since listing with its 
    1. recently opened Holland V, 
    2. hospital extension in 2H17, and 
    3. Shanghai hospital in 2H18.
  • However, we expect profitability to worsen as expansionary costs hamper margins.
  • Maintain Reduce with an SOP-based TP of S$1.46.

Committed occupancy at Raffles Holland V at 95%

  • Raffles Holland Village was the first of RFMD’s three major expansion projects (the other two being its Singapore hospital extension and greenfield hospital in Shanghai) to be completed. Opened in Jun 16, committed occupancy is now at 95% and we understand rental rates were at the lower range of S$10-15 psf (or a yield of c.5%).
  • On breakeven, we are less concerned about Raffles Holland V given the rental income portion. Management also sounded more positive on its own medical centre and expected breakeven within a year. For comparison, its Shaw Centre medical centre is still loss-making having been in operations for about 1.5 years.

Singapore hospital extension on track for 2H17 opening

  • The hospital extension (S$310m cost, ~60% paid, 2H17 expected completion) will add 220k sq ft (+73%) to its existing hospital wing. 
  • In the longer term, we expect this to underpin topline growth and improve its hospital margins as it is better able to allocate facilities and wards across the old and the new wings. Management sees this as the runway for the next 10 years. However, both domestic demand and medical tourism are slowing. We expect cost pressures to mount, especially from hiring demands.
  • Management also updated that it now intends to lease out a smaller 30-40% of the extension (vs. 75% previously). This could lead to higher depreciation charges.
  • Upside risk could come from better returns from utilising the space for own use.

Shanghai hospital first major foray overseas

  • Expansion into China has been a theme across hospital groups in 2015, and is justifiably so after 
    1. the liberalisation of the Chinese healthcare space, 
    2. its large population base, and 
    3. ageing population. 
  • While there are obvious long-term prospects, it remains unchartered territory. The total development cost for RFMD’s 400-bed hospital (70:30 JV) is Rmb800m, which is likely to be funded by equity (1/3) and debt (2/3). Completion is slated for mid/end-2018.

Near-term margin pressure 

  • Overall, we see cost pressure and margin erosion as major headwinds for at least the next two years as RFMD digests its heavy expansionary projects. 
  • In particular, we think staff costs will come under the most pressure. 3Q16’s staff cost/sales was 51.5% (vs. 48-50% historically). 
  • Further, we understand ISOS has a much higher cost structure (staff cost/sales of over 60%).

Maintain Reduce

  • Our Reduce call is premised on slower growth on the back of cost pressures, execution risks in China, and the stock trading above peers and its historical band.
  • With no reprieve in sight and the company consistently reporting weaker margins, we maintain our Reduce call. Upside risk to our view is quicker than expected breakeven of expansion projects.

Jonathan SEOW CIMB Research | http://research.itradecimb.com/ 2016-12-05
CIMB Research SGX Stock Analyst Report REDUCE Maintain REDUCE 1.460 Same 1.460