Raffles Medical Group - CIMB Research 2017-02-20: Post analyst briefing update ~ Margins could yet worsen

RAFFLES MEDICAL GROUP LTD BSL.SI

Raffles Medical Group - Post analyst briefing update ~ Margins could yet worsen

We think it is still too premature to start turning positive on RFMD. Both 4Q16 topline and bottomline were weak, and costs could yet intensify.
Weak medical tourism, limited domestic growth and expansion costs are hitting the group’s hospital segment. Hospital saw its first ever PBT decline in FY16 (-3% yoy).
Losses at ISOS are also widening and route to profitability could take longer than expected.

We cut our EPS on slower sales growth and lower margins. Accordingly, our SOP-based TP falls to S$1.36. Maintain Reduce.

4Q16 topline growth was weak amid slowing demand. As 4Q is typically its strongest quarter, the 1% qoq sales decline in 4Q16 was especially poor.
Management attributed the weakness to medical tourism (declining Indonesian patients) and an uncertain macro environment which would have led patients to either postpone procedures or switch to the public sector.
We do not expect demand to recover soon and lower our FY17F hospital revenue growth forecast to 5% (prev. 8%).

The miss in medical tourism mostly came from Indonesian patients (single-digit decline). Indo patients now form less than 20% of RFMD’s total foreign patients (prev. 20+%).
Even as management cited growth from other markets (Malaysia, Vietnam, Myanmar and China), the tone was that medical tourism growth (if any) will likely be subdued.
Key deterrents include
1. a strong S$,
2. rising private healthcare costs, and
3. competition from regional hospitals.

Common investor concerns include the timing of its Singapore hospital extension (scheduled completion: 2H17) amidst slowing demand and associated cost pressures.
However, management guided that it operates a demand-led model and will ramp up in phases according to demand; cost concerns are, therefore, manageable. However, we remain cautious and note that margins are already being squeezed.
FY16 hospital PBT was down 2.8% yoy even as revenue grew 4.8% yoy.

Widening losses at 55%-owned ISOS have not helped the group’s cost pressures.
We understand the drag is mostly at the manpower level. Staff cost/revenue was 60+% upon acquisition but has been brought down to c.56%. Using RFMD’s existing operations as a benchmark, we think an optimal level will be 50%.
Management highlighted that it has taken an active role in managing this business and has a new management for ISOS. However, we still expect transition costs and view a turnaround in FY17 as unlikely.

Overall, we cut our FY17-18F EPS by 8-12% on the back of slower hospital segment growth and continued margin pressure. Accordingly, our SOP-based TP falls to S$1.36.
With valuations still rich at 26.7x CY17F EV/EBITDA and accompanied only by a 5% EPS CAGR over FY17-18F, we keep our Reduce rating.
The stock continues to trade above peers (23x CY17F EV/EBITDA) and its historical 5-year mean (also 23x).
Upside risks to our call could come from further greenfield hospital plans in China.

Jonathan SEOW CIMB Research | http://research.itradecimb.com/ 2017-02-20

CIMB Research SGX Stock Analyst Report REDUCE Maintain REDUCE 1.360 Down 1.460