Health Management International - CIMB Research 2017-03-10: Healthy vital signs

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HEALTH MANAGEMENT INTL LTD 588.SI

Health Management International - Healthy vital signs

• HMI is one of the top 5 private hospital operators (by number of licensed beds) in Malaysia, with 10% market share of the nation’s medical tourism.
• Poised to benefit from rising medical tourism, ageing demographics and increasing insurance penetration in Malaysia, in terms of higher average bill size and patients.
• Full consolidation of minority interests in both of its hospitals would create an enlarged entity to tap into wider financing options and M&A opportunities.
• Initiate coverage with Add and a DCF-derived TP of S$0.81 (7% WACC, 3% LTG).

Currently trades at 50% discount to CY18F industry average of 19.1x EV/EBITDA.

• Malaysia hospitals, Singapore private healthcare model HMI is a private healthcare provider with two tertiary care hospitals in Malaysia – Mahkota Medical Centre (MMC) in Malacca and Regency Specialist Hospital (RSH) in Johor. 
• Backed by a 20-year track record, it is one of the first (among the few) hospital groups in Malaysia to adopt the Singapore private healthcare model. 
• Apart from medical tourism, we believe HMI would be a long-term beneficiary of these structural trends in Malaysia – ageing population, rising insurance penetration and shortfall in hospital beds.

#1 vital sign: average bill size building mass 

• HMI now has c.10% market share of Malaysia’s medical tourism, which forms c.30% of its overall revenue (vs IHH’s 5-10% and KPJ’s 5%). We see growth potential from intensified marketing efforts aimed at foreign patients in the region and favourable government initiatives. 
• Most foreign patients require more complex surgeries, which generate higher average revenue intensity (and better margins). Development of more Centres of Excellence and a range of medical specialties could add to that, in our view.

#2 vital sign: increasing patient load with expansion plans 

• Patient numbers at both hospitals have been promising (at FY11-16 CAGR of 9%, higher than IHH’s 4.7%), owing to their accessible locations, affordable pricing and highquality healthcare. 
• To meet with increasing patient demand, HMI has announced that it plans to add operational beds by 10% at MMC, and launch a new extension of RSH in phases over the next 2.5 years, which will more than double its bed capacity.

#3 vital sign: MI consolidation removes stock overhang 

• We are positive on the consolidation of minority interests in MMC (51.1%) and RSH (39.2%) as the reformed structure would facilitate operational flexibility and ease of financing, in our view. 
• We believe 3Q17F headline earnings could be weak, attributable to one-off items such as professional fees related to the MI acquisition, while the absence of substantial MI would be more visible in 4Q17F onwards.

#4 vital sign: cheaper than peers with 3-year EPS CAGR of 29.5% 

• We initiate coverage on HMI with an Add rating and a DCF- based target price of S$0.81 (7% WACC, 3% terminal growth rate). 
• Given its 29.5% EPS CAGR in FY17-19F and 0.5-0.9% dividend yields, we do not think the stock should be trading at 25x CY18F P/E and 10x CY18F EV/EBITDA, far below its peers’ average of 39x and 19x, respectively.

COMPANY OVERVIEW 

Background 

• Established in 1998 and listed on the Singapore Exchange’s SESDAQ in 1999, before being upgraded to the Mainboard in 2008, Health Management International (HMI) is a private healthcare provider with presence in Singapore, Malaysia and Indonesia. 
• It started with a 60-bed Singapore hospital (formerly known as Balestier Medical Centre) in the early 1990s and ventured into Malaysia in 1998. 
• HMI currently owns and operates two tertiary care hospitals in Malaysia, namely Mahkota Medical Centre (MMC) and Regency Specialist Hospital (RSH), as well as a healthcare training institute in Singapore, Institute of Health Sciences (IHS). 
• HMI is one of the top 5 private hospital operators in Malaysia, in terms of number of licensed beds (private).  

Mahkota Medical Centre (MMC) 

• Established in 1994, MMC is the largest private tertiary hospital in South Malaysia with a 288-bed capacity and serving close to 300k patients a year. 
• Strategically located within the city centre of Malacca, MMC currently attracts 10% of Malaysia’s medical tourists (based on the 80k foreign patients it attracts a year), but is also a first mover in Indonesia, venturing into the country in 1999. It currently has over 120 consultants across various medical and surgical specialties and sub-specialties.

Regency Specialist Hospital (RSH) 

• RSH has a shorter operating history (established in 2009) than MMC but is one of the fastest-growing private hospitals in Malaysia, with a 218-bed capacity and serving over 110k patients per year. Its location east of the Johor Bahru City Centre makes it the closest tertiary hospital to the Pasir Gudang industrial area and the new Petronas oil refinery-petrochemicals complex. 
• Backed by over 70 practicing consultants, RSH is also the only private hospital in Malaysia to have a 24-hour accident and emergency (A&E) department staffed by emergency specialists.

HMI Institute of Health Sciences (IHS) 

• IHS is the first specialised private provider of healthcare training and education in Singapore, offering nationally-accredited nursing education and healthcare vocational skills training, as well as courses on emergency life support.
• Appointed by the Singapore Workforce Development Agency as a Continuing Education and Training Centre for Workforce Skills Qualifications (WSQ), IHS has trained more than 3,500 healthcare graduates to date.

CLEAN BILL OF HEALTH FOR HMI 

Well-positioned for higher patient volume 

• Although it is constrained by only two hospital assets in Malaysia, we believe HMI is well-positioned to tap on a wider patient pool. MMC is the largest private tertiary hospital located within the city centre of Malacca, with close links to Malacca International Airport and the ferry port. We believe the announced S$14bn joint development of Melaka Gateway by the Malaysia and China governments, together with the upgrading of Malacca airport, could improve regional connectivity and bring in more medical tourists for MMC. MMC currently has 10% market share of total medical tourists in Malaysia and 75%/25% patient load split of between local/foreign patients.
• Meanwhile in Johor, competition for RSH is more intense as it faces off with more established peers like Gleneagles Medini, KPJ Pasir Gudang and the upcoming Thomson Iskandar. The government’s zoning policy that sets a limit of one private hospital per 30km radius could offer some relief to competition, in our view. Given that it is the only private hospital in Johor with a 24-hour A&E department staffed by emergency specialists, as well as its proximity to the Pasir Gudang industrial area, the new RM60bn Petronas oil refinery-petrochemicals complex and Johor Bahru City Centre, RSH is equipped to handle a catchment of industrial and residential patients.
• Private hospitals in Malaysia do not compete directly with public hospitals, in our view, as they serve different market segments. HMI targets the middle to upper-middle classes vs. heavily-subsidised public healthcare that caters to the less wealthy segments of the population. Because of their wider range of medical and surgical specialties, both RSH and MMC often receive patient referrals from public and other private hospitals, and at times, rent out their facilities for use by public hospitals nearby.
• The estimated addition of 1,372 beds by its competitors (the likes of Gleneagles Medini, Thomson Iskandar, and KPJ UTM) over the next 1-5 years may heighten competition for RSH in Johor, but management continues to see opportunities in Malaysia, which remains a severely-underserved healthcare market with a significant shortage of beds. Johor has a bed-topopulation ratio of 1.6, below the Malaysia (and Malacca) average of 1.9.
• RSH has confirmed plans to double its existing capacity of 218 beds (via a new hospital extension by 2020F for capex of RM160m) to meet increasing patient demand. More clinical services, medical suites and a bigger operating theatre capacity would also be added.

Limited price competition; Average bill size growth stems from higher revenue intensity 

• In contrast to Singapore where there are no doctor fee guidelines and private specialists have the discretion to fix their own fees, Malaysia’s Ministry of Health (MOH) places controls on consultation and procedural fees (Malaysian Medical Association’s 13th Medical Fee Schedule stipulates the maximum allowable fees to be charged by the medical profession for consultations and procedures). Therefore, the range of Malaysia doctors’ fees is tighter than those of their Singapore counterparts, suggesting that price competition by doctors in Malaysia is limited. Hospital fees or charges, on the other hand, are not regulated in Malaysia. HMI adopts single pricing for all its patients, regardless local or foreign.
• In 1Q-2QFY17, the increase in HMI’s average bill size was mainly driven by higher revenue intensity per patient, which offsets the increase in costs (staff expenses, medical supplies, etc.) as management is mindful of sustaining patient volume in times of slowing economy. We expect HMI to gradually hike its fees in 3Q17F onwards to compensate for increasing costs.
• Apart from capacity expansion, HMI’s business focus lies in: 
  1. developing new centres of excellence (CoEs) at RSH, such as cancer treatment facilities and nuclear medicine, as well as 
  2. continued recruitment of specialists and sub-specialists for both hospitals. 

• We expect the company’s revenue intensity to increase moving forward, as it benefits from an expanded range of medical disciplines and diversified team of healthcare experts.
• HMI typically earns from patients the sale of medical supplies, admission use of facilities and beds, while consultation and surgical fees are separately billed by the specialists. Therefore, its business model is skewed in favour of inpatient admissions. The first day of hospital generates the highest profitability (HMI’s average length of hospital stay is 2.0-2.5 days), and dispensing rights of medicinal drugs reside with the hospital group for inpatient treatment.

Adapting Singapore private hospital model to Malaysia won half the battle in doctors’ recruitment 

• The shortage of medical specialists is a global phenomenon, especially in Malaysia, which currently has a doctor-to-population ratio of 1:633 (the government targets 1:400 by 2020) compared to Singapore’s 1:440. While the restrictions placed by the Malaysian Medical Council may have deterred foreign doctors from joining private hospitals in Malaysia, we believe overseas-trained Malaysians returning to their home country may be more accepting of the compulsory six- to twelve-month attachment to public hospitals.
• HMI has a successful track record of adapting the Singapore private healthcare model to Malaysia. The hospital group offers sale or rent of medical suites to all its resident consultants, instead of employing doctors. In our view, such a model of independent clinic practice appeals to specialists who prefer independence and certainty over the location of their medical practices.
• No consultant who has purchased a suite from HMI has ever left to join a competitor hospital to date, according to management.

Expanding its foreign patient load, especially from Indonesia 

• HMI saw more than 400,000 patients in FY16, of which around 20% were international patients. The company has the potential to expand its overseas patient segment by leveraging its extensive regional network of 17 patient representative offices (ROs) across Southeast Asia to refer overseas patients to its hospitals in Malaysia. RSH has a 96%/4% split between its local and overseas patient load (predominantly Indonesians), and is ramping up marketing efforts aimed at foreign patients.
• The inadequate number of qualified doctors in Indonesia is driving more Indonesia medical tourists to other nations. Given the geographical proximity and cultural similarities that Malaysia shares with Indonesia, as well as the healthcare quality and price competitiveness of HMI’s medical services, it would not be too difficult for the company to grow its share of foreign patient load, especially from Indonesia, in our view. 
• HMI hospitals have also been approved by the Singapore Ministry of Health since 2010 for the usage of Medisave (Singapore’s national medical savings scheme) overseas, potentially enticing budget-conscious Singaporeans to seek treatment across the causeway.

Eyeing regional expansion 

• Apart from placing emphasis on higher revenue intensity cases and optimising operating leverage, HMI is on the lookout for inorganic opportunities in Malaysia and the region. 
• We believe brownfield and small-scale standalone hospitals could be attractive candidates, as the integration process would be faster and there are potential cost-saving synergies to be reaped in the form of procurement and resources. 
• Management does not rule out other suitable healthcare-related business opportunities.

MALAYSIA HEALTHCARE LANDSCAPE 

Ageing demographics and improving access to medical insurance underpin rising domestic healthcare expenditure 

• Malaysia is becoming an ageing country, according to Global Age Watch, as 8.3% of today’s population are aged above 60 years, and this is estimated to rise to 9.9% by 2020 and 15% by 2030. By 2050, over 20% of Malaysia’s population will be aged above 60 years. We believe such a growing profile of ageing population, coupled with increasing affluence, could heighten demand for local hospital needs and translate into higher healthcare expenditure.
• Meanwhile, increasing penetration of medical insurance packages in Malaysia could be a boon for the industry as it reduces reliance on out-of-pocket spending for private healthcare services. We believe this encourages people to transition from public to private healthcare services, particularly for the middle-income population.
• According to The Business Year Malaysia 2016, currently about 79% of hospital and clinic treatments carried out by the private sector are borne by the consumer, with insurance coverage only capturing about 18% of private spending. Bank Negara Malaysia targets to attain 75% insurance penetration rate by 2020 (up from 55.7% currently), hoping that this will indirectly prompt the private sector to build more hospitals. The government may spearhead universal health coverage (UHC) through public and private partnerships and the development of voluntary private insurance schemes, based on statements released by the MOH.

Underserved and lacking beds 

• Notwithstanding the influx of private hospital operators into Malaysia and various expansion plans to cater to increasing demand, Malaysia’s hospital bed capacity still lags its peers’ in Asia. 
• The country desperately needs to make up the significant shortfall of 16,000 beds to catch up with the international standard ratio of 2.5 beds per 1,000 population, based on statistics from the local Ministry of Health. 
• We opine that HMI’s capacity expansion plans for its existing hospitals (MMC and RSH) and potential M&A opportunities could fit in well against such a backdrop.

Malaysia’s healthcare affordability spurs medical tourism 

• While Singapore may be at the forefront of the regional medical tourism market, the hospitals in neighbouring countries like Thailand and Malaysia have stepped up their game. 
• Apart from modern private healthcare facilities and highly efficient medical professionals, the affordability of healthcare services is the other key draw for most medical tourists to Malaysia, boosted by the weak ringgit in recent years, according to an article published in Becker’s Hospital Review. In particular, average medical fees and room charges at MMC and RSH are a fraction of those charged by Singapore private hospitals.

FINANCIALS 

Higher patient volume and revenue intensity to drive topline growth 

• Our forecast of 11-13% annual topline growth for HMI over the period of FY17- 20F (MMC: 7.4% on average; RSH: 19.2% on average) is a function of both patient volume growth and average bill size growth. 
• Given its more mature operating history, we assume that patient volume at MMC will rise more gradually as compared to RSH, which seeks to: 
  1. double its existing bed capacity in the next 2.5 years, and 
  2. intensify its marketing efforts to attract medical tourists.
• We assume the average inpatient/ outpatient revenue to grow at 5-7% and 8% for MMC and RSH respectively, each year in FY17-19F. This is premised on increasing revenue intensity and complexity of surgeries, through enhancement of sub-specialties at MMC and Centres of Excellence (e.g. cancer treatment, nuclear medicine) at RSH.

EBITDA margins to continue on upward trend 

• MMC’s historical EBITDA margins have been stable in the range of 26-28%, while RSH has seen remarkable improvement in EBITDA margin from 10.1% in FY14 to 19.8% in FY16. The key reason that MMC commands higher EBITDA margin than RSH is that it has greater revenue contribution from medical tourists (c.33%) vs RSH’s estimated 5-10%. The higher concentration of fulltime doctors at MMC and strong surgical workload (>12,000 procedures per year) also contributed to better margins. 
• We anticipate rising medical tourism and higher revenue intensity cases to boost EBITDA margin expansion at both hospitals.
• Led by revenue growth and margin expansion, we project that HMI’s PATMI would expand at 51.8% CAGR for FY16-19F, after factoring in the consolidation of minority interests and contribution from associated corporations, offset by additional depreciation and financing expenses. 
• Our forecasted core EPS will expand by FY16-19F CAGR of 30.8%, even after considering the new share issuance and assuming full rights subscription (total 232m new shares).

MI consolidation to pave way for regional expansion 

• On 11 Nov 2016, HMI announced that it would consolidate its non-controlling interests in both MMC and RSH via a combination of cash (S$69.3m/ RM210.5m) and new HMI shares (S$113.9m/RM346m at S$0.57/new share).
• Total consideration of S$183.2m (RM556.5m) implies FY16 EV/EBITDA transaction multiple of 12.1x. Funding options for the cash portion consist of a S$18.5m rights issue and acquisition debt facility of up to S$55m (5-year tenure, at 5.25%).
• We view this transaction positively as we think the enlarged group structure will be clearer without the substantial non-controlling interests and that it will thereby enhance HMI’s operational flexibility and access to financing options. We highlight the following financial impact of the MI consolidation: 
  • We expect the MI consolidation to be completed by end-Mar 2017; hence, the full effect would only materialise in 4QFY17F onwards.
  • The “share of results of associates” line item will also be consolidated into the listed HMI entity. The associated corporations refer to 49% interest in Mahkota Commercial Sdn Bhd (MCSB) and 29% stake in Regency Medical Centre (RMC). MCSB and RMC are asset-holding companies that lease the hospital building and commercial units for use by to MMC and RSH, respectively.
  • We observed that HMI incurred one-off professional fees of S$0.9m related to the transaction in 2Q17 and expect a recurrence in 3Q17F closer to the completion date (based on HMI’s projected timeline). These non-recurring items are excluded from our FY17-19F core net profit forecasts.
  • We assume full rights subscription of S$18.5m and debt drawdown of S$50.8m to finance the acquisition of minority interests. Based on our estimates, this would add an annual interest cost of approximately Rm8.1m in FY18F and beyond, depending on how fast management pares down the borrowings.

Cash-generative and robust balance sheet to support expansion plans 

• In spite of higher capex needs arising from RSH hospital extension over the next 2.5 years (budgeted RM160m to be partially funded by debt), we expect free cash flow to firm (FCFF) to remain positive in FY17-19F. 
• The company is likely to turn from net cash position at end-FY16 to net debt by end-FY17F due to: 
  1. acquisition debt from MI consolidation, and 
  2. capex financing.
• However, we project that net gearing ratio will remain low at 10-15% over the period of FY17-19F, as the management has stated that it plans to repay borrowings via internally-generated cash. We also note that its net gearing is lower than those of its regional peers, putting it in a favourable position to pursue M&A opportunities, in our view.
• Separately, we believe that management is committed to rewarding shareholders although it does not have a formal dividend policy in place. We expect HMI to maintain its historical dividend record of 20% payout ratio in FY17-19F, translating into 0.6-0.9% forecasted dividend yields.

VALUATION AND RECOMMENDATION 

Initiate with Add; trading discount to peers not justified 

• We initiate coverage on HMI with an Add rating and DCF-based target price of S$0.81 (7% WACC, 3% terminal growth rate). Our target price represents more than 30% potential upside and implied CY18F EV/EBITDA of 17.9x. 
• HMI currently trades at 24.5x CY18F P/E and 9.6x CY18F EV/EBITDA, which is significantly cheaper than its regional hospital peers’ average of 39.2x CY18F P/E and 19.1x CY18F EV/EBITDA.
• We like the stock for its high-quality healthcare assets in Malaysia, attractive positioning for medical tourism and robust earnings outlook of 51.8% PATMI CAGR in FY16-19F (3-year EPS CAGR of 29.5%). With such a profile stronger than most of its peers, we believe HMI should trade at a narrower discount to them.

RISKS 

FX risks 

• Given that it is listed in Singapore but its core operations are based in Malaysia, HMI is exposed to potentially unfavourable FX changes, especially in the form of FX translation loss when the Malaysian ringgit (RM) depreciates against the Singapore dollar (S$), its functional currency. 
• There is some natural FX hedging in the business because revenue is denominated in RM, as are most of its operating costs. Only a portion of the medical supplies are purchased in US dollar and other regional currencies, but the associated FX risk is mitigated, in our view, as these drugs are sold on a mark-up basis, allowing the company to pass on any cost inflation. 
• As of end Dec-16, the majority of HMI’s borrowings are denominated in RM. However, the acquisition debt relating to MI consolidation will be in S$.
• Management intends to minimise this FX exposure by partially paying down the acquisition debt early with existing cash balance. A stronger RM vs regional currencies like Indonesian Rupiah, on the other hand, may hurt medical tourism, as medical treatment costs may become relatively more expensive.

Regulatory changes 

• The healthcare industry in Malaysia is tightly regulated. With only two operating assets in the country, HMI is susceptible to adverse regulatory changes. 
• Rules and regulations that could have negative impact on HMI include stricter hospital licensing and hospital operation requirements, as well as restrictions on the recruitment of doctors and healthcare staff.

Gestation period for hospital acquisitions 

• Depending on the location and quality of hospital assets that it may acquire in the future, HMI may incur some start-up costs which could drag on the company’s profitability. 
• We note that HMI took 3-5 years to turn around MMC and RSH, in line with the industry standard’s gestation period for new hospitals.

NGOH Yi Sin CIMB Research | William TNG CFA CIMB Research | http://research.itradecimb.com/ 2017-03-10

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