Health Management International - Phillip Securities 2017-03-10: Heading for another leg up

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HEALTH MANAGEMENT INTL LTD 588.SI

Health Management International - Heading for another leg up

• Increased capacity, stronger patient demand, and higher revenue intensity to boost revenue growth at 11.5% CAGR over the next five years.
• Quality medical services and improved economies of scale will lead to margin expansion. Robust margin coupled with consolidation of hospitals ownership could translate to 38.0% CAGR in PATMI over the next five years. 
• Initiate with “Buy” rating and SGD0.83 TP, implying a 36.6% upside.

Company Background 

• Health Management International Ltd (“HMI”) is a growing private healthcare provider in Malaysia. 
• The Group’s key assets comprise of two tertiary hospitals in Malaysia, the 288- bed capacity Mahkota Medical Centre (“MMC”) in Malacca and the 218-bed capacity Regency Specialist Hospital (“RSH”) in Johor. These hospitals are supported by a network of 17 patient referral centres across the region. 
• The Group also owns and operates the HMI Institute of Health Sciences (“HMI-IHS”) in Singapore.

Investment Merits 

1. Expansion will provide the next leg of growth. 

• Expansion pipeline set for the next three years: 
  1. a new ward with c.30 operational beds to be added to each of MMC and RSH by 1H FY2018, and 
  2. a Hospital Extension Block at RSH by FY2020. 
• This implied a 14.9% increase in total operational beds in the next one year and more than doubling the existing capacity (in terms of area) at RSH three years from now. We expect revenue to grow at 11.5% CAGR over the next five years, supported by a strong patient load, higher revenue intensity, and expanding capacity. 
• Next prospective expansion in the long term could be a new hospital extension for MMC.

2. Superior EBITDA and EBIT margins compared to peers, which we view as sustainable and is still growing on improving economies of scale. 

• Comprehensive multi-specialist hospital focused on middle to upper income patients, with unique business model, provides resiliency in patient volume, as well as helped to attract and retain top specialist doctors. 
• Being a tertiary healthcare provider and delivery of quality medical services warrant a higher average hospital bill size. Scalable model enables it to gain economies of scale as it expands. 
• In near term, we expect EBITDA margin expansion will mainly come from its Hospital segment as RSH has just turned profitable in FY2014. 
• HMI’s Hospital FY2016 EBITDA is at 24.8%, with MMC’s at 27.5% vs RSH’s 19.8%.

3. Exceptional track record to showcase its core expertise in hospital management and enjoying its first mover advantage. 

• It managed to turnaround two hospitals within five years since commissioning. Early mover in medical tourism: In adopting independent clinic model and in accrediting HMI under the Singapore Medisave scheme.

4. Cleaner structure by consolidating the ownership of its two hospitals, i.e. from 48.9%-owned MMC and 60.8%-owned RSH to 100% each. 

• The Group expects to complete the consolidation transaction by end March 2017. We deem the consolidation as favourable as 
  1. the transaction is 30.4% accretive to HMI on a FY2016A fully diluted EPS Pro Forma basis, and 
  2. HMI’s group structure will be clearer with no significant non-controlling interest (“NCI”).

Initiate coverage with “Buy” rating with a DCF valuation of S$0.83. 

• We believe that healthcare has a long-term investment potential. Asia’s favourable socio-economic landscape and supportive government policies underpins medical tourism in Malaysia. 
• We expect earnings to grow 38.0% CAGR over the next five years, following the consolidation of NCI, expanding capacity, and realisation of operating efficiencies.

Forecast Assumptions 

1. Growing patient base coupled with expanding inpatient beds, facilities and services to drive revenue at 11.5% CAGR over next five years 

• We think Net Revenue from Hospital should remain buoyant with c.11% CAGR growth in FY17-19F, benefiting from 
  1. favourable macro backdrop, and 
  2. the new wards which is slated to complete in 1H FY2018.
• We believe that the new Hospital Extension Block, which is targeted to complete by FY2020, will add another leg of growth to HMI. It will provide the necessary capacity for new inpatient beds, services and facilities for RSH, and ramp up Net Revenue from Hospital to c.12.5% CAGR growth in FY20-21F.
• Next phase of extension could be the construction of new hospital extension for MMC on its adjacent plot of land, which could be a catalyst for further re-rating.

2. Steady costs pressure and enhanced economies of scale to improve margins 

• Staff costs and costs of services accounts for c.80% of the Group’s total expenses. Cost of services mainly comprises materials costs and consultants’ fees.
• Staff costs as a percentage of revenue had been relatively stable at c.20% in the past three years. Meanwhile, cost of services as a percentage of revenue decreased 1.3 percentage points over the same period to 46.5% in FY2016. The lower materials costs had offset the upward pressure from consultants’ fees.
• We expect staff costs to remain stable at c.20% of revenue. Meanwhile, 
  1. effective cost management, 
  2. improved economies of scale, and 
  3. higher average hospital bill size via expansion, 
  should lift EBITDA and net margins progressively over the next five years.

3. Improving cash conversion cycle 

• HM’s cash conversion cycle has been improving over the past five years, with 5-year average of 22 days. We assumed that its cash conversion cycle to remain as FY16’s.

4. Financial position remains strong; consolidation of hospitals ownerships to cut leakage to non-controlling interests 

• HMI has been deleveraging over the years. Total debt decreased by 40% over the last five years to RM41.9 as at end-FY2016. Its strong and positive cash flow generated from operations brought HMI into a solid net cash position of RM37.1 mn as of endFY2016, which provides plenty of headroom for expansion.
• In November 2016, HMI announced to consolidate its 48.9%-owned MMC and 60.8%- owned RSH to 100% each for a total consideration of RM556.5 mn, via a combination of cash (37.8%) and new HMI shares (62.2%) at S$0.57 per share. The cash consideration of RM210.5 mn (or S$69.3 mn) will be funded mainly via debt facility; while the new HMI shares are subjected for 1 year lock-up period. The transaction is targeted to complete by March 2017.
• We expect the transaction to bring HMI from net cash position to net gearing of 0.6x by end-FY17F. However, we deem the consolidation as favourable as 
  1. the transaction is accretive to HMI, and 
  2. HMI’s group structure will be clearer with no significant non-controlling interest (“NCI”). Without NCI, FY2016 PATMI would have been RM36.2 mn (+81.7% compared to pre consolidation), and a fully diluted FY2016 EPS would have been RM4.40 cents (+30.4% compared to pre consolidation).
• The capital expenditures (CapEx) expected for the new hospital extension block in RSH will be at least RM160 mn. We expect it to spread over two and a half years, and will be funded via a mix of debt and internal cash resources.

5. No dividend policy but the increasing cash flow could warrant dividend payout moving forward 

• HMI made its first dividend payout of RM0.75 cents per share in FY2016 after its last dividend payout in 2008. FY2016 dividend represents 22% dividend payout ratio.
• After its consolidation transaction, we think that HMI will continue to payout dividend to its shareholders, as it has been paying annual dividends to its non-controlling interests. We conservatively forecast HMI to maintain its dividend payout ratio at 20% moving forward.

Valuation 

• We think HMI’s scalable business model is well positioned to capture strong patient load.
  1. Growing patient demand underpinned by favourable macro environment.
  2. Its expansion plan in line with its strategy to lift top line while maintaining robust margins. Higher average hospital bill size with: 
     1. increasing inpatient beds in RSH and MMC by FY18F, and 
     2. construction of a new hospital extension block in RSH by FY20F.
  3. Enhance margins via continuous cost management and improved economies of scale.
  4. Potential annual dividend payout of 20% payout ratio post consolidation in FY17F.
• We initiate coverage on HMI with a “Buy” rating with a target price of S$0.83 based on discounted cash flow (DCF) methodology. This implies an upside of 36.6% from its last done price.

Soh Lin Sin Phillip Securities | http://www.poems.com.sg/ 2017-03-10

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