Raffles Medical Group - CIMB Research 2017-04-04: Furthering its ambitions in China with another

RAFFLES MEDICAL GROUP LTD BSL.SI

Raffles Medical Group - Furthering its ambitions in China with another hospital; but could spell further cost pressures

Raffles Medical Group (RFMD) announced it will develop a 700-bed hospital in Chongqing, with expected completion in 2Q18. Total capex will be c.Rmb1bn.
Group margins have already been on a downward trend and we have yet to see the impact from upcoming hospitals. The new hospital will further weigh down margins.

Our cost impact study of other new hospitals suggests pre-operating costs from Chongqing could drag down our FY17-18F EBITDA by 5-30%.
We keep our forecasts intact for now as we await further clarity from the management. Maintain Reduce with SOP-based TP of S$1.36.

RFMD announced today that it will develop a 700-bed tertiary general hospital in the New North District of the Liangjiang New Area in Chongqing, with expected completion in 2Q18 (100% stake for now but could sell down). Total capex will be c.Rmb1bn.
This is a sizeable hospital and will be the group’s biggest hospital (in terms of beds). This will also be the group’s second major foray into China, with the group’s inaugural 400-bed Shanghai hospital due to open in end-2018.

Since the group’s first announcement in May 2015 that it was building a hospital in Shanghai, management has always reiterated that China represents an attractive market (growing demand with better returns and margins than Singapore). We therefore view its latest plan to develop a hospital in Chongqing as a strong signal of the group’s ambitions to build a presence in China.
Recall that RFMD is also in talks to develop a 200-bed hospital in Shenzhen, although no concrete plan/timeline has been finalised.

To put into context, RFMD is currently in a heavy expansionary phase. Even as margins have been declining over the past three years (FY13 core EBITDA margin: 23%; FY16: 19.7%), this was only due to gestation costs from smaller projects (Shaw Centre, ISOS, Holland V).
We have yet to see the cost impact from its larger investments (Singapore hospital extension in 2H17, Shanghai hospital and now Chongqing hospital). We therefore strongly believe margin pressure will further intensify over FY17-18F.

To get a sense of the magnitude of costs, we start by drawing parallels to start-up costs incurred by other new hospitals (Mount E Novena and Gleneagles HK).
Overall, our analysis shows that RFMD’s Chongqing hospital could drag down our FY17-18F EBITDA by 5-30%. Management said that it will provide more details following the 1Q17 results briefing. As such, we maintain our forecasts for now.

Consensus’ implied EBIT margins are c.17% for FY17-18F vs. our 16.3%. Reported FY16 EBIT margins were 17.3%, which did not include pre-operating costs from new hospitals. Now that the group also has to recruit for a 700-bed hospital in Chongqing, we think consensus could lower its margin assumptions in the coming quarters.

Overall, we keep our FY17-19F EPS intact as we await further details from the management. RFMD reported its first core net profit decline in 4Q16 and we could see similar pressure once pre-operating costs start to kick in.
With valuations still rich at 26x CY17 EV/EBITDA (above peers’ 23x and its historical average of 23x), we choose to maintain our Reduce call.
Key risk to our view is lower than expected gestation costs.

Jonathan SEOW CIMB Research | http://research.itradecimb.com/ 2017-04-04

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