IHH Healthcare (IHH SP) - UOB Kay Hian 2017-08-24: 1H17 Earnings Miss On High Start-up Costs

IHH HEALTHCARE BERHAD Q0F.SI

IHH Healthcare (IHH SP) - 1H17: Earnings Miss On High Start-up Costs

IHH Healthcare's 1H17 adjusted core earnings fell 32% yoy, missing our and consensus estimates.
Pre-operating costs at new hospitals such as GHK were the main drags, offsetting top-line growth (10% yoy). That said, existing core markets registered good operating performance with higher inpatient volume and revenue intensity.
Reduce 2017-19 earnings estimates by up to 30% to build in cost pressure.

Maintain HOLD with a lower SOTP target price of S$1.73 (previously S$1.80). Entry price: S$1.50.

IHH Healthcare’s (IHH) 2H17 headline earnings increased 63% yoy to RM786.6m, mainly due to a RM555m gain from the disposal of Apollo Hospitals.
Stripping out the exceptionals, 1H17 adjusted net profit would have seen a 32% yoy decline to RM288m. This is below our and consensus estimates, representing 31%/30% of our/consensus 2017 earnings forecasts.

1H17 revenue grew 10% yoy to RM5,456m as the group saw organic growth from existing operations and a continuous ramp-up in hospital openings in 2017 such as Gleneagles Hong Kong (GHK) as well as the Altunizade Hospital.

Earnings were dragged as costs continued to outpace revenue growth. The decline in earnings was mainly due to higher depreciation (+15% yoy), finance costs (+140% yoy) and staff costs (+15% yoy), associated with the opening of new hospitals.
As an indication, start-up costs at GHK had expanded to RM149.8m in 1H17, compared to just RM8.7m in 1H16. With several hospital projects still in the pipeline, and with three China hospitals coming on-stream in 2018-19, we expect cost pressure to remain elevated in the near- to mid-term.

We understand GHK’s operations are ramping up nicely, with the hospital already taking on more complex cases only three months into its opening, faster than Mt E Novena when it first opened. As an indication, revenue intensity at GHK is tracking at RM28,447, relatively in line with Singapore’s (RM 29,161).
While we understand start-up costs will remain elevated for FY17 considering all 500 beds were opened at one go instead of the usual phased fashion, we did see an encouraging 16.4% qoq decline in start-up losses at GHK in 2Q17 (1Q17: 81.1m v 2Q: RM 67.8m).
Overall, we are optimistic that GHK will see a similar, if not a faster growth trajectory than Mt E Novena in Singapore, which turned EBITDA positive in less than a year. We estimate GHK would contribute 5% of group EBITDA for 2018.

IHH currently has three greenfield China projects coming on-stream from 2018-19; Gleneagles Chengdu (350 beds in 2018), Gleneagles Nanjing (70 beds in 2019) and Gleneagles Shanghai (450 beds in 2019).
We believe near-term costs will remain elevated on pre-operating expenses, where we estimate new hospitals will take an average of 12-18 months’ runway before reaching EBITDA breakeven level. However, in terms of magnitude of start-up losses, we opine it may not be as steep as that of GHK since beds at these hospitals will be opened in phases.

Commendably, IHH recorded a resilient set of operational data for 1H17, where all core markets charted higher patient volumes as well as revenue intensity.
For 1H17, the two largest markets, Singapore and Malaysia, recorded 3%/4% yoy increases in inpatient volumes while revenue intensity grew 6%/11% yoy respectively.

Notably, the group continued to see higher foreign patient revenue, where IHH recorded a 15% yoy increase in revenue from Indonesian patients. This is commendable, given its peers are seeing a decline in foreign patients for 1H17.
We believe this was due to the continued ramp-up of service offerings at the hospitals, which attract foreign patients who seek complex or high revenue intensity treatments. As such, for 1H17, we see revenue intensity in Singapore growing 6% yoy on the back of a complex case mix.

Adjust 2017-19 earnings forecast downwards by up to 30% to build in higher cost assumptions, including higher staff, finance and depreciation cost. This reflects a ramp-up at new hospitals as well as start-up costs in lieu of the new hospitals coming on-stream in 2018-19.

We have rolled forward our valuation from 2017 to 2018, where valuations of IHH’s core businesses in Singapore, Malaysia, Turkey and India are pegged to EV/EBITDA multiple of 19x based on the sector average. Furthermore, we included the DCF-derived value of GHK to accurately capture the long-term contribution of the Hong Kong greenfield hospital.
While we remain positive on the long-term prospects of IHH, given that is situated in growth markets in China, Hong Kong as well as India, we believe near-term earnings will be crimped on expansion plans.
Entry price is S$1.50.
Key risks:
1. execution risk,
2. forex risk,
3. inflationary pressures on operating expenses, and
4. competition.

Thai Wei Ying UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | http://research.uobkayhian.com/ 2017-08-24

UOB Kay Hian SGX Stock Analyst Report HOLD Maintain HOLD 1.73 Down 1.800