Raffles Medical - DBS Research 2017-08-02: Near-term Softness

RAFFLES MEDICAL GROUP LTD BSL.SI

Raffles Medical - Near-term Softness

We maintain our HOLD rating on Raffles Medical and lower our TP to S$1.20 from S$1.40 previously, taking into account start-up costs from the opening of new hospitals in China.
At its current valuation of 23x FY17F EV/EBITDA, the counter has reflected its longer term growth potential in our view, while near-term growth would be muted following gestation period from its expansion plans (Raffles Hospital Extension and two new hospitals in China in 2018/2019).

Raffles Medical’s 1H17 net profit grew 0.3% y-o-y to S$32m; marginally below DBS’ FY17 estimates at 44% of full-year estimates. Typically, 1H17 tends to be weaker than the latter part of the year. The slower growth was mainly due to a weak 1Q17 offset by slightly better 2Q17 results.
1H17 revenue fell 0.3% y-o-y offset by lower operating expenses (-0.5%) and tax expense (- 13%).
2Q17 net profit grew 0.7% y-o-y led by 1% revenue growth and lower tax expenses (-14%) from utilisation of some tax losses.
Revenue growth was mainly led by Hospital Services division, registering 0.3% y-o-y growth while Healthcare Services division fell 1.1%. Revenue growth was partially offset by 1.4% y-o-y increase in operating expenses largely from staff cost (+3%) and inventories and consumables (+6.6%) mitigated by lower other operating expenses (-7.9%) from lower business promotion and advertising expenses.
Management commented that foreign patient demand remains challenging, resulting in an overall muted revenue growth. However, stronger demand from local patients continues to partially mitigate the weak demand from foreign patients.
Nevertheless, management continues to manage its costs; 2Q17 EBITDA margin improved by 0.4 ppts q-o-q to 19.4%, but was still 0.4 ppt lower y-o-y (2Q16 was 19.8%).
Raffles Medical declared an interim dividend of 0.5 Scents per share, flat y-o-y.

As at July 2017, Raffles Holland V is 100% leased (vs 95% in February 2017).
MC Holdings (MCH) and Shaw Centre have yet to break even though MCH recorded lower losses according to management, and expects Shaw Centre to break even soon. MCH is a chain of ten clinics across China, Vietnam and Cambodia, which the group acquired a 55% stake in late 2015 for US$24.5m.

According to its latest plans, management expects to lease out 50% of the new building with an increased proportion of F&B (expects to open a food court). With the opening of the new block, management targets to open 50+50 beds over 1 to 2 years according to demand.
On new clinics in Singapore, management targets to open 6 new clinics in 2017. Raffles has also successfully renewed its Emergency Care Collaboration contract with the Ministry of Health (MOH) for another 5 years.

Management targets to open newly acquired brownfield Chongqing Hospital by 2H18, ahead of Raffles Hospital Shanghai (for details: Raffles Medical: Riding on One Belt, One Road).
With initial plans to open 200 private beds and 50 public beds, management expects to hire up to 120 doctors with two-thirds being local doctors. The remaining one-third of the doctors could be transfers / secondments from existing doctors or new hires of international doctors.
Management believes this hospital, being the first and only foreign hospital in Chongqing, would target the expatriate population in the area. We expect start-up costs will likely kick-in from 1H18.

The construction works on Raffles Hospital Shanghai remains on track. Management plans to open the hospital with 200 beds by 2H19 upon the completion of the hospital by end-2018.

We maintain our HOLD recommendation and lower our TP to S$1.20 from S$1.40.
We have lowered our FY17F earnings estimates by 5% to reflect a more muted growth seen in 1H17. Taking into account some start-up costs impact from its China expansions in FY18F-FY19F, we have lowered our FY18-19F earnings by 13-23%.
We have also imputed a lower target PE multiple of 25x (29x previously), pegged to 1 standard deviation below the historical average to derive our revised TP, given potential risks to lower earnings in FY18F to FY19F partially impacted by higher depreciation costs when the new hospitals become operational and on a moderated growth environment from its existing hospital.
Despite the more conservative view adopted, we believe management of Raffles will continue to monitor and manage its costs. While we like the group’s exposure to the healthcare sector and its long-term growth plans, we believe its current valuation at 23x FY17F EV/EBITDA, close to the higher end of the sector’s historical range, has largely priced in the longer term growth prospects.
Moreover, FY17F-19F growth rates are projected to moderate, weighed down by macroeconomic headwinds and start-up costs for its expansion projects.
Potential re-rating catalysts are
1. better-than-expected ramp-up of new projects/integration process, and
2. further accretive acquisitions and/or JVs/strategic alliances for entry into new markets.

While we believe in the long-term growth potential from Raffles Medical’s expansion plans into China, we believe near-term growth would remain subdued due to start-up costs and gestation period of a few years, and less robust macroeconomic growth and outlook on existing operations. Hence, we adopt a more cautious and conservative view compared to consensus.

Our target price of S$1.20 is based on 1 standard deviation below historical average PE of 25x on blended FY17F/18F earnings. This includes S$0.20/share for its China hospitals.

Economic slowdown. While healthcare is relatively resilient, private healthcare could be impacted by a slowdown in the economy as elective procedures can be deferred or patients can choose public hospitals as a lower-cost alternative.

Rachel Lih Rui Tan DBS Vickers | Andy Sim CFA DBS Vickers | http://www.dbsvickers.com/ 2017-08-02

DBS Vickers SGX Stock Analyst Report HOLD Maintain HOLD 1.20 Down 1.400