Raffles Medical Group - CIMB Research 2017-09-18: Upgrading Ward

Raffles Medical Group - CIMB Research 2017-09-18: Upgrading Ward RAFFLES MEDICAL GROUP LTD BSL.SI

Raffles Medical Group - Upgrading Ward

  • Raffles Medical Group (RFMD)’s share price has corrected c.27% YTD, we now think it looks more attractive in terms of risk-reward. Upgrade from Reduce to Add with SOP-based TP of S$1.21.
  • At the current price, we believe the Singapore operations have been priced in with little value ascribed to the long-term potential of its China hospitals.
  • Our best-case scenario for both Singapore and China suggests a S$1.49 TP with 35% upside, while we think the worst-case scenario is unlikely to materialise.
  • Growing pains for new hospitals in China are inevitable, but a home-field advantage could help to offset near-term overseas weakness.

Upgrade to Add; current level attractive for long-term gain in China 

  • Raffles Medical’s share price has underperformed 27% YTD; we now think it looks attractive to gain exposure to the growing China healthcare market, especially for long-term investors, as gestation woes have been largely priced in. RFMD currently trades at 22.5x CY18 EV/EBITDA, below its 5-year historical mean of 23.2x. 
  • As we include start-up costs from the China hospitals, our FY17-19F EPS fall by 1.3-26.2%, resulting in a lower SOP-based TP of S$1.21. Any near-term share price weakness could be an entry window.

Almost getting the Chongqing hospital for free 

  • We value our Singapore operations at S$1.02/shr, switching to DCF methodology from 19.2x CY18 EV/EBITDA previously. The Chongqing and Shanghai hospitals are valued at S$0.12/shr and S$0.07/shr, respectively, in our base-case scenario, premised on a 3- year EBITDA breakeven period. 
  • At the current price level, investors are buying a premium healthcare play in Singapore, with China exposure at a discount. 
  • Our S$1.49 TP in a best-case scenario presents even higher upside of 35%.

Home-field advantage to mitigate near-term overseas weakness 

  • Looking beyond the start-up costs in China, we remain positive on the long-term growth prospects of RFMD’s Singapore operations, which should benefit from secular trends of an ageing population and increasing insurance penetration. 
  • As the number of Singaporeans aged 65 and above is expected to double to 900k by 2030, and widening insurance coverage improves affordability, we expect higher private healthcare demand, possibly mitigating a soft medical tourism outlook.

Playing the devil’s advocate 

  • In our worst-case scenario analysis, we derive a value of S$0.77/shr for its Singapore operations, assuming zero growth rate and deteriorating PBT margins. 
  • China hospitals are worth at least S$0.11/shr, based on a 5-year gestation period (vs. our base case of 3- year EBITDA breakeven). 
  • The combined value of S$0.88/shr implies 20% downside risk from its current level, which we believe is unlikely.

Worst-case scenario unlikely 

  • We think zero growth for RFMD’s Singapore business is unlikely. Apart from a steady base of corporate clients and expanding network of clinics to drive organic growth, we also expect Holland V’s full rental contribution from 3Q17F and the hospital extension (opening in 4Q17F) to provide an earnings uplift in the medium term. 
  • A faster-than-expected turnaround for both ISOS and Shaw Centre could further boost its bottom-line.

Key risks and catalysts to our Add rating 

  • Further consensus EPS downgrades could pose downside risks to our Add call, while the successful execution of its first major overseas expansion project in Chongqing could be the key catalyst for the stock. 
  • This note also marks a change in analyst coverage.


Singapore business: slow and steady 

  • RFMD reported a lacklustre 2Q17 performance for both its healthcare services (-1.1% yoy) and hospital services (+0.3% yoy), as medical tourism (representing c.30% of its patient volume) slowed down and the local patient load remains decent. We think the slowdown could be temporary as foreign patients defer their treatments, and are not overly concerned with the longer-term prospects of its Singapore operations given RFMD’s consistent track record since 2001. 
  • We also believe the following factors could underpin demand for private healthcare and RFMD’s topline growth: 
    1. Ageing population in Singapore, coupled with increasing penetration of private insurance, are favourable tailwinds for the group, given that domestic patients make up c.70% of its patient volume at Raffles Hospital. We opine that a better insured resident population would encourage consumption for private healthcare, over public healthcare.
    2. Steady organic growth from more clinics and broad base of corporate clients. Management aims to add seven new clinics to its existing network. It opened one in Hillion Mall in 2Q17 and four more (Changi Airport Terminal 4, Transit 4, Dover, Tampines) are scheduled to open in 3Q17.
    3. Full rental contribution from Holland V beginning in 3Q17 (5.8% gross yield) – As at end-Jul 2017, the building has been fully leased, counting Virgin Active, DBS and some F&B outlets as tenants.
    4. Raffles Hospital Extension to offer earnings uplift in the medium term – It aims to complete and open the extension in 4Q17, which will also be partially leased out for commercial and medical-related purposes (full rental contribution estimated in FY19F), and it will also relocate its middle to back office functions to this location. Management plans to increase the bed capacity at its existing hospital by 50+50 (depending on demand) over the next two years, to care for its various groups of patients.
    5. Faster-than-expected turnaround of International SOS (ISOS) and Shaw Centre could boost the group’s profitability. Acquired in 2015, the expatfocused ISOS (55%-owned) recorded operating loss of S$3.5m in FY16. With the recent rebranding to Raffles Medical, and management’s continued efforts to rationalise costs, we expect to see narrowing losses over FY17-18F and expect it to break even in FY19F.

Singapore operations worth S$1.02/shr 

  • Our base-case scenario assumes a single-digit growth rate in revenue from FY18-22F, led mainly by the addition of new clinics (both GP and specialist) to its network and upcoming hospital extension, as well as the expansion of bed capacity by 50+50 over the next two years at the existing building. Excluding any rental income contribution (recognised under ‘investment holdings’), we derive a DCF-based target price of S$1.02/shr for RFMD’s Singapore operations.
  • In the unlikely worst-case scenario, our target price falls to S$0.77/shr as we forecast zero growth from FY18F onwards. However, our best-case scenario gives rise to a slightly higher TP of S$1.05, keeping most assumptions in the base-case scenario unchanged, but with slightly better FY21- 22F PBT margins.


Growing pains until FY19F inevitable, but China exposure offers long-term gain 

  • Most greenfield hospitals undergo a gestation period and suffer from start-up costs – the extent of which depends on both
    1. management’s execution and
    2. demographics of the population in the area. 
  • Unlike the typical 9-12 months that Singapore hospitals take to break even at the EBITDA level, we think China hospitals could have a longer gestation period of 3-4 years. With the 700-bed Chongqing hospital expected to be operational in 2H18 and 400-bed Shanghai hospital in 2H19, we project the full impact of pre-opening and start-up costs to be most felt in FY19F, before an earnings recovery in FY20F, in tandem with a ramp-up in patient load. 
  • In our scenario analysis below, we tested various assumptions and concluded that the China operations could be worth S$0.11- S$0.44 on a per share basis.
    • Base case: 3 years for EBITDA breakeven, and up to 15% EBITDA margin (taking reference from the average EBITDA margin of Jian Gong Hospital in China). Total combined value of S$0.19/shr.
    • Worst case: 5 years for EBITDA breakeven, and up to 15% EBITDA margin. Total combined value of S$0.11/shr.
    • Best case: 3 years for EBITDA breakeven, and up to 25% EBITDA margin (average Singapore EBITDA margin). Total combined value of S$0.44/shr.


Upgrade to Add on more positive risk-reward 

  • As we factor in start-up costs from both China hospitals and tweak our growth assumptions for Singapore operations, our FY17-19F EPS fall by 1.3-26.2%.
  • Our SOP-based target price also drops slightly to S$1.21 as we switch the valuation methodology for the Singapore business to DCF (from 19.2x CY18 EV/EBITDA previously) and incorporate higher valuations for the China hospitals.
  • Raffles Medical’s share price has corrected 27% YTD, and at the current price level, only the Singapore operations are fully priced in with little value ascribed to the China hospitals. Its current valuation of 22.5x FY18 EV/EBITDA is also relatively attractive vs. its 5-year historical forward EV/EBITDA mean of 23.2x (Figure 17).
  • We upgrade our stock rating from Reduce to Add.

NGOH Yi Sin CIMB Research | LIM Siew Khee CIMB Research | http://research.itradecimb.com/ 2017-09-18
CIMB Research SGX Stock Analyst Report ADD Upgrade REDUCE 1.21 Down 1.250