Raffles Medical - DBS Research 2017-10-31: Near Term Pain For Long Term Gain

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RAFFLES MEDICAL GROUP LTD BSL.SI

Raffles Medical - Near Term Pain For Long Term Gain

• 9M17 earnings up 0.5% y-o-y, in line.
• 3Q17 revenue (+0.3% y-o-y) and earnings (+1% y-o-y) continue to record muted growth.
• Raffles Hospital Extension to open by Dec17.
• Estimated start-up losses could be S$8m to S$10m in first year of operations.

Downgrade to FULLY VALUED, TP at S$1.00. 

• We downgrade our rating on Raffles Medical to FULLY VALUED (from HOLD) with a lower TP at S$1.00, taking into account estimated startup costs from the new hospitals in China. Trading at 29x-34x FY18F-FY19F PE, the valuation reflects its longer term growth potential but we project medium-term downside risks to earnings due to expected gestation period from its expansion plans (Raffles Hospital Extension and two new hospitals in China in 2018/2019).

Where we differ. Lower earnings in the medium-term impacted by start-up losses. 

• While we believe in the long-term growth potential of Raffles Medical’s expansion plans into China, we believe earnings could decline during its gestation period, accentuated by less robust macroeconomic growth and outlook on existing operations. Hence, we adopt a more cautious and conservative view compared to consensus.

Potential catalysts: Better-than-expected ramp-up of new projects / new expansion plans; recovery of existing operations.

• 3Q17 results in line; growth remains muted. 9M17 net profit grew marginally, +0.5% y-o-y, forming 69% of our full year estimate. The slower growth was mainly due to a weak 1Q17, offset by slightly better results in subsequent quarters. 3Q17 net profit grew 1% y-o-y led by 0.3% revenue growth. 
• Key highlights:
  1. Healthcare division revenue fell 4%;
  2. Estimated start-up losses of S$8m-S$10m in first year of operations for Chongqing Hospital; and
  3. Shanghai Hospital expected to open by 2H19.

Valuation

• Our target price of S$1.00, implies 26x/30x FY18F/FY19F PE.
• This is based on sum of parts, pegging FY18F/FY19F earnings to historical average PE (since 2005) of 22x plus S$0.20/share for its China hospitals.

Key Risks to Our View

• 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.

WHAT’S NEW - Near term pain for long term gain 

Revenue and earnings growth remains muted. 

• Raffles Medical’s 9M17 net profit grew 0.5% y-o-y to S$49m; 69% of DBS’ FY17 estimates. Typically, 4Q is the strongest quarter in the financial year. The muted growth was mainly due to a weak 1Q17 offset by slightly better 2Q17 and 3Q17 results.
• 9M17 revenue fell 0.1% y-o-y, offset by lower operating expenses (-0.1%) and tax expense (-12%).
• 3Q17 net profit grew 1% y-o-y led by 0.3% revenue growth and lower tax expenses (-11%) from utilisation of some tax losses. Revenue growth was mainly led by Hospital Services division, registering 3% y-o-y growth while Healthcare Services division fell 4.2%. The Healthcare Services division recorded lower revenue, impacted by the lower renewal of international healthcare plans for expatriates (from its healthcare insurance business) in Singapore due to the departure of expatriates especially in the financial industry.
• Foreign patient demand remains relatively flat, resulting in an overall muted revenue growth. However, stronger demand from local patients continues to partially mitigate the muted demand from foreign patients.
• Revenue growth was partially offset by 0.7% y-o-y increase in operating expenses, largely from staff cost (+2%) and inventories and consumables (+7%) mitigated by lower purchased and contracted services (-9.4%).
• 3Q17 EBITDA margin fell 100 bps q-o-q to 18.4%. Despite the deterioration in margins q-o-q, on a y-o-y basis, margins fell 30bps as management continues to manage its costs.

Singapore: Raffles Hospital Extension to open by Dec17; Shaw Centre is EBITDA positive. 

• The construction of Raffles Hospital Extension is close to completion (refer to figure on the next page) and is expected to open by Dec17.
• Shaw Centre has now turned EBITDA positive. However, MC Holdings (MCH) is still recording losses, with some clinics making progress while integration process is still ongoing at some clinics (mainly in China). 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.
• The construction of Raffles Hospital Extension is on track and expected to open by 4Q17. According to its latest plans, management expects at least 60% would be used for its own expansion while the remaining portion will be leased out as retail / commercial space. With the opening of the new block, management targets to open 50+50 beds over 1 to 2 years depending on demand.
• On new clinics in Singapore, Raffles has successfully opened 4 new clinics vs its target of 6 new clinics in 2017. The remaining 2 clinics at Changi Airport Terminal 4 and Transit 4 are expected to be opened by 4Q17.

To open new Chongqing Hospital by 2H18; estimated start-up EBITDA losses of S$8m to S$10m in first year and to breakeven by year three. 

• The Chongqing Hospital is being fitted out, and procurement of equipment has started. It remains on track to open by 2H18, possibly end- 2018. With initial plans to open 200 private beds and 100 public beds, management expects to hire up to 120 doctors with half being local doctors and half comprising international doctors (including secondment of existing doctors). At the results briefing, management provided some estimates of start-up losses for the first time for its Chongqing hospital.
• Management estimates to incur start-up EBITDA losses of S$8m to S$10m in first year of operations, S$4m to S$5m in second year of operations and expects to breakeven on EBITDA level by year three.

Construction works for Raffles Shanghai Hospital on track to open by 2H19. 

• The construction works on Raffles Hospital Shanghai remains on track. Management plans to open the 200 bed hospital by 2H19, one year after the opening of Chongqing Hospital.

Downgrade to FULLY VALUED, lower TP to S$1.00. 

• We downgrade our recommendation to FULLY VALUED and lower our TP from S$1.20 to S$1.00. We lower our FY18FFY19F earnings estimates by 1% and 10% respectively to factor in management’s guidance on start-up losses. As such, we project EPS to decline by 4% and 14% in FY18F and FY19F, respectively. Our estimates include S$6m – S$22m of net losses in FY18F-FY19F from both Chongqing and Shanghai hospitals. Despite the more conservative view adopted, we believe management of Raffles Medical will continue to monitor and manage its costs.
• Our target price of S$1.00 is based on historical average PE (since 2005) of 22x on blended FY18F/19F earnings plus S$0.20/share DCF valuation for its China hospitals. Our target price implies 26x FY18F PE and 30x FY19F PE.
• While we like the group’s exposure to the healthcare sector and its long-term growth prospects with expansion into China, we believe its current valuation of 29x-34x FY18FFY19F PE and 21x-22x FY18F-FY19F EV/EBITDA has priced in the longer-term growth prospects. While we believe in the capabilities of Raffles Medical’s management team in developing these new hospitals and the prospects that the China market may offer, we believe start-up losses would weigh on earnings in the medium-term especially in an environment of muted growth in existing operations largely impacted by less robust macroeconomic outlook.
• Potential re-rating catalysts are:
  1. better-than-expected ramp-up of new projects/integration process,
  2. stronger than expected earnings growth from existing operations, and
  3. further accretive acquisitions and/or JVs/strategic alliances for entry into new markets.

Rachel Lih Rui Tan DBS Vickers | Andy Sim CFA DBS Vickers | http://www.dbsvickers.com/ 2017-10-31

DBS Vickers SGX Stock Analyst Report FULLY VALUED Downgrade HOLD 1.00 Down 1.200