Singapore Medical Group Ltd - DBS Research 2017-11-13: Robust Growth Prognosis

Singapore Medical Group Ltd - DBS Vickers 2017-11-13: Robust Growth Prognosis

SINGAPORE MEDICAL GROUP LTD 5OT.SI

Singapore Medical Group Ltd - Robust Growth Prognosis

Initiate coverage on Singapore Medical Group with BUY and TP of S$0.75 on the back of continued robust growth post a successful turnaround.
Project net profit growth of 292%/32% on ramp-up in diagnostics, recent acquisitions, and margin improvements.
Further re-rating catalysts to come from acquisitions, better operating performance and overseas ventures.
TP based on 25x FY18F/19F PE.

Investment Summary -

Robust growth prognosis: Initiate with BUY and TP of S$0.75.

We initiate coverage on Singapore Medical Group (SMG) with a BUY call and a TP of S$0.75, implying 25% upside.
We believe the group's continued robust earnings growth following the successful turnaround of its operations since FY16, will provide a re-rating catalyst for the counter. We are projecting core earnings growth of 292%/32% in FY17F/18F on the back of
1. further scaling up of its Diagnostics business;
2. recent acquisitions; and,
3. margin expansion from larger scale of operations.

Further catalysts – acquisitions, better-than-expected operations.

Our TP is pegged to 25x FY18F/19F PE, a 10% discount to Singapore-listed healthcare peers to account for its smaller, albeit fast growing, size. At this juncture, we believe this is justified given uncertainty on the extent of integration and synergies to be derived from its recent acquisitions. Further upside in TPs could be expected as the group delivers and exceeds expectations.
Our earnings forecasts are marginally below consensus, and have not factored in further acquisitions. Based on our critical factor analysis, acquisitions are a key factor in the re-rating of the share price.

One of the largest private specialist healthcare provider groups in Singapore.

Singapore Medical Group (SMG) is a private specialist and primary healthcare provider with a network of more than 20 medical specialties and more than 30 clinics, based primarily in Singapore.
In recent years, SMG has also invested in joint ventures (JVs) in overseas markets, namely Jakarta and Vietnam, which are believed to have growth potential given the rising middle-class population and need for quality private healthcare.

Lifescan Imaging turnaround.

We believe that Lifescan Imaging will continue to add favourably to SMG’s bottom line in FY2017 as we see the first full-year of its contribution.
Lifescan Imaging has started to contribute profitably to SMG’s bottom line since 2H16, post the acquisition of several loss-making entities: Pacific Healthcare Imaging by SMG’s JV Lifescan Imaging Pte Ltd (LSI) in August 2015, Novena Radiology Pte Ltd (NRPL) by SMG and LSI in March 2016, and LSI in August 2016.
SMG has since fully integrated the entities and operate them under Lifescan Imaging in Paragon and Novena. In the last year, SMG saw the addition of a fourth radiologist to Lifescan Imaging. While diagnostics imaging is a capital-intensive business, we believe that there are decent margins to be derived, given Lifescan Imaging’s strategic location in Paragon and Novena, coupled with referrals from its growing network.
Going forward, we expect margin expansion as SMG’s new facility spanning 5,500 sqft at Novena Medical Hub consolidates its existing facilities at Novena held in two centres.

Extending foray into Obstetrics & Gynaecology (O&G) and Paediatrics.

In the last year, Singapore Medical Group (SMG) announced three acquisitions, comprising six O&G clinics (under the Astra Women Specialists arm) and three separate paediatric clinics. This represents SMG’s first foray into a new business vertical, and SMG has plans to grow its O&G and Paediatrics segments by recruiting more specialists and opening new clinics going forward.
Since its O&G acquisition which was completed in February 2017, SMG has opened a new O&G clinic at Toa Payoh under the Astra Women's Specialists brand name and hired a new O&G specialist. We believe the foray into O&G and Paediatrics will help boost SMG’s margins.

Overseas initiatives via JVs to aid in medium-term growth.

Based on our understanding, the Ciputra eye JV clinic in Jakarta is showing signs of growth and profitability YTD in 2017, after an impairment loss was written off from SMG’s investment in FY2016.
In Vietnam, SMG has started to execute on its growth initiatives at its two 15,000-sqft clinics in Ho Chi Minh and hired a paediatric consultant to spearhead growth initiatives at its clinic in Careplus Vietnam. Since then, another five paediatricians have been hired to ramp up the paediatrics division at Careplus Vietnam.
According to the management, patient count has grown significantly since the hiring of the six paediatricians. There may be potential for SMG’s operations in Indonesia and Vietnam in the medium term.

Sustainability is the key to growth.

With Lifescan Imaging turning around, as well as O&G and paediatrics’ contribution to the bottom line, we believe that SMG is headed for growth in NPAT in FY2017.
Over the longer term, sustainability is the key to SMG’s growth, as SMG would need to demonstrate earnings sustainability over the long run, especially when the consultancy agreements run out, by recruiting and training new doctors, as well as retaining existing doctors.

Dividend policy.

Singapore Medical Group (SMG) does not have a concrete dividend policy at the moment and have not paid dividends since FY2011. Given that it is still in a growth phase, we have not assumed any dividend payout in our forecasts.

Company Background

Corporate History.

Incorporated in 2005, Singapore Medical Group (SMG) is a private specialist and primary healthcare provider with a network of more than 20 medical specialties and more than 30 clinics, based primarily in Singapore.
The group currently has more than 30 full-time doctors with expertise in Oncology, Ophthalmology, Obstetrics & Gynaecology, Executive & Corporate Health Screening, General Medicine, Dermatology, General Surgery, Orthopaedics, Otorhinolaryngology (ENT), Dentistry, Urology, Paediatrics. SMG’s Refractive Surgery clinic is one of the largest private laser vision correction centres in Singapore.

Business review in 2013, and appointment of Dr Beng as CEO eventually.

In May 2013, Dr Beng Teck Liang was first appointed as an independent consultant to review and streamline the business. Subsequently, Pure Beauty Investment (~57% owned by Mr Tony Tan, ~43% effectively and ultimately owned by Dr Ho Choon Hou) launched a voluntary conditional cash offer for all the issued ordinary shares of SMG, and emerged with 68.8% shares (including Dr Beng’s shares).
In December 2013, Dr Beng was appointed as Executive Director and CEO.

Strengthening balance sheet in pursuit of growth.

Since 2014, Singapore Medical Group (SMG) has embarked on a series of fund-raising activities to support its targeted growth. Through various placements and rights issues, SMG has raised ~S$30m till date. Going forward, we believe management could continue to look towards equity raising to grow its existing business, and for M&A and expansion opportunities. In the latest round of placement completed in July 2017, SMG raised S$14.95m from CHA Healthcare Co Ltd, a subsidiary of Korean healthcare provider CHA Medical Group with operations in Korea, United States, and Japan.
We note that the number of outstanding shares has increased from ~145m (as of 24 December 2013 when the first proposed rights issue was announced) to ~458m as of 7 November 2017 due to the various equity fund-raising activities (including issuance of shares for acquisitions), on top of employee share options. Dr Beng, Mr Tony Tan and Dr Ho Choon Hou’s percentage of shareholdings have reduced over the years, from 68.8% in 2013 to ~35% in Oct 2017.

Series of acquisitions (S$110m) made.

Over the last 3.5 years, the group has completed ten acquisition transactions with a total consideration of ~S$110m, funded via internal resources, bank facilities, as well as equity. As a result, the following new specialisations were added or expanded within the group: Oncology, Paediatrics, Obstetrics and Gynaecology.
In the process, the group also disposed of a wholly owned subsidiary operating as an eye surgery clinic in Beijing for S$450,000 cash in view of the continued losses incurred and lower-than-expected sales.

Other joint ventures, including overseas expansion.

Separately, the group has participated in several joint ventures (JVs), including PT Ciputra SMG which was set up in late 2014, an eye specialist JV clinic with Ciputra Group, one of the largest and most diversified property developers in Indonesia.
In 2015, SMG also set up a new JV, SMG Leaders Pte Ltd, which is engaged in sales of aesthetic-related range of products in Southeast Asia with Leaders Cosmetics Co Ltd (formerly) Sansung Life & Science Co Ltd, founded by dermatologists from Seoul National University.
In 2016, SMG Cardioscan Pte Ltd, a JV with Cardioscan Pty Ltd based in Australia, was formed to venture into cardiac services in Singapore, Malaysia and Thailand.

Number of clinics has more than doubled since 2013.

The group’s number of clinics has more than doubled from 15 in 2013 to more than 30. The group currently has > 30 full-time doctors, and more than 37 SMG Associate doctors across Singapore, as well as two visiting consultants at The Dental Studio.
The acquisitions in the Obstetrics and Gynaecology, as well as Paediatric space have expanded the group’s expertise in its specialist and primary healthcare business on top of its diagnostics and aesthetics business, and SMG has plans to continue growing the Obstetrics and Gynaecology segment by recruiting more specialists and open up more clinics.

Multiple medical specialties.

Singapore Medical Group (SMG) offers a network of more than 20 specialties. With its recent acquisitions of Astra Women’s Specialists with a team of five doctors, this has helped to diversify its revenue stream. The expansion into O&G has also facilitated its projected growth into paediatrics given the complementary services of both specialties.
Dentistry. SMG’s Dentistry segment has five full-time dentists and three visiting dentists, operating in Paragon and OUE Downtown, under The Dental Studio brand.
Medical Oncology. SMG’s Medical Oncology segment is represented by The Cancer Centre and its doctors, Dr Wong Seng Weng, who also sits on SMG’s board and owns ~2% shares in SMG, and Dr Wong Chiung Ing. The Cancer Centre has two clinics, one each at Paragon Medical Centre and Novena Specialist Centre. Both Dr Wongs also practise at SMG Specialise Centre, Paragon.
Obstetrics & Gynaecology. SMG originally operated two brands under its Obstetrics & Gynaecology division, namely The Obstetrics & Gynaecology Centre (three clinics) and Wellness & Gynaecology Centre by Dr Julinda Lee (one clinic).
The latest acquisition of six clinics under Astra Women's Specialists saw the addition of six clinics and five senior obstetricians. Thereafter, another specialist was hired to head the new Astra Women’s Specialists clinic at Toa Payoh Central. The division now has ten doctors and 11 clinics, with plans to hire more specialists and open up more clinics going forward.
Ophthalmology. SMG’s Ophthalmology segment is represented by The Lasik Surgery Clinic and Singapore Vision Centre by Dr Marc Tay and Dr Eugene Tay. SMG’s Refractive Surgery clinic considers itself as one of the largest private laser vision correction centres in Singapore, offering a comprehensive suite of services (ReLEx® SMILE, LASIK, EpiLASIK and LASIK, etc). Dr Marc Tay has more than 25 years’ experience as a practising ophthalmologist, performing laser refractive surgery for 20 years, and was a founding member of the Laser Vision Centre, Singapore National Eye Centre when laser vision correction technology was first introduced in Singapore. The JV clinic in Ciputra is one of the first clinics in Jakarta to offer various laser vision correction solutions and is, according to SMG, showing signs of growth and profitability.
Paediatrics. In 2017, SMG announced two acquisitions which will see the addition of three senior paediatricians, Dr Heng Shiok Kheng, Dr Oh Meng Choo and Dr Ng Pau Ling Simon with 20-30 years of experience each. We view this as a natural extension of its growing obstetrics vertical. Going forward, SMG has plans to hire more specialists and open up more clinics.
Radiology. Following the acquisition of Lifescan Imaging Pte Ltd (LSI), which is now a wholly-owned subsidiary, and the acquisition of Novena Radiology Pte Ltd (NRPL) which owns two imaging centres at Novena, SMG’s imaging business is now collectively known as Lifescan Imaging, operating at four clinics now known as Lifescan Imaging Paragon, Lifescan Imaging Novena Specialist Center, Lifescan Imaging Novena Medical Center, with an upcoming centre at Lifescan Imaging OUE Downtown Gallery. Collectively, the centres provide ~9,000 sqft of medical space. SMG intends to consolidate its operations at Novena under one space, which will span across 5,500 sqft. Lifescan Imaging now has four radiologists, Dr John Huang, Dr Kenneth Sheah and Dr Howe Tse Chiang, with Dr Tony Stanley being the latest addition to the team.

Cost structure.

According to SMG’s management, non-clinical functions such as billing system, procurement and other administrative costs are being centralised. In terms of doctors’ compensation, we understand that dentists are on revenue-share entirely.
For other specialisations, SMG is working towards senior doctors having more variable incentives, with junior doctors having greater fixed incentives for stability. It is hoped that such compensation structure will incentivise junior doctors to cross over from the public and private sector for stability, as well as retain experienced senior doctors. However, we do note that young doctors may not bring about the same revenue as senior doctors in the near term as it takes time for them to establish themselves in the industry.

Cost of sales mainly doctors’ remuneration.

Given the nature of its industry, we estimate that doctors’ remuneration should constitute a large proportion of the cost of sales, followed by consumables. We understand that doctors’ remuneration is largely variable, and dependent on the topline contribution, particularly for senior doctors. With that, we believe its costs of sales should track topline rather closely.

Consultancy agreements for selected acquired clinics.

For selected acquisitions, consultancy agreements are signed with the respective doctors. Typically, these agreements relate to the continuity of operations and management of the acquired business(es) for a period of 5-6 years. We summarise the agreements as follows:
1. Singapore Medical Council ethical code and guidelines. In April 2017, SMG notified shareholders that through dialogues with Singapore Medical Council, the management’s attention has been drawn to the Singapore Medical Council's Ethical Code and Ethical Guidelines, which states that doctors must not let business or financial considerations influence the objectivity of their clinical judgment in the treatment of patients. We believe that this has resulted in the removal of profit guarantees which was initially proposed for the acquisition of Children's Clinic Central Pte Ltd and Kids Clinic @ Bishan Pte Ltd. This acquisition initially had a profit guarantee of ~S$2.3m per 12 months until 29 June 2022. In the subsequent acquisition of another paediatric clinic announced on 19 October 2017, a profit guarantee was not put in place. We believe this sets forth the mode of acquisitions from hereon.
2. Key management own ~26% of shares. SMG’s free float is ~52%, while Non-Executive Chairman Mr Tony Tan and Executive Director and CEO Dr Beng owns 13.34% and 12.52% of total outstanding shares respectively. Silver Mines Global Limited, which is a wholly-owned subsidiary of Red Ancient Global Ltd and in turn wholly-owned by Dr Ho Choon Hou, holds 9.24% of total outstanding shares. CHA, through the placement earlier in 2017, owns 6.54% of total outstanding shares. SMG does not have a concrete dividend policy at the moment and has not been paying dividends since FY2011.
3. Board and management composition. The Board is led by Mr Tony Tan while Dr Beng sits on both the board and management team. We note that Dr Wong Seng Weng, who owns the remaining 10% stake in The Cancer Centre, serves as an Executive Director.

Competitive Strengths

Experienced medical practitioners.

Singapore Medical Group (SMG) has experienced medical practitioners across its medical specialties, with most of its full-time doctors having more than ten years of experience. SMG also hires young doctors in the hope of training them for succession purposes.

Scalable asset-light model for healthcare segment.

For SMG’s healthcare segment, i.e. excluding aesthetics and diagnostics, its business model is mainly asset-light and hence scalable, with potential operational efficiencies to be derived as SMG scales up.
SMG’s wide network of specialties also taps on cross-selling and referral opportunities within the group, as well as referrals from outside the group, creating an ecosystem of its own.

Testament in turnaround of Lifescan Imaging.

When LSI acquired Pacific Cancer Centre Pte Ltd (PCCPL) for S$2.3m cash in August 2015 for its radiology and diagnostic imaging assets, PCCPL saw a net loss of S$1.68m in FY2014. SMG and LSI then subsequently acquired NRPL for its imaging assets and two clinics for S$0.55m cash in March 2016, with NRPL seeing a net loss of ~S$0.2m for the 12-month ending 30 September 2015.
SMG acquired the remaining 61.9% stake it did not own in LSI in August 2016 and has since turned Lifescan Imaging around to profitability and has in the last year saw the addition of another doctor, bringing the total number of doctors to four. Lifescan Imaging will see its first full year contribution to SMG in FY2017.
While diagnostics imaging is a capital-intensive business, we believe that there are decent margins to be derived, given Lifescan Imaging’s strategic location in Paragon and Novena.

Growth Strategies

Organic growth and restructuring.

Singapore Medical Group (SMG) has plans to groom the next generation of specialists for further growth, for instance, in its Obstetrics & Gynaecology division, by putting in place varying compensation structure with senior doctors to be offered more variable incentives and junior doctors to have greater fixed incentives for stability.
With the acquisition of specialty practices along with senior doctors, SMG will look to recruit doctors to join the network. There are also ongoing restructuring efforts to derive cost synergies across the group, such as centralising non-clinical functions.

Growth of diagnostics business.

SMG believes there is growth potential for its diagnostics business and has recently made a move to consolidate its two centres in Novena into a bigger premise to enhance efficiency. In addition, with the growth of its business, SMG has plans to bring in additional MRI (Magnetic Resonance Imaging) and CT (Computed Tomography) machines.

Acquisitions of clinics.

Despite having spent approximately S$110m in acquisitions, we believe SMG will continue to selectively acquire specialty clinics to add to its network, particularly with the current trend in the corporatisation of healthcare practices in Singapore.
Earnings-accretive clinics can help SMG to grow inorganically, possibly achieving revenue and cost synergies with the rest of the group.

Venture into overseas market.

SMG currently has JVs in Vietnam and Indonesia and we note that the Ciputra eye JV clinic in Jakarta is showing signs of growth and profitability.
SMG has started to execute on its growth initiatives at its two 15,000-sqft clinics in Ho Chi Minh and has hired a paediatric leader to spearhead growth initiatives at its clinic in Careplus Vietnam. SMG intends to enter new geographies outside of Vietnam and Indonesia via M&A or JVs going forward by identifying trustworthy partners.

Key Risks

Regulatory risks.

Various regulatory changes, increased scrutiny and compliance requirements from the Singapore Medical Council could have adverse impact on Singapore Medical Group (SMG)’s businesses. For instance, the SMC has warned against profit guarantees involving healthcare services as it is incompatible with its ethics guidelines.

Execution, integration and impairment risks.

Singapore Medical Group (SMG) will need to demonstrate a sustainable track record in quality recruitment, training and retention of doctors, especially doctors recruited via acquisitions. With its trail of acquisitions, we project that the Group intangibles will amount to over S$100m by end FY17F on its balance sheet. This will be subjected to annual impairment test and/or the occurrence of events; and, if the values are assessed to be lower than that carried in the books, there could be impact on the profits, which could affect the share price (even though that is noncash in nature).

Dependent on key doctors.

SMG is dependent on its key specialist doctors. SMG may face earnings risk should it fail to renew the consultancy agreements (for the selected acquisitions) when they expire in 5-6 years’ time, should SMG fail to train and recruit new doctors in the meantime.

Increased competition.

As most of SMG’s revenues are derived from Singapore, increased competition in the Singapore healthcare industry could pose a risk to SMG’s business, which depends on its ability to hire and retain experienced doctors. For instance, SMG’s main competitors in the diagnostics imaging business include RadLink and MediRad.

Key man risk.

Since 2013, SMG has been dependent on Dr Beng, as well as the new Board, for various strategic directions.

Lack of experience in overseas market.

SMG may lack experience in the overseas market, and JVs in unfamiliar overseas markets may incur losses. For instance, Singapore Medical Group (HK) Limited, an eye surgery JV clinic in Beijing, was eventually disposed of in view of the continued losses incurred and lower-than-expected sales from the eye surgery clinic with the group having to provide for an impairment loss of S$872,000 in relation to the investment in FY2013.

Litigation risks.

There is a higher risk of malpractice suits in the specialist healthcare segment, compared to the general and primary healthcare segments.

Valuation

Initiate with BUY and TP of S$0.75.

We initiate coverage on Singapore Medical Group (SMG) with a BUY call and a TP of S$0.75, implying 25% upside. We believe the group's continued robust earnings growth following the successful turnaround of its operations since FY16, will provide a rerating catalyst for the counter.
We are projecting core earnings growth of 292%/32% in FY17F/18F on the back of
1. further scaling up of its Diagnostics business;
2. recent acquisitions; and,
3. margin expansion from larger scale of operations.

Pegged at 25x FY18F/19F.

Based on our selected peer group analysis, we noted that the group is trading at an average forward PE multiple of about 28-29x.
The healthcare market has re-rated in the past several years on the back of investors’ preference for the structural changes that are expected to come with the ageing population, coupled with the relatively defensive nature of the industry.
We pegged our valuation of SMG to 25x FY18F/19F PE, a slight 10% discount to peer average. This presents a 25% upside from current share price. At this juncture, we believe our discount is warranted given the initial phases and expectations of robust earnings growth from its recent acquisitions.
We apply a discount to reflect some level of conservatism in our projections, in the event that the consolidation and its acquisitions take longer than expected to reap rewards.

Andy SIM CFA DBS Vickers | Singapore Research Team DBS Vickers | http://www.dbsvickers.com/ 2017-11-13

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