Raffles Medical Group - Maybank Kim Eng 2019-05-13: Hurdles Before The Race


Raffles Medical Group - Hurdles Before The Race

Risk-reward not attractive; initiate at HOLD

  • We initiate coverage of RAFFLES MEDICAL GROUP LTD (SGX:BSL) with a HOLD due to a lack of compelling upside catalysts, near-term cost risks, negative/flat EPS growth in FY19/20E, and fair valuation.
  • We believe the company will also face headwinds from the strong SGD vs regional currencies that will dampen Raffles Medical Group’s prospects for medical tourism directed into Singapore. That said, longer-term fundamentals are supportive, such as robust domestic patient load due to positive structural factors, aging population demographic shift and overstretched health system.
  • We are also constructive on the long-term prospect of Raffles Medical Group’s new China hospitals. However, longer-than-expected gestation period or higher-than-expected start-up costs are key risks.
  • Our Target Price of SGD1.05 (WACC: 9%, LTG: 3%) is based on a DCF valuation.

Domestic patient load robust

  • Structural factors underpinning domestic patient loads are healthy. These are:
    1. an aging society and rising incidences of chronic diseases;
    2. rising affluence and take-up of insurance; and
    3. overburdened public healthcare system.
  • Further, domestic patient load is supported by Raffles Medical Group’s mid-range pricing strategy, as well as government subsidies and grants, in our view. Raffles Medical Group’s clinics in Singapore are CHAS-approved.

Headwinds from medical tourism

  • Singapore’s medical tourism industry has faced headwinds from:
    1. strengthening SGD against regional currencies in recent years; and
    2. rising competition from regional alternatives Malaysia and Thailand.
  • Since 4Q16, Raffles Medical Group’s revenue growth has lagged IHH HEALTHCARE BERHAD (SGX:Q0F)’s Singapore operations. One reason could be because IHH Healthcare’s hospitals, such as Mount Elizabeth and Gleneagles, receive more price-inelastic medical tourists, as a result of its premium services.

China hospitals face growing pains

  • China’s population is demographically aging but increasingly affluent. Also, incidences of chronic diseases are rising, amid higher stress levels and pollution. We believe these are favourable for Raffles Medical Group’s hospitals longer term.
  • However, Raffles Medical Group could face stronger-than-expected challenges in attracting doctors and patients, which have an entrenched preference for public healthcare. This could lengthen the breakeven period for both hospitals, which Raffles Medical Group estimates to be three years, at the EBITDA level.

Corporate Information

On an expansion trail

  • Raffles Medical Group is a private healthcare provider in Asia. Although much of its presence is in Singapore, it has presence across 13 other cities, including in China, Japan, Vietnam and Cambodia. In China, Raffles Medical Group has presence in eight cities. The group operates three segments, namely healthcare services, hospital services and investment holdings.
  • In the healthcare services segment, Raffles Medical Group operates medical clinics and other general medical services, and provision of health insurance, amongst others. This segment was expanded in 2015, following the acquisition of International SOS, which had a network of 10 clinics (six in China, three in Vietnam and one in Cambodia).
  • In the hospital services segment, Raffles Medical Group operates two hospitals. These are 380-bed Raffles Hospital Singapore, which opened in 2003, and 700-bed Raffles Hospital Chongqing, which opened in Jan-19. Raffles Medical Group also expects to complete construction of its third hospital, 400-bed Raffles Hospital Shanghai in 4Q19. According to management, the new hospitals in Shanghai and Chongqing will each start with 100-150 operational beds.
  • In Singapore, Raffles Medical Group completed Raffles Specialist Centre, which is adjoined to Raffles Hospital, in early 2018. With this, bed capacity at Raffles Hospital has more than doubled to 380 from 180. Ward renovations at Raffles Hospital Singapore is currently ongoing, and is expected to be complete by 1H19. Management indicated that the initial centres of excellences in the Chongqing hospital are gastrointestinal surgery, O&G, paediatrics, cardiovascular surgery, neuroscience and oncology.
  • While RHSH was Raffles Medical Group’s own expansion initiative, RHCQ was established because of the invitation of the Chongqing government. According to a South China Morning Post article in Mar-19, RHCQ was “strongly welcomed”, as the Chongqing government wanted to foster better services for foreign businesses. The hospital was also helped by a Chongqing-Singapore government cooperation framework.
  • Raffles Medical Group operates under the Group Practice Model. Through this model, doctors work in a multidisciplinary group, and are employed by Raffles Medical Group, as opposed to individual doctors running their own practices within the Group. With each doctor having their own specialties, they can work in teams to provide integrated and coordinated care for the patients. This Group Practice model is adopted by some of the top medical institutions in the world, such as the Mayo Clinic, Cleveland Clinic and Kaiser Permanente.

Investment Thesis

Prospects in the price

  • We initiate coverage on Raffles Medical Group with a HOLD, amid a lack of near-term catalysts and fair valuation. In Singapore (88% of revenue), we continue to expect a strong SGD vs. regional currencies, and rising competition from Malaysia and Thailand to continue to adversely impact foreign patient volumes (around 30% of the total).
  • We believe the potential from new China hospitals, which is expected to be a material long-term earnings growth driver, is broadly priced in. Amid gestation costs for China hospitals, we expect FY19E EPS to fall 14% y-o-y, remain flat in FY20E, and rebound 13% in FY21E.
  • We recommend investors await a more attractive entry point and when potential catalysts begin to emerge in the form of:
    1. lower than expected gestation costs at new China hospitals as a result of strong cost management;
    2. Improving visibility regarding confirmation of the projected three years to EBITDA break-even at the new China hospitals; and
    3. a cyclical rebound in medical tourist volumes.
  • Key risks to our earnings forecasts include:
    1. longer than expected gestation for the new China hospitals;
    2. steeper-than-expected decline in foreign patient load; and
    3. rising competition in Singapore from the public healthcare system.

New hospitals in China – short term pain before long term gain

  • Per management’s guidance, we presently factor in SGD10m/5m EBITDA loss for the first and second year of operations for each of the new China hospitals in Chongqing and Shanghai. Management expects these hospitals to break-even at the EBITDA level in year three.
  • Like most private hospitals in China, we expect Raffles Medical Group’s start-up phase to be challenging. According to multiple sources, including a joint study between the World Bank, WHO and the Chinese government, doctors and patients generally prefer the public healthcare system and tend to stigmatise private healthcare providers. This may make it difficult for Raffles Medical Group to attract good doctors and scale patients in the initial stages, which may in turn pose risks to our earnings growth expectations.
  • From multiple sources, including DHR International (international executive search firm) and Clearstate (a healthcare research and consultancy specialist), doctors prefer the reputation, stability and academic opportunities from their careers at public hospitals, while patients tend to trust doctors at public hospitals as they perceive these doctors as more experienced due to the sheer volume of patients they receive, in addition to the fact that much of the treatment cost is covered by social healthcare insurance.
  • However, we expect Raffles Medical Group to eventually overcome these challenges. Upon overcoming these challenges, we believe Raffles Medical Group’s China hospitals will be well positioned as a beneficiary of favourable structural trends from:
    1. a society with rising incidences of chronic diseases from aging, stress and pollution;
    2. rising affluence and take-up of private insurance;
    3. an overburdened public healthcare system; and
    4. favourable government resently expect Raffles Medical Group’s new China hospitals to generate about 70% the level of revenue as the Singapore operations by 2029E.
  • In a Mar-19 article in the South China Morning Post, Dr. Loo, founder, chairman and CEO of Raffles Medical Group, commented that revenue for the company’s China operations could be same or larger than those in Singapore’s in ten years.

Healthy domestic volumes checked by medical tourism

  • In Singapore, Raffles Hospital generated a 12% revenue CAGR from 2009-15. However, this slowed to a 2% CAGR during 2015-2018 amid a reduction in the volumes of medical tourists. However, we believe prospects for the domestic patient load remain robust. This will be driven by positive industry factors:
    1. rapidly aging demographic shift with rising incidences of chronic diseases; and
    2. overburdened public healthcare system.
  • We also believe that Raffles Medical Group’s pricing, which is generally affordable and in the mid-tier pricing bracket, will also continue to underpin domestic patient volumes. Further, Raffles Medical Group’s CHAS-approved clinics in Singapore should also potentially benefit from increasing government grants and subsidies through the enhanced CHAS (Community Health Assist Scheme) programme, and the Merdeka Generation package – which was announced in Budget 2019. CHAS is a scheme that enables Singaporeans from lower-to-middle income households to receive subsidies for medical and dental care at participating GP clinics.

Financial Analysis

Earnings could bottom in FY19E, growth to resume in FY21E

  • We forecast revenue growth of 10%/11%/6% in FY19-21E, of which 7ppt/8ppt/3ppt are from contributions of new hospitals in China. For both China hospitals, we also factor in EBITDA losses of SGD8/4m for the first two years, before breaking even in year 3. Consequently, group EBITDA margin falls from 21% in FY18 to 17% in FY21E.
  • While we estimate Raffles Medical Group’s PATMI may bottom out in FY19E at SGD61m (- 14%), we also forecast that a meaningful recovery will only resume in FY21E (SGD71m, +16% y-o-y). This is because we expect initial start-up costs of the Shanghai hospital, slated to begin in 2020, to offset any growth coming from other operations.
  • We note that Raffles Medical Group’s cost control in recent quarters has been strong. In particular, in 2Q-4Q18, staff costs declined 2% y-o-y despite a 2% increase in revenue. For 1Q19, Chongqing’s EBITDA loss was SGD1.8m, which if annualised, still remains within management’s guidance of SGD8m. However, this is still early days for Raffles Medical Group’s China hospital operations, and we remain of the view that potential difficulties in attracting doctors and ld result in downside risk to our earnings forecasts.

Still healthy balance sheet and cash flows

  • Throughout Raffles Medical Group’s listing history, cash flows from operations have been able to fund dividends. While there are years that Raffles Medical Group has delivered negative free cash flow, these were due to large capex or investments. Balance sheet is robust, being largely net cash from 2003-17, and in net gearing of 1.4% in 2018.
  • We expect FCF to be negative in FY19E, due to construction activities for the Shanghai hospital. However, we expect FCF to revert to positive territory in FY20E as capex normalises to lower levels. We are presently factoring in capex of SGD90m in FY19E for the construction of RHSH. We also assume SGD30m of capex in FY20E to factor in equipment purchases at new hospitals.

China hospitals revenue and EBITDA margin assumptions

  • Key assumptions and caveats for new China hospitals are as follows:
    • EBITDA breakeven profile – We assumed EBITDA breakeven period of three years, at SGD10m loss for the first year and SGD5m loss in the second. This is consistent with management guidance.
    • EBITDA margin profile – We assume a gradually improving EBITDA margin profile of 4% to 22% from year 4 to 9. As reference, Raffles Hospital Singapore’s PBT margins were 10% in year 4, gradually improving to 27% in year 9 (Raffles Medical Group does not break out EBITDA for Raffles Hospital Singapore). We stay conservative owing to uncertainties operating in a new market. We have also used Raffles Hospital Singapore as a comparison as there is insufficient data for peer analysis for private hospital ramp-up profiles in China.
    • Revenue growth assumptions – We forecast year 2 to 10 revenue CAGR of 22%. This is similar to Raffles Hospital Singapore’s revenue CAGR profile of 21%.
    • Pricing assumptions – We have assumed a starting point of CNY22,000/CNY450 for average inpatient/outpatient bill sizes, respectively (guidance not provided). We also factor in average bill size increase of 6% to factor in medical inflation and improving revenue intensity. For reference, United Family Shanghai’s last disclosed average inpatient/outpatient spend in 2012 was CNY24,800/CNY1,935 respectively, and average inpatient/outpatient spend at third-level general hospitals was CNY12,900/CNY293 in 2016. (Refer to the table below for additional pricing references.)
    • Volume assumptions – We assume each hospital begins with 150 beds, gradually being expanded to 400 beds by year 8. We also assume initial average length of stay of 8 days, gradually moderating to 6 days. For comparison, the national average is around 10 days, Chongqing’s is 8 days, and Shanghai is 21.5 days. We have assumed initial bed utilisation of 70%. For reference, private sector bed utilisation for Shanghai/Chongqing is 75%/66% respectively.


Initiate HOLD with Target Price of SGD1.05

  • We value Raffles Medical Group on a DCF basis, with explicit forecasts to FY29E. Our terminal value is based on 3% long-term growth rate. As we assume long-term capital structure to be net-cash, our WACC is equal to COE of 9%.
  • Our COE is based on 1x beta, higher than its historical 3-year beta of 0.7x to factor increased risk from the new China hospitals. Our Target Price implies 30x/30x/26x FY19-21E P/E.
  • Our DCF valuation scenario analysis of Raffles Medical Group ex-new China hospitals is SGD0.75. In this analysis, key assumptions are WACC of 7% and LTG of 1.5%. Our WACC assumption is lower as we referred to historical beta of 0.7x to derive COE. We also used a lower LTG as much of Raffles Medical Group’s business ex-new China hospitals have already matured.

Peer comparisons

  • We believe the closest competitor to Raffles Medical Group is IHH Healthcare (BUY, Target Price MYR 6.90, see report: IHH Healthcare - Still Good For The Long Haul). This is because IHH Healthcare’s Singapore operations, which account for 34% of the ex-REIT total revenue, include contributions from four hospitals and 50 clinics that are direct competitors to Raffles Medical Group’s Raffles Hospital and primary care clinics. IHH Healthcare’s hospitals in Singapore are Mount Elizabeth, Mount Elizabeth Novena, Gleneagles, and Parkway East. In addition, IHH Healthcare is also in the midst of expanding hospital presence in China. Its 350-bed capacity Gleneagles Chengdu and 450-bed capacity Gleneagles China are expected to be completed in 2019/20 respectively.
  • However, IHH Healthcare is not a perfect comparable, in our view. This is because IHH Healthcare’s revenues include operations in Malaysia, India and Turkey, where Raffles Medical Group does not conduct business. From the perspective of forward P/E, IHH Healthcare is currently trading at 43x, 43% above Raffles Medical Group’s 30x. We believe this premium could be due to:
    1. IHH Healthcare’s strong and growing international presence, which may not be easily replicable by peers; and
    2. IHH Healthcare’s more favourable earnings growth profile over the next three years.
  • MKE analyst Yen Ling Lee is forecasting FY18-21E EPS CAGR of 11%, whereas for Raffles Medical Group, we are expecting flat FY18-21E EPS CAGR due to start-up costs for the new China hospitals.

Lai Gene Lih CFA Maybank Kim Eng Research | https://www.maybank-ke.com.sg/ 2019-05-13
SGX Stock Analyst Report HOLD INITIATE HOLD 1.05 SAME 1.130