Healthcare Sector - CGS-CIMB Research 2019-06-10: China The Cure For Anaemic Local Growth?

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HEALTH MANAGEMENT INTL LTD (SGX:588) Q & M DENTAL GROUP (S) LIMITED (SGX:QC7) RAFFLES MEDICAL GROUP LTD (SGX:BSL) IHH HEALTHCARE BERHAD (SGX:Q0F)

Healthcare Sector - China: The Cure For Anaemic Local Growth?

• We estimate China’s population offers c.45x greater healthcare demand than Singapore in 2020F, with policy tailwinds for private healthcare providers.
• Our channel checks and peer analysis show that healthcare can be profitable in China, notwithstanding near-term gestation costs.
• The sector seems resilient but is not cheap at 28.8x forward P/E (+0.5 s.d. above its long-term historical mean of 25.0x). We like IHH HEALTHCARE BERHAD (SGX:Q0F) and HEALTH MANAGEMENT INTERNATIONAL (HMI, SGX:588) best.

OVERVIEW: SINGAPORE VS. CHINA

Singapore healthcare players investing in China

• Singapore-listed healthcare players have in recent years, been active in pursuing growth outside of their home markets. Apart from attracting medical tourists in the ASEAN region, there are companies venturing further into China, with some better positioned to benefit from the evolving healthcare landscape.
• In our note, we discuss some of the differences between Singapore and China healthcare regime, as well as highlight recent policy changes and underlying drivers which could make investing in China healthcare easier for new private entrants. These would tie in with recent ventures by some of the Singapore-listed healthcare companies to invest in China healthcare.
• We also share some key takeaways from our recent visit to Chongqing and Chengdu to see both public and private hospitals, which have direct relevance to two companies under our coverage – namely, IHH Healthcare (SGX:Q0F) and Raffles Medical Group (SGX:BSL).

Public sector dominates acute care sector

• The tertiary healthcare market in Singapore and China is monopolised by the public hospitals, which currently represent about 80% of total admissions in Singapore and 85% of total hospital revenue in China. In China, the total amount of services provided by private hospitals accounted for less than 10% in 2011, and only 1% of those privately-owned hospitals were Tier 3A hospitals.
• Primary care, on the other hand, is dominated by private and independent players given the industry fragmentation in Singapore, and less prevalent in China as Chinese residents prefer to visit large specialist hospitals even for minor ailments. This results in long waiting queues, lack of individualised care, as well as an inefficient public healthcare system in China.

Equally committed to improving healthcare affordability

• Like most other countries including Singapore, China has its own socio-medical insurance scheme - 医保 (also known as “Yibao”), which covers over 95% of population. The level of coverage depends on whether the insured is an urban employee, an urban resident or a rural resident; quantum of subsidies and reimbursements also vary across hospitals and cities. While not compulsory for all private hospitals in China, most implement Yibao as it is often seen as helpful in driving patient volumes especially for new hospitals.

The Chinese central government sets to achieve universal health insurance coverage by 2020.

• The three schemes, previously under different agencies, have been unified under a single entity “State Medical Insurance Administration”, since Jun 2018. Apart from raising the basic medical insurance and serious disease insurance benefits, China continues to expand the coverage of interprovincial settlement of medical bills, which will benefit migrant workers and those without local household registration.
• While more than 90% of the population in China have achieved nominal universal healthcare, the underfunded and overburdened state system remains inadequate, in terms of limited depth of insurance coverage (strict reimbursement caps), and poor service standards. Therefore, public healthcare spending per capita and as a percentage of GDP in China lags the average level of developed nations.
• Furthermore, the majority of private facilities and treatments/medicine, particularly for cancer, are excluded from Yibao coverage. Even with the universal social insurance, Chinese users are generally still required to pay c.35% out-of-pocket for their care. According to a 2012 McKinsey report on healthcare in China, outpatients in Shanghai face 30-50% copayments and a US$240 deductible, while the Beijing Normal University estimates state programmes cover just 40% of costs related to children’s leukaemia (2017). Singapore’s out-of-pocket expenditure may be slightly lower at 31% (in 2016), but these are largely financed by private medical insurance, which saw a recent implementation of minimum 5% co-payment rider with effect from 1 Apr 2021.
• Driven by strained public healthcare resources and rising income levels, we see an increasing number of consumers turning towards private insurers for more complete coverage and seeking premium healthcare options. This spells substantial market growth potential for private insurance given the low penetration level currently. In a 2017 survey carried out by FT Research Confidentiality (FTCR) among 2,000 consumers in China, only 21.7% has private coverage on top of state insurance; coverage is higher particularly for high-income households (42.5%), as well as residents of first-tier cities (25.8%), as compared to 17.4% of residents in third-tier cities.
• Based on Boston Consulting Group (BCG) estimates, China’s private health insurance market expanded at a 29% CAGR from 2010 to 2015 to Rmb241bn (US$36.7bn), comprising mainly critical-illness policies (lump sum payout if the insured person is diagnosed with any of a set of agreed upon medical conditions). Private reimbursement policies are relatively underdeveloped, representing c.30% of private health insurance in 2015, and predominantly purchased as group insurance (81%) by employers. As more local Chinese companies and small/mid-size foreign enterprises grow in scale and seek to retain human capital, this segment is likely to fuel growth for private reimbursement insurance. Our China healthcare team at China Galaxy International (CGI) expects private insurance gross written premiums to grow by more than 20% y-o-y p.a. over the next few years.
• In Singapore, all citizens and permanent residents are covered by MediShield Life (whose premiums are heavily subsidised by the government) for basic medical coverage, and approximately two-thirds pay for an integrated shield plan (IP) from one of the seven private insurers: AIA, Aviva, AXA, Great Eastern, NTUC Income, Prudential and Raffles Insurance. With such extensive insurance coverage, recent policy changes in Singapore have instead focused on managing rising healthcare costs (and escalating insurance premiums).

More tax allowances could also help patients cope with medical bills and incentivise private healthcare insurance.

• In Oct 2018, China’s Ministry of Finance and State Administration of Taxation jointly announced a list of new tax deductible items which will take effect from 1 Jan 2019. Amongst other items, these include children’s education, continuous education, medical expenses and elderly care expenses. For medical bills that exceed Rmb15k per annum, patients will receive personal tax allowance of up to Rmb60k/year.
• The government has also allowed tax deductions of up to Rmb2.4k on employer-provided health coverage. In Singapore, tax-deductible items for employers include medical expenses (capped at 1-2% of total employee remuneration accrued for the year, depending on availability of other medical benefits arrangement), and premiums paid on health insurance plans for employees.

China has more favourable demographics than Singapore

• Firstly, China’s population size of c.1.4bn is a few hundred times bigger than Singapore’s 5.6m (as of 2018). Its population is also ageing faster than other low-and middle-income countries, which tends to concentrate in the densely-populated urban areas. Income levels are also rising quickly, with its middle class being among the fastest growing globally, surging from 29m in 1999 (2% of population) to 531m in 2013 (39% of population). McKinsey & Company estimates this population segment to reach 550m by 2022, making up 75% of urban households.
• Other structural drivers like increasing urbanisation and sophistication of certain population segments also position reimbursement policies purchased by individuals to become a bigger part of China’s health insurance market. We believe such demographic trends are favourable to a burgeoning healthcare market and more investment opportunities in China (Rmb8tr by 2020F according to Deloitte Analysis’ projections), vs. Singapore’s relatively mature and developed healthcare system (US$24.6bn by 2020F according to Frost & Sullivan’s estimates).

INDUSTRY OUTLOOK

Start-up challenges facing private hospitals

• As compared to public hospitals in China, private hospitals have higher entry barriers to overcome.
• Firstly, we believe there is a common negative perception against for-profit hospitals that they are more likely to engage in over-treatment and illegitimate practices. Chinese patients are also biased towards public hospitals and tertiary/teaching institutions for seemingly better quality of care as they have more experienced doctors due to the abundant volume of cases, particularly in the larger, more renowned Class 3A public hospitals in major cities.
• Secondly, differences in reimbursement by social health insurance schemes contribute to the uneven playing field between private and public hospitals. Recruitment of good and reputable doctors is not an easy task for private healthcare operators, because other factors like academic affiliations, accreditations, and training influence a practitioner’s decision to move from public to private practice, apart from attractive compensation.

Once tightly controlled…

• Healthcare services have long been classified as a restricted sector in China’s 1997 Foreign Investment Catalogue, which must be led or majority-owned by the Chinese partners. This shareholding percentage was subsequently lowered to at least 30% in 2015. Foreign parties looking to have a presence in multiple cities, or at multiple sites within a city, must establish separate joint ventures (JVs) for each outlet. Such approval process is usually onerous and requires dual approval from:
  1. the National Health Commission and relevant local health bureaus, as well as
  2. commercial government oversight agencies such as Ministry of Commerce, National Development and Reform Commission, State Administration of Industry and Commerce.
• Investment policies regarding medical institutions in China can be split into the following three stages:-
  • Prior to 2010: From Apr 1997 to Nov 2010, foreign investors were not allowed to establish any wholly foreign-owned enterprise (WFOE) medical institution in China.
  • 2010 - 2015: From Nov 2010 to Apr 2015, the foreign shareholding cap restriction in the medical institutions sector was lifted. Foreign investors could also establish WFOE hospitals in the Shanghai Pilot Free Trade Zone and six other pilot cities (Beijing, Tianjin, Shanghai, Jiangsu, Fujian, Guangdong and Hainan); qualified HK, Macau and Taiwan service providers could establish WFOE hospitals in cities at or above the prefectural level.
  • Post 2015: Effective Apr 2015, foreign investors are prohibited from establishing any WFOE medical institution in China but qualified HK, Macau, and Taiwan service providers can still establish WFOE hospitals in cities at or above the prefectural level. Foreign companies are restricted from owning more than 70% interest in establishing or acquiring new hospitals.

…China healthcare undergoes liberalisation and reforms

• The Chinese government has shifted its stance in recent years, introducing changes to attract more foreign investment into the private healthcare industry, especially at the urban premium-care and specialist levels.
  • The state-owned enterprises (SOE) reform. Based on the “Guidance on Deepening State-owned Enterprises Reform” and the “Notice on Accelerating to Divest Social Obligations and Historical Issues”, medical institutions established by SOEs are required to be categorised and divested by end 2018; the notice also encourages alternative models such as government procurement services and involving private capital in the restructuring of medical institutions established by SOEs.
  • The healthcare system reform. The 13th Five-Year Plan for Healthcare focuses on the development of private hospitals and the formation of diversified healthcare services model.
  • Private and foreign-invested hospitals are now eligible for the permanent preferential value-added tax and business tax treatments, announced by the PRC Ministry of Finance. Licence and Yibao application processes are made easier.
  • According to the Opinions on Encouraging Development of Diverse Private Healthcare Services issued by the General Office of the State Council in May 2017, eligible private healthcare institutions will be treated equally as public institutions and enjoy the same benefits in areas such as patient referral, charges and payments, performance assessment, as well as incentives.

Easing entry barriers for hiring of qualified staff

• In the past, doctors from the public sector were prohibited from practicing in the private sector. However, since 2009, they are allowed to work at multiple public sites (maximum three) subject to approvals from the hospital management, but such approvals are hard to secure as public hospitals are extremely busy. Moreover, Chinese doctors’ licences are held by the hospital where they work, rather than by the doctor as an individual, which makes many unwilling to work in more than one facility, and any transfer of licensing usually takes up to 30 days to finalise. Hence, less than 2.2% of China’s 2m physicians nationally have applied for a multiple site practice permit in 2015, according to a Worker’s Daily report.
• Meanwhile, foreign physicians are allowed to practice in China, but the licensing requirements and process vary in each jurisdiction. Jurisdictions such as Beijing mandate each applicant to take a board-level examination, while others are able to issue local licences upon submission of application and original licence from home country. Licences issued to foreign physicians are also subject to renewal every year, and come with age restrictions of up to sixty years old, unless qualified as a “foreign expert”.
• In May 2019, new guidelines were jointly issued by China’s five authorities and published on the official website of the National Health Commission, encouraging qualified physicians (with more than five years of experience and have obtained intermediate-level or above qualifications) to run their own clinics, either on full-time or part-time basis for general or specialty medical practices, under a pilot programme (target to start by Sep 2019) in ten cities, including Beijing, Shenyang, Shanghai and Nanjing. Some industry insiders also believe that reforms to the traditional pension system, which include the removal of non-contributory pensions financed solely by enterprises and discontinuation of special pension plan1 for public-sector employees (in Jan 2015), could ease restrictions on labour mobility.
• With the government’s push for more private investment and private clinics to be incorporated into the medical treatment partnership system, we believe this could help attract more talent and raise the number of licensed doctors per 1,000 population in China from current 2.4, to be closer to developed countries' 3.1 (on average).
• In the meantime, private institutions have turned to hiring of 2nd tier, equally famous doctors from large hospitals as full-time employees or regular consultants. In the case of Raffles Medical Group and IHH Healthcare, they have tapped their international network of Chinese speaking doctors to recruit from Malaysia, Taiwan, and Singapore. Raffles Medical Group is also in the midst of building a training school next to its Raffles Chongqing hospital, which could help to attract and prepare the right talent, in our view.

Redirecting patient flow to under-utilised lower-tier hospitals from first-tier cities

• Medical facilities in lower-tier cities traditionally operate at less-than-ideal utilisation rates, while top-tier, large hospitals are overcrowded as approximately 50% of patient visits are for the treatment of minor, common and chronic diseases. To address this, China is shifting its focus towards hierarchy diagnosis and more hospitals outside Beijing and Shanghai, where the number of beds per 1,000 population is significantly lower. Local authorities also aim to invest more in family medicine, by pushing each household to sign a contract with a family doctor by 2020, and subsidising patients’ visits, as well as increase the number of general practitioners to two or three, and eventually five, for every 10,000 people from current 1.5.
• Across the major Chinese cities, public and private hospitals in Shanghai, Chongqing and Sichuan (Chengdu) record bed utilisation levels higher than the national average of 63.4% in 2017, an indication of capacity expansion needs. Given their upcoming projects in Chongqing (Raffles Hospital is the only international hospital of such scale in western China), Chengdu and Shanghai, we think Raffles Medical Group and IHH Healthcare are well-placed to benefit from these healthcare reforms.
• Amid deliberate attempts by local authorities to redirect patient flow, top tier cities remain the first-choice location for many hospital operators due to their bigger population sizes, based on our conversations with listed healthcare groups with presence in China. This is followed by third-and fourth-tiered cities where most SOE-backed hospitals are established, and such hospitals (owned by government, SOEs, university and military) are often the go-to hospitals for local patients. The reform of public hospitals mandates these institutions and corporations to separate their non-core operations, which makes these SOE-related hospitals attractive takeover targets, in our view.

The rise of private hospitals

• Private healthcare in China has witnessed exponential growth over the last decade. According to statistics from the National Health Commission, the number of private hospitals more than doubled from 7,068 in 2010 to 16,000 in 2016, partly attributed to the “privatisation” of state-owned hospitals. There were more than 18,000 private hospitals as of Feb 2018, which represent 60% of total number of hospitals, vs. 12,279 public hospitals. Small-scale and specialty hospitals make up the majority of China’s fragmented and competitive private hospital market.
• On the same note, patient visits to private hospitals registered 30.9% CAGR during 2010-15, which accounts for less than 15% of total visits, vs. a 6.3% CAGR for public hospital visits. The drawbacks of state hospitals – including the lack of privacy, personal care, over-prescription of drugs and tests (as drug sales accounted for a third of the income of public hospitals in 2016, according to the Beijing Commission for Health and Family Planning), and unnecessary intravenous (IV) use – could have led to the faster growth in private hospital visits. Unlike those in the public system, private specialists do not have the same pressure to see many patients in a short period of time, and are not compensated by income from drug prescriptions. The supply of private hospitals is likely to continue on an uptrend, and growth in private patient visits could accelerate in our view, against the backdrop of government reforms, increasing affordability and improving public perception of private healthcare.

OUR JOURNEY TO THE WEST

Channel checks in Chongqing and Chengdu

• In late Apr 2019, we made a healthcare trip to China, visiting hospitals and healthcare companies in Chongqing and Chengdu, where Raffles Medical Group and IHH Healthcare have recently expanded into respectively. Raffles Medical Group opened its first overseas 700-bed multi-disciplinary hospital in Chongqing at the start of 2019, while IHH Healthcare will be opening a 350-bed comprehensive hospital in the medical city of Chengdu in 2H19F. Both entities will also be unveiling their Shanghai hospitals (Raffles Medical Group: 400- bed, IHH Healthcare: 450-bed) in 2020F. Based on our channel checks, we gathered the following insights:-
  • Location means accessibility. A city-centre location is ideal as patient catchment area, but competition could be more intense because of more hospitals within a certain radius. Severe traffic congestion could be a deterrent. Close links with key transportation hubs (like international airport, high-speed railway stations) are important, as well as proximity to sizeable residential projects, schools and/or industrial developments.
  • Size of the hospital matters for brand image. Hospitals with bigger licensed bed capacity are able to qualify for higher grading and therefore have higher pricing power for the same type of service or treatment, as compared to smaller hospitals. Moreover, the more noticeable presence also helps to elevate brand awareness and attract patient flow.
  • Insurance partnerships ease affordability concerns. Given the limited coverage of state health insurance and higher medical charges at private hospitals, having a robust insurance panel (local and international insurers) will attract not only expatriates, but also the more affluent locals. Raffles Medical Group has entered into an MOU in Aug 2018 with China Taiping Insurance Group (966 HK) to jointly provide medical insurance solutions and healthcare management services, while IHH Healthcare is also partnering with Taikang Insurance Group (Unlisted) to jointly invest in primary care clinics and greenfield hospital projects in China.
  • Hub and spoke model helps in patient referrals. Raffles Medical Group’s purchase of International SOS (MC Holdings) Pte Ltd (Unlisted) in 2015 gives immediate access to more than 10 clinics globally, including China (Shanghai, Beijing, Tianjin, Dalian, Shenzhen), Vietnam and Cambodia. It will also be adding two medical centres in Nanjing, which could benefit inter-city patient volumes, in our view. Apart from its recent acquisition of Chengdu Shenton health clinics, IHH Healthcare’s ParkwayHealth China also operates 10 medical and dental centres in Shanghai, Suzhou, Beijing and Hong Kong.

Current modus operandi in China

• The prevailing service model at most Chinese hospitals and clinics does not allow patients to make appointments; instead patients have to queue and register to see a doctor. Several government directives require public facilities in big cities to institute appointment systems, but implementation has been difficult due to technical difficulties and high demand. Certain hospitals have moved online to allow appointment bookings via the WeChat platform.
• We also understand that current restrictions on advertising make attracting patients difficult for new private hospital operators, which is essential in achieving critical mass. To reach potential clients, private healthcare players conduct extensive outreach activities instead, for example, blood drives, sports events and on-site health checks. During our visit to Raffles Chongqing Hospital, we learnt of an ongoing “promotion period” where walk-in patients are offered 50% discount on consultation charges, including specialists consultations, for a limited period. We believe such initiatives allow patients to experience the quality of care and facilities at the new hospital, without significant financial constraints.
• Some state-owned hospitals and foreign healthcare companies have established VIP wings to offer privacy, better furnishing and attention to patients. According to China Resources Medical Holdings (1515 HK), some of their hospitals already have VIP departments which cooperate with private medical insurance companies to allow direct billing, but such VIP care has been less well-received by patients.

Metrics of hospital investments

• Based on our cross-checks with management of other hospital operators and our CGI healthcare analyst, we understand that greenfield hospitals generally take 3- 4 years to achieve EBITDA breakeven, and 5-7 years on the net profit level. Investment payback period for new medical examination centres can range from 3-5 years to 6-9 years for new specialty hospitals. This is in line with the 3-4 years breakeven and 6-9 years payback period for new specialty hospitals, as stated in the IPO prospectus of Rich Healthcare (1526 HK). Another general observation is that specialty hospitals, such as the likes of Aier Eye (300015 CH), tend to achieve better profitability than multi-disciplinary hospitals as they face less competition vs. public hospitals.

Raffles Medical Group is an early mover into 3rd largest city of China

• Chongqing is one of the four municipal cities under the direct administration of central government and has a population size of over 30m, of which urban residents represent 15m (as at Jan 2019). This makes it the third-largest city in China. Utilised foreign direct investment (FDI) into Chongqing was US$2.2bn in 2017, with Hong Kong being the largest source, while other major investors came from Singapore and South Korea. By end of 2018, over 280 of the Fortune 500 companies globally have set up operations in Chongqing, including Hewlett- Packard Inc (HPQ US), Foxconn (2354 TT), Inventec (2356 TT), Taiwan's Acer (2353 TT), and Honeywell (HON US), based on findings from the Hong Kong Trade Development Council (HKTDC) research.
• Raffles Chongqing Hospital (慎安莱佛士医院) occupies approximately 28,000 sqm with a built-up area of over 100,000 sqm, and is situated within the Liangjiang New Area (重庆两江新区大竹林), which was the third national development and opening zone in China approved by the State Council (in 2010), after Shanghai Pudong New Area (2005) and Tianjin Binhai New Area (2006).
• In terms of connectivity, the international hospital with licensed capacity of 700 beds (address: No. 2 Huashan Middle Road, Yubei District, Chongqing) is about 30 minutes’ drive away from the Chongqing Jiangbei International Airport, and 20 minutes’ drive away from the Chongqing North Railway Station, making it easy for international and domestic travellers to access. By capitalising on its medical centres located in 13 Asian cities (including Osaka, Shanghai, Ho Chi Minh), Raffles Chongqing Hospital targets to attract medical tourists from other cities and countries in the region, apart from the local middle class population and expatriates.

Key takeaways from the hospital tour.

• By being located c.30 minutes (by car) from the city centre, Raffles Chongqing Hospital benefits from patients facing less traffic congestion getting to the hospital, as well as lower competition because the city centre is dominated by local hospitals such as Southwest Hospital (西南医院) and Chongqing Medical University Affiliated Hospitals (重庆医科附属医院), in our view. During our visit, we observe that there are no residential or commercial buildings nearby (within walking distance), although the town planning map of Chongqing Lijiang New Area shows promising prospects for eight development areas, across sectors such as automotive, IT communications, aviation and biopharmaceuticals.
• The clinics in Raffles Chongqing Hospital that are open during the trial operation stage include international medicine, surgery, obstetrics & gynaecology (O&G), paediatrics, health screening and dentistry. We also understand that only three levels (and c.120 beds) are operational since opening its doors in Jan 2019, and current staff headcount of 200 is sufficient, with some of the doctors and management roles seconded from Singapore. We believe the limited operations, together with the absence of lower-margin Yibao beds, helps to keep the hospital’s operating costs in the initial opening phase low, amounting to S$1.8m EBITDA loss (and S$2.2m net loss) in 1Q19. We believe management has plans to introduce the subsidised beds at a later time, pending approval from the local authorities.
• We also visited three popular public hospitals in Chongqing - Southwest Hospital, Xinqiao Hospital (also known as the 2nd affiliated hospital of Third Military Medical University) and Chongqing Medical University 2nd Affiliated Hospital (重庆医科大学附属第二医院). Patient footfall at these public hospitals is significantly higher than at Raffles Chongqing Hospital. The public hospitals are also bigger in scale but their facilities are more worn-out. At these public hospitals, visitors could make appointments, pay consultation fees and collect their prescription from standalone information kiosks or manned counters, which could be found on most floors. In some hospitals, we found names of specialists who were on duty for the week put on display, as well as consultation charges which vary across type of treatment and choice of doctor. These consultation charges are substantially cheaper than those of private hospitals and Singapore, and are partially subsidised by the Yibao insurance.

IHH Healthcare’s next China project after Gleneagles Hong Kong

• We travelled from the city of Chongqing to Chengdu in order to visit Perennial International Health and Medical Hub, which officially opened in Jun 2018. Strategically situated next to the Chengdu East high-speed railway (HSR) station, this medical hub is positioned to serve not only residents of Chengdu and the neighbouring cities, but also the wider community of Southwest China and the Sichuan province. The urban resident population of 7.1m makes up almost half of the total population of Chengdu (2017: 16.04m based on Sichuan Statistical Yearbook), which is also one of the major tourist cities in China.
• Apart from Gleneagles Chengdu Hospital (part of IHH Healthcare), which is slated for opening no later than 4Q19F (initial: 3Q19F) according to management, other anchor medical tenants are Care Alliance Rehabilitation Hospital of Chengdu, Sichuan Integrative Medicine Hospital International Traditional Chinese Medicine Centre, as well as four other healthcare businesses by PERENNIAL REAL ESTATE HOLDINGS (SGX:40S) (Rating: ADD, Target Price: S$0.99, see report: Perennial Real Estate Holdings - Making Slight Progress).

Key takeaways.

• The Perennial International Health and Medical Hub site is well-linked to a major transportation hub and located not more than 30 minutes’ drive from the town centre, with more residential and commercial buildings in sight. Given that Chengdu is a highly-popular city for tourists and expatriates (14,000 expatriates, based on unofficial estimates as of 2014), we believe that Gleneagles Chengdu Hospital has a competitive edge in attracting medical tourists from within and outside of China. We expect Gleneagles to leverage its network of Parkway Health primary care medical centres in China and international presence to obtain patient referrals, especially with its recent acquisition of Chengdu Shenton health clinics.
• While the shopping mall close by has been in operation for more than six months, footfall remains weak and we think there could be intensifying competition for Gleneagles Chengdu Hospital from other medical tenants. Given the progress of retrofitting and pending approvals from the local health ministry, we think there could be further delays to its opening (management’s initial target of 3Q19F), which would shift the bulk of the start-up costs for the hospital to FY20F.

PEER ANALYSIS

Cross-checks with our China healthcare analysts

• According to our China Galaxy International (CGI) analysts that cover China’s healthcare sector, the sector experienced de-rating in 2H18 and continues to be an Underweight for them, premised on spillover effects from ongoing reforms, which target to make drugs more affordable (zero price mark-up, revised national essential drug list) and better management of the national medical insurance reimbursement. These reforms have negatively affected the profitability of some downstream hospitals during the transition period, but we see less-severe impact on private hospitals that mainly generate revenue from medical services. Other China government policy changes in the pipeline include the second phase of group purchasing organization (GPO) and adjustments to the National Reimbursement Drug List in Sep 2019.
• The CGI analysts do not cover any hospital-related stocks currently, and their healthcare sector top picks – Shanghai Pharmaceuticals (2607 HK), China Traditional Chinese Medicine Holdings (CTCM, 570 HK) and Sinopharm Group (1099 HK) – have clear earnings visibility, low policy risk and relatively-small exposure to GPO risk. Apart from healthcare services providers, pharmaceutical manufacturers and distributors, the healthcare value chain in China comprises other sub-segments such as biotechnology, medical devices, Traditional Chinese Medicine (TCM) and healthcare/internet.

Market rates and volumes

• The pricing for medical procedures and consultation charges vary across different hospitals in China, depending on the city, hospital category (for profit or non-profit), size and type (public or private, general or specialised). Referencing the pricing information extracted from publicly-available resources, we estimate outpatient charges are typically in the range of Rmb200-1,000 (S$40-200) per visit and inpatient charges range from Rmb10,000-28,000 (S$2,000-5,600). We identify Jian Gong Hospital and Shanghai United Family Hospital as the closest comparables to Raffles Chongqing Hospital and Gleneagles Chengdu Hospital for our analysis, given that both are for-profit and comprehensive hospitals accredited by the Joint Commission International (JCI).
• Raffles Medical Group’s management shared that the average pricing at its China hospital is 10- 20% lower than its Singapore hospitals, and we observed that the charges for its health screening packages are 30-40% lower in China than in Singapore. The group’s average bill size is determined by several factors, such as the average length of stay, case mix and complexity. In terms of EBITDA, management guided for Raffles Chongqing Hospital to incur S$8m-10m loss in the first year of operations and S$4m-5m loss in the second year, before achieving breakeven in the third year.
• As a benchmark, the Parkway Group of hospitals in Singapore (under IHH Healthcare) on average earned S$10,266 (c.Rmb51,000) per inpatient admission in 2018. In the first year of operations, Mount Elizabeth Novena and Gleneagles Hong Kong (GHK) each contributed S$17m-26m revenue (or S$34m on an annualised basis). Mount Elizabeth Novena achieved EBITDA breakeven within the first nine months of opening, whereas GHK continues to work on achieving EBITDA breakeven.

CASE STUDY

Q&M dental: Singapore’s 1st China healthcare proxy

• Q & M DENTAL GROUP (S) LIMITED (SGX:QC7) was first listed on the Singapore Exchange (SGX) in 2009 as the country’s largest private dental healthcare group (by number of clinics). The group expanded into China via the acquisition of majority stakes in Aidite (specialised dental ceramics manufacturer) and Aoxin (primary dental care company, with four hospitals and seven centres in China) in 2014. This led to P/E multiple re-rating for Q & M Dental Group, which traded at above 40x forward P/E between 2015- 17, before its plans to spin-off both entities.
• Aidite was separately listed on China New Third Board in Dec 2016 (now delisted), while Aoxin was spun-off as a separate listing, AOXIN Q & M DENTAL GRP LIMITED (SGX:1D4), on the SGX Catalist Board in Apr 2017 (both recognised as Q & M Dental Group’s associates). The group subsequently saw its share price de-rate, as it struggled with lack of acquisitions in China (no thanks to the North-South restriction) and suffered from lower associates’ contribution (due to start-up losses incurred by its new dental hospitals).
• See report: Q & M Dental Group - Teething Problems At A Cost.

VALUATION AND RECOMMENDATION

Maintain sector Neutral, with IHH and HMI as preferred picks

• Backed by their solid operational track records and multinational experience (be it hospitals or chain of clinics), we think Singaporean healthcare companies entering into China like IHH Healthcare and Raffles Medical Group would be able to navigate the healthcare landscape there successfully, notwithstanding the gestation costs from their hospital expansion plans. We are also optimistic on the long-term growth prospects for China’s private healthcare sector, in view of the policy tailwinds and improving dynamics for the segment.
• As a relatively under-owned and defensive sector in Singapore, we view healthcare as a potential safe haven for investors amid the US-China trade tensions. However, Singapore’s healthcare sector is now trading at 28.8x forward P/E (above the long-term historical average of 25.0x), which leads to our Neutral rating. Within the sector, we like IHH Healthcare for its multi-year earnings growth prospects, underpinned by GHK and Fortis turnaround, as well as its debt restructuring in Turkey. See report: IHH Healthcare Bhd - Becoming A Pan-Asian Healthcare Provider.
• We also have an ADD call on Health Management International (HMI) because of its status as a healthcare proxy for Malaysia’s rising medical tourism and its new exposure to Singapore rising demand for healthcare services. See report: Health Management International - Our Preferred Small-Cap Pick In Healthcare.
• We turn more positive on Raffles Medical Group’s cost execution after our visit to its Raffles Chongqing Hospital and its 1Q19 results (refer to company note below for more details). We raise our FY19-21F EPS forecasts by 4.9-5.2% on lower net loss assumptions based on management’s strict cost discipline and moderate pace of bed openings. However, we lower our SOP-based target price to S$1.10 (previously S$1.19) as we update the financing structure and capex pipeline in our DCF valuation for both hospital projects. Our HOLD call on Raffles Medical Group is unchanged in view of near-term gestation costs and its current expensive valuation of 31x FY20F P/E. See report: Raffles Medical Group - Nursing A Cold, But Recovery On The Horizon
• We keep our REDUCE call on Q & M Dental Group, as we lower our FY19-20F EPS estimates by 23.9-25.7% (refer to company note below for more details), given the company’s unexciting earnings growth outlook. In our view, the bulk of its earnings from Singapore/Malaysia cannot support Q & M Dental Group’s current 29.2x FY20F P/E valuation, which is 25% above the industry average of 23.3x. Upside risks are faster expansion via M&As, the lifting of the North-South restriction and shorter gestation period for its new establishments. See report: Q & M Dental Group - Teething Problems At A Cost.

NGOH Yi Sin CGS-CIMB Research | https://research.itradecimb.com/ 2019-06-10

SGX Stock Analyst Report ADD MAINTAIN ADD 0.680 SAME 0.680

REDUCE MAINTAIN REDUCE 0.400 DOWN 0.47

HOLD MAINTAIN HOLD 1.100 DOWN 1.19

ADD MAINTAIN ADD 6.370 DOWN 6.40