AmWatch - Healthcare Sector : Margin pressure from GST NEUTRAL, 24 Mar 2015

SECTOR FOCUS OF THE DAY

Healthcare Sector : Margin pressure from GST   NEUTRAL

The two healthcare stocks under our coverage – KPJ Healthcare Bhd and IHH Healthcare Bhd – reported FY14 core earnings that were within both our and market expectations. Both companies reported earnings growth as a well as margin improvements. Core earnings for KPJ and IHH grew by 20% and 29% YoY, respectively, on the back of 13% and 9% topline growth. Both companies saw EBITDA margins improved by ~2ppts each. KPJ’s EBITDA margin improved to 12% (vs. 10% in FY13), while IHH recorded a margin of 26.4% (vs. 24.5% in FY13).

We foresee some margin pressure in the coming quarters as GST is rolled out in April. Both KPJ and IHH expect input costs to increase by 2%-4% when GST is implemented but this will be partially mitigated by price reversions. With new hospitals coming on-stream and expanding capacity, we expect flattish margin growth this year. The majority of the doctors who provide services at IHH and KPJ hospitals are independent practitioners – i.e. not under the hospitals’ payroll – and thus, their services are GST standard-rated.  Ancillary services are considered exempt supplies. Medicines listed on the National Essential Medicine List (NEML) are zero-rated; other medicines are GST standard-rated. In general, we expect some margin pressure in the near term, as the healthcare players will have to absorb the cost increase, namely for the exempt supplies.

The weakening MYR has little impact on KPJ as its entire borrowings are MYR-denominated and 90% of its revenue are derived from domestic hospitals. The strengthening SGD is positive for IHH; however it continues to be partially offset by the weakening Turkish Lira. The weakening MYR is expected to result in an influx of medical tourists in the country. KPJ’s medical tourism will be spearheaded by the upcoming Bandar Dato’ Onn Specialist hospital; we expect continued growth at IHH’s three main markets – Malaysia, Singapore, and Turkey.

While demand for healthcare will continue to rise, we see possible margin pressure for KPJ due to GST as well as new hospital openings in the pipeline.  Hence, we maintain HOLD on KPJ with a DCF-based fair value of RM4.10/share. Meanwhile, IHH continues to achieve growth in inpatient and revenue intensity and has better margins compared to those of peers; but we deem its valuations to be fair at this juncture at 51x FY15F PE. Thus, we maintain our HOLD call for IHH with a fair value of RM5.40/share.

Others :

IHH Healthcare : Acquires 51% stake in India’s Continental Hospitals        HOLD

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