HEALTHCARE Sector report Margin pressure from GST 24 Mar 2015 NEUTRAL Max Koh (Maintained) [email protected] 03-2036 2299 Rationale for report: Sector update

Investment Highlights

 Healthcare stocks performed within expectations: 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.

 20%-29% earnings growth on higher revenue: Core earnings for KPJ and IHH grew by 20% and 29% YoY, respectively, on the back of 13% and 9% topline growth. The topline growth could be attributed to increased patient volume, ramp-up of beds in existing hospitals and commencement of new ones last year. Recall that KPJ opened the Rawang Specialist and Maharani Specialist hospitals in March and June, while IHH had opened the Aicibaden Atakent Hospital and Pantai Hospital Manjung in January and May.  EBITDA margin improvements of ~2ppts: 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 believe the improved margins could be attributed to better operational efficiency, continued ramp-up of beds and price reversions.

 Healthcare demand remains robust: We believe that healthcare demand remains healthy on the back of an ageing nation (10% of population over 60 years old by 2020), increasing health awareness and improving economic wellbeing. According to Frost & Sullivan, healthcare expenditure in Malaysia is expected to surpass USD20bil (RM72bil) by 2025. It also projects the healthcare industry to register a CAGR of 11% until 2020.

 …but margins may come under pressure: While margins had improved last year, we foresee some 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.

 GST leads to rise in medical costs: According to the Customs Department, services provided by healthcare professionals employed by private healthcare facilities are tax-exempt. However, 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 (e.g. prescription, food, mortuary services) are considered exempt supplies. Standard-rated supplies include non-related healthcare services (i.e. food catering, parking, laundry services), rental/leasing (operation theatre, clinics), seminars/training by doctors, fitness programmes (gym, spa), and medical aids for patients. Medicines listed on the National Essential Medicine List (NEML) are zero-rated; other medicines are GST standard-rated. (See Exhibit 9). 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.

 Forex impact: 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. For IHH, only 1.7% of its total borrowings of RM4.3bil as at end-Dec 2014 were MYR-denominated. The strengthening SGD is positive for IHH; however it continues to be partially offset by the weakening Turkish Lira. While the exchange rate is expected to be volatile, this is hedged by IHH’s borrowings in the domestic currencies of its operations.

 Medical tourism on the rise: The weakening MYR is expected to result in an influx of medical tourists in the country. According to the Malaysia Healthcare Travel Council, healthcare travelers recorded a CAGR of 12% to 770,000 from 2007-2013. Foreign patients make up ~30% of revenue for IHH’s Singapore operations with patients mainly from Indonesia, the Middle East and China. Only ~5% of its Malaysia operations are contributed by foreign patients, which is similar to KPJ’s 5%. 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.

 Maintain NEUTRAL: 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 (KPJ Pahang and Perlis slated for completion in 1H15 and 2H15,

respectively). 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. We have a NEUTRAL call on the sector.

PP 12246/05/2013 (032379)

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Healthcare 24 Mar 2015

FY14 RESULTS WITHIN EXPECTATIONS  IHH to open Gleneagles Medini and Gleneagles Kota Kinabalu  Core earnings within expectations As for IHH, both Gleneagles Medini (Phase 1A: 150 beds) The two healthcare stocks under our coverage – KPJ and Gleneagles Kota Kinabalu (250 beds) are targeted for Healthcare Bhd and IHH Healthcare Bhd – reported FY14 completion in 1H15. core earnings that met both our and market expectations. In Turkey, its brownfield project Acibadem Taksim is Both companies reported earnings growth as a well as targeted for completion in 1H15 with 120 inpatient beds margin improvements. expected. Generally, the better performance could be attributed to  Pantai and Gleneagles KL to complete this year increased patient volume, ramp-up of beds at existing hospitals, and commencement of new ones last year. Phase 1 (200 consultant suites) of IHH’s Pantai Hospital KL is slated for completion in early 2015. Meanwhile,  KPJ core earnings up 20% Gleneagles KL expansion will be completed in 2H15, which will add another 100 beds (current: 316 beds). KPJ recorded core net earnings of RM123mil for FY14, up 20% from RM103mil a year earlier. This was on the back of In Turkey, Acibadem Sistina Skopje (81 beds) and a 13% growth in revenue. Acibadem Bodrum (101 beds) are slated for completion in 1H15 and 2H15, respectively.  IHH core earnings rose 29% Other expansions slated for completion this year include its IHH’s core net earnings increased 29% to RM785mil on 50:50 JV Gleneagles Khubchandani, India (450 beds), and the back of a 9% topline growth. The better performance the Danat Al Emarat Hospital, Abu Dhabi (consultancy could be attributed to higher inpatient volume at its three agreement, 126 beds, operation in 1Q15). key markets (Singapore, Malaysia, Acibadem: +9% each), as well as revenue intensity growth (4%-9%).  KPJ continues to ramp up  EBITDA margins improved by ~2ppts Meanwhile, KPJ continues to ramp up capacity at its Both companies saw EBITDA margins improved by hospitals opened in the last three years. ~2ppts each during the year. KPJ’s EBITDA margin had Notably, Pasir Gudang Specialist (opened May 2013) is improved to 12% from 10% in FY13, while IHH recorded a expected to break even soon at the EBITDA level but it margin of 26.4% (vs. 24.5% in FY13). may take longer for Maharani Specialist (opened June We believe the improved margins could be attributed to 2014) as it is a very new market. better operational efficiency, continued ramp-up of beds and price reversions.  Quicker turnaround for IHH See Exhibit 1 and 2 in following page for KPJ’s and IHH’s core earnings and EBITDA margin trend. As for IHH, its Acibadem Atakent hospital had achieved positive EBITDA of RM8mil in 4Q (vs. RM5.6mil loss in 3Q), NEW HOSPITALS IN THE PIPELINE within 12 months of opening in Jan 2014.

 Two new hospitals opened each last year Mount Novena’s EBITDA had also continued to improve with 170 beds already operational and a 60% occupancy Recall that KPJ opened the Rawang Specialist and rate. Maharani Specialist hospitals in March and June, while IHH had opened Aicibaden Atakent Hospital and Pantai Hospital Manjung in January and May.

KPJ’s Rawang Specialist hospital was opened in March 2014 with an initial capacity of 30 beds (full capacity: 159 beds). Meanwhile, its Bandar Maharani hospital was opened in June with an initial capacity of 60 beds (full capacity: 120 beds).  KPJ to open Pahang and Perlis Specialist this year

This year, KPJ is expected to complete construction for the Pahang (120 beds) and Perlis Specialist (60 beds) hospitals in 1H15 and 2H15, respectively. This will increase its stable to 27 hospitals.

AmResearch Sdn Bhd 2 Healthcare 24 Mar 2015

EXHIBIT 1: KPJ’S CORE EARNINGS AND EBITDA MARGIN TREND

200.0 14.0

180.0 12.8 12.6 12.3 12.0 11.9 12.0 160.0 11.6 11.5 11.1 140.0 10.0 120.0 9.0

100.0 8.0 RM mil RM 80.0 % Margin 6.0 60.0 40.0 4.0 20.0

- 2.0

FY11 FY09 FY10 FY12 FY13 FY14

FY16F FY15F FY17F

Core earnings EBITDA margin

Source: Company, AmResearch

EXHIBIT 2: IHH’S CORE EARNINGS AND EBITDA MARGIN TREND

1,600.0 32.0

1,400.0 27.0 26.2 26.4 26.3 26.3 26.4 1,200.0 24.5 22.0 1,000.0

800.0 17.0 RM mil RM 600.0 (%) Margin 12.0 400.0 7.0 200.0

- 2.0

FY12 FY13 FY14

FY15F FY16F FY17F

Core earnings EBITDA margin

Source: Company, AmResearch

AmResearch Sdn Bhd 3 Healthcare 24 Mar 2015

EXHIBIT 3: HEALTH EXPENDITURE IN MALAYSIA, 1998-2012

45,000 30.0

40,000 26.4 25.0 35,000 21.1 30,000 20.0 19.0 25,000 15.0

RM mil RM 20,000 13.3 11.0 11.5 15,000 10.8 10.0 9.7 9.2 9.6 8.0 7.9 8.4 10,000 7.3 5.0 5,000 1.3

0 0.0

1999 1998 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Total Health Expenditure, Nominal (RM mil) YoY growth (%)

Source: Dept of Statistics, AmResearch

EXHIBIT 4: HEALTH EXPENDITURE AS % OF GDP HEALTHCARE DEMAND ROBUST 4.6 4.46 4.49  Healthcare to grow at 11% CAGR 4.4 4.4 4.35 4.27 4.2 We believe that healthcare demand remains healthy on the 4.05 back of an ageing nation (10% of population over 60 years 4 3.95 3.92 old by 2020), increasing health awareness and improving % % 3.8 3.78 3.7 economic wellbeing. 3.6 3.58 3.4 For the 2008-2012 period, healthcare expenditure had increased at a CAGR of 10% to RM42.2bil. As a 3.2 percentage of GDP, it has risen from 3.8% to 4.5% (see

3 Exhibit 3 and 4).

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2002 According to Frost & Sullivan, healthcare expenditure in % of GDP Malaysia is expected to surpass USD20bil (RM72bil) by 2025. It also projects the healthcare industry to register a Source: Dept of Statistics, AmResearch CAGR of 11% until 2020.

EXHIBIT 5: SENIOR CITIZENS AS % OF POPULATION 6,000 14  Revenue CAGR of 11% over last three years 12.0 5,000 12 9.9 The growing healthcare demand can be reflected in KPJ 10 and IHH’s revenue CAGR of 11% each over the past three 4,000 7.4 years. 8 6.3 3,000 5.7 5.9 Last year, KPJ’s sales rose 13% while IHH’s Malaysian 4.8 5.2 6 operating revenue increased by 12%. 2,000 4 We project sales for KPJ and IHH to grow at CAGR of 8% 1,000 2 and 13%, respectively, over the next three years. 387 546 745 1,032 1,399 2,135 3,440 4,933

0 0

1790 1980 1991 2000 2010 2020 2030 1960  KPJ and IHH command ~43% of admissions No of senior citizens ('000) % of total population

According to the Ministry of Health, total admissions and Source: Dept of Statistics, AmResearch outpatient attendances amounted to 1.02mil and 3.9mil, respectively, in 2013. Based on the two companies’ data,

we estimate KPJ and IHH to have 26% and 17% market shares of the total inpatient volume that year.

AmResearch Sdn Bhd 4 Healthcare 24 Mar 2015

MEDICAL TOURISM ON THE RISE  Ramping up capacity to cater to medical tourists

 Weakening MYR to boost medical tourism To ride on the growth of medical tourism, both KPJ and IHH are expanding and ramping up capacities at strategic The weakening MYR is expected to result in an influx of locations. medical tourists in the country. KPJ is targeting medical tourism contribution to total Frost & Sulllivan said that more medical tourists may opt revenue to increase to 25% by 2020 from 5% currently. to seek treatment in Malaysia due to the weakening MYR Apart from its current marketing activities in the Middle as SGD strengthens and the political unrest in Thailand. East, Asia, and East Africa, future growth will largely The MYR has weakened to 3.70 against the USD hinge on the completion of its flagship Bandar Dato’ Onn currently from 3.50 in the beginning of 2015 (see Exhibit Specialist Hospital (BDO) in Johor (Phase 1: 2016, 150 6). beds).

According to the Malaysia Healthcare Travel Council, BDO, with a development cost of RM400mil, will healthcare travellers recorded a CAGR of 12% to 770,000 spearhead KPJ’s strategy to increase foreign patients from 2007-2013. Last year, local medical tourism revenue under the medical tourism programme. grew 19% YoY to RM228mil. We expect medical tourism revenue will continue to grow for IHH’s three main markets – i.e. Malaysia, Singapore, EXHIBIT 6: USDMYR RATE Turkey – on the back of continuous marketing efforts and 3.8 favourable operating environments. 3.7 3.6 3.5 3.4 ALL EYES ON GST 3.3 3.2  GST leads to rise in medical costs 3.1 3 2.9 There has been numerous public discourse on the impact 2.8 of GST after the Royal Malaysian Customs Department released the updated GST healthcare services guide last

Nov.

24-Jul-14

24-Jan-15

24-Jun-14

24-Oct-14

24-Apr-14 24-Feb-15

24-Sep-14

24-Dec-14

24-Aug-14

24-Nov-14

24-Mar-14 24-May-14 In Dec, the Association of Private Hospitals Malaysia Source: Bloomberg , AmResearch (APHM) and Malaysian Medical Association (MMA) said that Malaysians will have to pay at least 5% more for EXHIBIT 7: HEALTHCARE TRAVELLERS 2007-2013 private healthcare when GST kicks in. However, the 900 60 Customs Department said charges should only go up by 1%-2%. 800 48 50 700 40  Patients to pay 6% GST for doctor’s fee 600 30 500 According to the Customs Department, services provided 20 by healthcare professionals employed by registered 400 15 17 15 15 10 10 private healthcare facilities are tax-exempt. 300 200 0 However, the majority of the doctors who provide services 100 -10 -10 at local private hospitals are deemed to be “independent 0 -20 consultants” – i.e. not under the hospitals’ payroll – and 2007 2008 2009 2010 2011 2012 2013 thus, their services are GST standard-rated.

No. of healthcare travellers ('000) YoY % Recently, it was reported that the medical fraternity may Source: Malaysia Healthcare Travel Council, AmResearch take a legal action against the government in regard to this.  Foreign patients make up 5% of revenue  Other standard-rated supplies Last year, foreign patients make up ~30% of IHH’s Ancillary services (e.g. prescription, food, mortuary Singapore revenue. These patients mainly came from services) are considered exempt supplies. Indonesia, China, and the Middle East. Other standard-rated supplies include: - non-related As for its Malaysian operations, foreign patients make up healthcare services (i.e. food catering, parking, laundry ~5% of its revenue, which is similar to KPJ’s 5%. services), rental/leasing (operation theatre, clinics), Note that foreign patients are mainly concentrated at seminars/training by doctors, fitness programs (gym, IHH’s bigger hospitals, e.g. Gleneagles Kuala Lumpur, spa), and medical aids for patients. and Gleneagles Penang. The same applies for KPJ as well.

AmResearch Sdn Bhd 5 Healthcare 24 Mar 2015

 Medicines on NEML are GST zero-rated In the latest results briefing, IHH management noted that it is exploring options to mitigate forex fluctuations. Medicines listed on the National Essential Medicine List (NEML) are zero-rated; other medicines are GST Generally, we expect forex’s impact on IHH to be net. standard-rated.

Please see Exhibit 9 for GST treatment on healthcare services. MAINTAIN NEUTRAL

 GST may exert pressure on margins  Maintain HOLD on KPJ on margin pressure

In general, we expect some margin pressure in the near While demand for healthcare will continue to rise, we see term, as the healthcare players will have to absorb the possible margin pressure for KPJ due to GST as well as cost increase, namely for the exempt supplies. new hospital openings in the pipeline (KPJ Pahang and Perlis slated for completion in 1H15 and 2H15 Both KPJ and IHH expect input costs to increase by 2%- respectively). 4% when GST is implemented but this will be partially mitigated by price reversions. We forecast net profit to grow 13% this year (FY14: 10%) but margins may remain flattish at 11% (FY14: 12%) due With new hospitals coming on-stream and expanding to pressure from GST as well as new hospital openings capacity, we expect flattish margins this year. this year.

KPJ will complete construction for Pahang (120 beds) and Perlis Specialist (60 beds) hospitals in 1H15 and 2H15, FOREX IMPACT respectively. This will increase its stable to 27 hospitals. We maintain HOLD on KPJ with a DCF-based fair value  KPJ’s borrowings are MYR denominated of RM4.10/share. This implies FY15F PE of 32x.

The weakening MYR has little impact on KPJ as its entire  Maintain HOLD on IHH, valuations fair borrowings are MYR-denominated and 90% of its revenue are derived from domestic hospitals. Meanwhile, IHH continues to achieve growth in inpatient and revenue intensity and has better margins compared  Net impact on IHH to those of peers.

As for IHH, only 1.7% of its total borrowings of RM4.3bil We forecast net earnings to grow 12% this year and as at end-Dec 2014 were MYR-denominated (see Exhibit flattish EBITDA margins of 26% (FY14: 26%) as 8 for breakdown). Gleneagles Kota Kinabalu and Gleneagles Medini are slated for completion this year (which will result in higher The strengthening SGD is positive for IHH, however it operating costs) and the expansion of Pantai KL and continues to be partially offset by the weakening Turkish Gleneagles KL. Lira. Positively, its Atakent hospital had been EBITDA positive While the exchange rate is expected to be volatile, this is since 4Q14 (within a year) while capacity will continue to hedged by IHH’s borrowings in the domestic currencies of be ramped-up at Mount Elizabeth Novena (currently 170 its operations. beds out of the 300 licensed). IHH should be able to mitigate rising cost pressure through improved efficiency EXHIBIT 8: IHH’S BORROWINGS AT END-DEC 2014 and higher revenue intensity. Currency RM mil Positively, its newly hospitals may also turned EBITDA SGD 1436.6 positive sooner-than-expected. MYR 76.1 Nevertheless, we believe that the positives are already USD 1095.9 priced in and deem its valuations to be fair at this juncture at 51x FY15F PE. Thus, we maintain our HOLD call for Macedonian Denar 5.8 IHH with a fair value of RM5.40/share. Swiss Franc 53.6 We have a NEUTRAL call on the sector. Euro 195.1 Turkish Lira 246.4 JPY 1101.5 HKD 58.4 Total 4269.4

1 SGD =RM2.68 1 Lira = RM1.483 1 USD = RM3.5044

Source: Companies, AmResearch

AmResearch Sdn Bhd 6 Healthcare 24 Mar 2015

EXHIBIT 9: GST RATES FOR PRIVATE HEALTHCARE SECTOR GST rate Supplies/services Examples GST standard rate Healthcare services provided by healthcare professionals in a private healthcare facility who (biz claims input tax, end- are not employees nor under its payroll on basis of contract users pay 6%) Pharmaceutical services not provided by govt or private healthcare facilities Retail pharmacies selling medicines not under NEML

Other services supplied by private healthcare facilities - (i) Non-related healthcare services, Food catering, parking, security, laundry, canteen, (ii) Rental/leasing, (iii) Seminar and training, (iv) Fitness and well-being programme, (v) hygienic cleaning, rental of operation theatre, rental of Traditional and complementary medicen services. medical equipment, rental of office & clinics, spa, massage centres. Outsourcing of services * Healthcare facility cannot claim input tax on GST charged by service providers, but service Food catering, canteen, security, parking, cleaning provider can claim GST if it is registered and laundry, laboratory and imaging services Sale of goods used as medical aids Crutches, wheelchair, artificial limb, hearing aid Imported services Medical opinion sought by cardiologist in a local private hospital from a heart specialist in London Acquisition of goods and services - e.g. machinery, equipment, non-NEML medicines *However, private hospitals registered under the Private Healthcare Facilities and Services Act 1998 will be given relief from GST payment unde the GST (Relief) Order 2014 for the acquisition of certain medical equipments to be used directly for the purpose of providing healthcare services as approved by DG of Customs GST exempt Healthcare services provided by healthcare professionals employed by registered/licensed (biz cannot claim input healthcare facility tax, consumers don't pay 6%) Registered of licensed private healthcare facility acting as a panel clinic to a company and provides services in the company's premises Healthcare services provided by a registed/licensed private healthcare facility to another Supply of blood test/ x-ray services by SPJ Hospital registered or licensed private healthcare facility to Ahmad Clinic. Ancillary services Prescription given by the doctor including medical aids which come as a package for the healthcare services, supply of food, mortuary services

Provision of medical reports for the purpose of providing certificate of fitness or occupational health services Plastic surgery and treatment provided by the licensed private healthcare facility * if services are provided by other than the licensed private healthcare facilities are for aesthetic purpose rather than reconstructive purpose, then such services will be subject to standard rate GST Zero rated Supply of goods and services exported from Malaysia (biz can claim input tax, consumers don't pay 6%) Medicaments and medical gases in the NEML and put up in measured doses or in forms of packaging for retail sale Source: Royal Malaysian Customs Department, AmResearch

AmResearch Sdn Bhd 7 Healthcare 24 Mar 2015

EXHIBIT 10: VALUATION MATRIX Name Call Price (RM) Fair value (RM) Mkt Cap (RM bil) PE (x) EV/EBITDA (x) P/B (x) Div. Yield FY15F (%) ROE (%) FY15F FY16F FY15F FY16F Median 7.7 35.9 30.9 20.5 18.9 5.0 1.1 14.9 IHH HEALTHCARE BHD BUY 5.81 5.40 47.5 50.6 40.7 20.6 18.0 2.4 0.5 4.9 KPJ HEALTHCARE BERHAD BUY 4.03 4.10 4.2 31.1 27.3 16.0 14.1 3.3 1.9 10.8 BANGKOK DUSIT MED SERVICE n/a n/a n/a 35.8 36.5 31.4 24.5 20.5 6.8 0.9 16.9 BUMRUNGRAD HOSPITAL PUB CO n/a n/a n/a 12.3 35.3 30.4 23.6 18.0 10.0 1.2 26.7 APOLLO HOSPITALS ENTERPRISE n/a n/a n/a 11.2 51.9 41.8 18.5 21.3 6.4 0.4 11.1 SAMITIVEJ PUBLIC CO LTD n/a n/a n/a 3.4 n/a n/a 17.8 n/a 5.0 2.4 21.7 RAMKHAMHAENG HOSPITAL PUB CO n/a n/a n/a 3.0 n/a n/a 42.2 n/a 4.2 n/a 17.3 BANGKOK CHAIN HOSPITAL PCL n/a n/a n/a 2.3 31.0 25.0 17.7 13.5 4.9 1.1 12.9 Source: AmResearch, Bloomberg

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