SINGAPORE (Mar 18): Investors do not appear to have much choice if they wish to have exposure to the local healthcare sector. Apart from a bunch of clinics — which have business models akin to multi-level marketing schemes — there are the two big players, Raffles Medical Group (RMG) and IHH Healthcare. IHH Healthcare is dual-listed on Bursa Malaysia and the Singapore Exchange. There is also Thomson Medical Group, a healthcare play aspirant, but its relatively weak financials preclude it from being a serious contender.

In a nutshell, RMG is the best of the non-real estate investment trust (REIT) grouping. It is the only private medical provider in Singapore that owns and operates a fully integrated healthcare organisation comprising a tertiary hospital, a network of family medicine and dental clinics, insurance services, Japanese and traditional Chinese medicine clinics and a consumer healthcare division. “We have an integrated model. We have everything under one roof,” says Goh Ann Nee, chief financial officer (CFO) at RMG.

Its recently opened hospital — Raffles Hospital Chongqing — is likely to create a short-term headwind in the form of startup losses. Goh has said the Chongqing hospital is likely to record losses of around $10 million for this year, $4 million to $5 million for 2020 and break even in 2021. Similarly, Raffles Hospital Shanghai in Pudong, which will be completed in 4Q2019, is likely to report a $10 million loss in 2020 and a further $4 million to $5 million loss in 2021 before breaking even in 2022.

Even then, RMG offers more near-term catalysts, given that its hospitals, which were under construction over the last few years, have either started or are starting operations and should yield income in the next few years. In the meantime, IHH’s investments are likely to have a longer gestation period.

Raffles Specialist Centre — a new 20-storey building with two basements and a total gross floor area (GFA) of about 220,000 sq ft that was developed at a total estimated cost of $310 million — opened in January. In addition, the new wing will also have more F&B options, including a food court in the basement, and cafés and restaurants on the first three levels of the building. The medical group also owns Raffles Holland V, a medical centre and mall. Raffles Specialist Centre and Raffles Hospital together yield a GFA of about 520,000 sq ft and will offer opportunities to expand capacity and enable RMG to develop new services. At the same time, renovation work has started at Raffles Hospital and is expected to be completed by mid-2019. The expanded outpatient and inpatient capacities will enable Raffles Hospital to meet expected growth for the coming years, according to a statement by RMG.

In January last year, RMG started a five-year partnership with the Ministry of Health and the Agency for Integrated Care (AIC) through three Primary Care Network clusters in the country. Mindful of rising costs, CFO Goh says RMG does not stray far from guidelines on fees. “MOH has published a fees benchmark [for guidance]. You can always look at the benchmark [and compare]. We would know all the core surgical procedures, because medical costs and insurance are going up. We wouldn’t want to over-treat patients, that is, the buffet syndrome. Singapore is making sure healthcare costs remain affordable,” Goh explains.

An additional catalyst could be the extension of the Community Health Assist Scheme (CHAS) and better benefits to the Merdeka Generation (those born in the 1950s), announced in the Budget last month, according to DBS Group Research. “[CHAS] should increase the number of people that are subsidised as they seek medical treatment from the GP clinic network. This bodes well for Raffles Medical’s healthcare services division,” the local bank says.

ParkwayLife REIT offers stable yield and capital gain

IHH’s diversification has increased its risk profile. On a positive note, the sprawling medical group is sponsor and major shareholder of ParkwayLife REIT, viewed as the only blue-chip healthcare S-REIT. With a more dovish US Federal Reserve, ParkwayLife REIT is up more than 9% since the start of the year. The price gain excludes a distribution per unit of 3.28 cents for 4QFY2018. For FY2018, DPU totals 12.87 cents, translating into a yield of 4.5%.

Although this is low for an S-REIT, ParkwayLife REIT’s defensive long-term lease structure and secure cash flows — it owns three hospitals in Singapore, Gleneagles Intan Medical Centre in Kuala Lumpur and 45 nursing homes in Japan — make it the de facto healthcare play for investors in view of uncertainties elsewhere in the sector. The Singapore hospitals contribute 59.8% of total revenue and the lease structures offer downside protection should medical tourism ease. Undoubtedly, ParkwayLife REIT is the jewel in IHH’s crown. IHH owns 35.7% of ParkwayLife REIT and Khazanah holds a 42.1% stake.

Other IHH investments could turn out to be more volatile. Last November, IHH became the controlling shareholder in Fortis Healthcare after completing an INR40 billion ($780 million) subscription to a preferential allotment of shares for a 31.1% interest in Fortis. It has since appointed five members to the Fortis board and continues to work towards the launch of the open offer for up to an additional 26% interest in Fortis, at an offer price of INR170 a share, subject to the Supreme Court of India’s ruling passed on Dec 14, 2018.

In January this year, Fortis completed the acquisition of RHT Health Trust’s Indian assets for a total cash consideration of INR46.7 billion. This consolidates Fortis’ control over the RHT assets. IHH claims the acquisition streamlines its Indian portfolio and should generate substantial cost savings, as Fortis will no longer need to bear significant rental fees paid to the trust.

Turkey proves a challenge

Elsewhere, in Turkey, in November 2018, IHH completed a transaction that simplified Acibadem Holdings’ shareholding structure and increased its stake in Acibadem to about 90% (from 60% previously). Acibadem is a private healthcare provider in Turkey. IHH is working to repay Acibadem’s existing non-lira loans equivalent to US$250 million ($339 million) and, over the medium term, will look to divest Acibadem’s non-core assets to further reduce its foreign debt obligations and deleverage its balance sheet. The group’s clear plans will put Acibadem in a stronger position to manage volatility in the Turkish lira, IHH says. Acibadem reported a 9% decline in revenue and a 13% fall in earnings before interest, taxes, depreciation and amortisation (Ebitda) in FY2018.

Closer to home, IHH acquired a 100% interest in Amanjaya Specialist Centre in Sungai Petani, Kedah. This has allowed the group to cater for strong demand at Pantai Hospital Sungai Petani, which is operating at near-full capacity.

In China, IHH plans to open Gleneagles Chengdu Hospital this year and Gleneagles Shanghai Hospital next year. Both hospitals are likely to incur start-up costs. Gleneagles Hong Kong Hospital opened in 2017 and its Ebitda losses are expected to narrow this year.

Overall, for FY2018, revenue increased 3% y-o-y to RM11.5 billion ($3.8 billion), while Ebitda was up 9% y-o-y to RM2.5 billion. Headline profit after tax and minority interests (Patmi) fell 35% y-o-y to RM627.7 million, largely because of higher forex losses for Acibadem’s non-lira loans. On March 11, Turkey announced a sharp deceleration in GDP growth in 4Q2018. For 2018, the country’s growth slowed markedly to 2.6% y-o-y, down from 7.4% in 2017. Still, according to an announcement by Acibadem, it expects its patient volumes to grow with the continued demand in and increased affordability of private healthcare as well as more foreign medical travellers going to Turkey for medical treatment.

Wide variations in outlook for IHH

After IHH released its results last month, a poll by Bloomberg showed that analysts are generally bullish on its stock. It garnered three “neutral” ratings and five “buy” recommendations. For instance Maybank Kim Eng is bullish about IHH’s prospects and raised its earnings per share forecast. It has a sum-of-the-parts valuation of RM6.90 a share. JPMorgan, on the other hand, is a lot more cautious.

“Despite turnaround plans for Fortis already under way, the acquisition, we believe, could still see near-term pain (with estimated 5% to 6% dilution to FY2019 estimates) before benefits, while the ramp-up and reduction in losses for Gleneagles Hong Kong remains slower than expected. Hence, on balance, we are neutral at current levels, but view any material share price strength on the back of the results as an opportunity to lock in some profits,” JPMorgan says. It has a price target of RM5.40.

Our in-house analysis using yield and margin-of-safety analysis indicates that IHH is overvalued. On the other hand, our discounted cash flow analysis, coupled with the market value of ParkwayLife REIT, gives a net present value (NPV) of RM5.71. The DCF assumes cash flow growth of 6.88% for this year, 6.22% for next year and 5.61% for FY2021. IHH currently trades at RM5.86 and is viewed as fairly valued.

For FY2018, RMG reported a 5.4% y-o-y increase in revenue to $489.1 million. Ebitda increased 7.8% y-o-y to $102.5 million and Patmi rose marginally to $71.1 million. RMG’s Patmi would have been higher had it not been for higher tax expenses and additional depreciation from Raffles Specialist Centre.

Interestingly, analysts are less bullish on RMG, which has only three “buy” calls on Bloomberg and six “neutral” ratings. However, in terms of our own yield and margin-of-safety analysis, RMG is relatively undervalued compared with IHH and Thomson Medical, but its growth rates are more modest than IHH’s. RMG’s cash flow growth is likely to be 3.38% this year, 3.06% next year and 2.76% in 2021. Although its NPV is $1.09 a share, our yield and margin-of-safety analysis shows that RMG has the highest yields relative to risk-free rates compared with IHH and Thomson Medical.

No surprise then that some investors still view RMG as a longer-term value investment. “I like their expansion into China, although it’s still early days. The Chongqing hospital is starting and Shanghai opens next year. In Singapore, the extension wing will provide scope for expanding their range of medical services, bed capacity, specialist clinics and so on,” says Goh Han Peng, director of R3 Asset Management. “Near-term challenges are a slowdown in medical tourists to Singapore, owing to the strong Singapore dollar, the gestation losses for the new hospitals and the execution of the China hospitals. Overall, I’m positive, given the track record of the management.”

Raffles Medical looks best, Thomson Medical the worst

Our in-house analysis — shown in Charts 1, 2 and 3 — compares the yields of Raffles Medical Group, Thomson Medical Group and IHH Healthcare with the risk-free rates of Singapore and Malaysia. Ideally, the fundamental yields should be higher than the risk-free rate for the company to be attractive at its current trading price. Only Raffles Medical appears to have better yields versus the risk-free rate, with IHH and Thomson Medical looking relatively unattractive. Of the two, Thomson Medical appears to be more unattractive, as its yields are very low and free-cash flow is negative.

This story appears in The Edge Singapore (Issue 873, week of Mar 18) which is on sale now. Subscribe here