RafflesMed – CIMB

Blessing wearing its disguise

Market intelligence suggests that RFMD may no longer be the medical service provider to the Singapore Prison from Dec 12.This could actually benefit its profitability. Yes, the contract size appears huge but the economics is a lot more than meets the eye.

We believe RFMD intends to rationalize its manpower and other resources to focus on chasing higher-margin healthcare businesses. Our EPS and target price, at 22x CY13 P/E(mid-cycle valuations), are unchanged. Maintain Outperform with catalysts expected from higher in-patient billings.

What Happened

There have been murmurings that RFMD will no longer be the medical service provider to the Singapore Prison come Dec 12, when its present contract expires. The estimated value of the new contract from the Ministry of Home Affairs is roughly S$300m, for 5+3 years, starting 2013.

What We Think

We do not think this is such bad news. In fact, we would applaud any such development. From a revenue-profit perspective, we think there is not much operating leverage from its previous public contract. Actual contribution to group revenue is roughly 4%, while net contribution is less than 2.5%.We believe new branches opened in recent years have more than replaced this source of revenue. Also, from a cost perspective, the manpower and resources spent do not favour the economics now unlike the past. With tighter restriction of the employment of foreign labour and new initiatives for expansion (new specialist centre, new wing and various new branches), management would be better off focusing its resources on its current private healthcare business, in our opinion.

What You Should Do

Stay invested. With readjustments in its inpatient billings, we see ample room for RFMD to catch up with rates, albeit gradually initially (5-10% in 4Q12). This provides scope for the company to close its pricing gap with its competitors. RFMD is still a laggard stock in this sector; it has a strong balance sheet among peers in the region. ROEs have also been strong. Maintain Outperform.

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