STILL POISED FOR GROWTH

•Strong beneficiary of medical travel growth

•Capacity to increase in stages

•Raising fair value to S$2.73

Healthy medical travel growth trend

We believe that Raffles Medical Group (RMG) would continue to benefit strongly from the healthy uptrend in medical travellers to the region, despite growing supply of new hospital beds from both local and regional competitors. This is premised on the group’s competitive pricing vis-à-vis its comparable peers, strong brand equity and continued drive to enhance the depth of its specialist offerings. Research firm Frost & Sullivan projected that the number of medical travellers to Singapore and the corresponding revenues generated would grow at a CAGR of 12.4% and 13.6% to 851k and S$2.03b, respectively, from 2012 to 2016.

Steady expansion plans to address rising demand

RMG’s new Specialist Centre in Orchard is scheduled to begin operations in 1H13, while its Raffles Hospital extension (additional 102,408 sf) is expected to be completed in early 2015. In the meantime, management has actively decanted some of its existing hospital facilities. This resulted in the opening of a Neuroscience specialist centre in Apr, while renovation works are ongoing for the expansion of its Health Screening facilities. We reckon this would improve its income streams as there could be follow-up treatment procedures.

Ease our margin assumptions slightly, but maintain BUY

RMG recently implemented wage increments across the board in 2Q12, driven by the Singapore government’s initiative to raise salaries in the public healthcare sector. We ease our EBIT margin assumptions and our PATMI forecasts for FY12 and FY13 are reduced by 2.1% and 1.4%, respectively. We believe that part of RMG’s cost pressure also arose from headcount expansion in preparation for the commencement of its new Specialist Centre. While these additional staff would also aid in the generation of revenue at existing premises now, pre-operating expenses incurred would cause some drag on its earnings as their contribution is not at an optimal level yet, in our view. We roll-forward our valuations to 24x blended FY12/13F EPS, which in turn raises our fair value estimate from S$2.58 to S$2.73. Maintain BUY.

Ready to rumble

ASEAN healthcare stocks have found a new lease of life, with share prices being re-rated amid increased trading volume. But is this happening on the back of an upcoming new listing or are there other catalysts?

We found various themes at work, including a lack of new capacity that is driving healthcare inflation in Singapore. An eventual unlocking of the value of RFMD's real estate for capital recycling could be on the cards. Maintain Outperform, EPS and target price at 20x CY13 P/E, its mid-cycle valuations.

No beds: good or bad?

Singapore's hospital bed shortage is an acute problem. The country has a lower bed ratio (2.22 beds per 1,000 people in 2010) than other developed nations. Though the government has been increasing bed capacity at public hospitals (through expansion and new developments), public hospitals are still unable to cater to rising demand for hospital beds. With capacity constraints in public and other private hospitals, patient loads at RFMD's flagship Raffles Hospital have been good.

Healthcare costs are surely rising

RFMD is creating capacity at its flagship hospital. When completed, the group will be able to increase its clinical services and specialist offerings. We expect the additional space to come on stream in FY14. With re-adjustments in in-patient billings and other charges, we see ample room for RFMD to catch up with its rates, albeit gradually initially (5-10% in FY12).

Catch this laggard

RFMD's balance sheet has been stronger than peers with a net cash position, though there may be additional capex in the next few quarters. ROEs are also strong, the result of the consistent return of spare cash to shareholders in the form of dividends. Valuation-wise, the stock is at 17x CY13 P/E (22.5x for peers) and 11x CY13 EV/EBITDA (Asian sector average of 14x).

Expect staff cost to inch up YoY

We recently hosted Raffles Medical at the OSK|DMG ASEAN Corporate Day. Key takeaways from the meetings: (1) Staff cost is expected to increase YoY, with increased headcount to prepare for operations at Thong Sia Building. (2) Continues to look out for suitable overseas expansion opportunities. (3) Dividend payout is likely to remain at about 40%. We continue to like Raffles Medical for its resilience and stable growth. Maintain BUY with DCF-based TP of S$2.67.

Increased headcount to prepare for expanded operations. Raffles Medical hired more staff as it prepares for operations at Thong Sia (its Specialist Medical Centre) and its hospital extension. Its plans for Thong Sia are progressing on track, and partial operations are expected in mid-2013, when a significant number of current tenants move out. Its hospital extension project is progressing well and construction is expected to be completed in 2015. Management also recently adjusted the salaries of its doctors, which would also contribute to YoY higher staff costs from 2Q onwards. However, management is optimistic that they would be able to progressively revise its prices upwards and still maintain competitiveness, given that its charges are still much lower than the other private hospitals. It aims to keep staff cost to below 50% of revenue (we are estimating 48%).

Still on the lookout for regional expansion opportunities. Raffles Medical remains interested in expanding its operations regionally. It remains keen in the China, Malaysian and possibly Vietnam markets, although management maintains that it would only proceed with the right partner. While it has a strong balance sheet and stable cash flows, management does not rule out the possibility of carrying out fund raising activities should there be a need.

Expects to maintain dividend payout. While Raffles Medical does not have a fixed dividend policy, management intends to keep the dividend payout ratio at 40%.

Due for a Re-rating

Cheapest hospital stock now, upgrade to BUY. The 11% dip in share price from its February high of SGD2.44 has resulted in Raffles Medical Group (RMG) emerging as the cheapest hospital stock in the region. We believe that the defensive nature of its hospital earnings is a strong attribute in an uncertain market. We upgrade our recommendation from HOLD to BUY, given its widening valuation discount relative to peers. Our DCF-based target price is lowered marginally to SGD2.71 after some minor adjustments.

Premium valuations intact. Despite the recent sell-off in equity markets, hospital stocks have managed to hold on to their premium valuations, trading at above-market average PERs of about 26x. Aside from defensive earnings, anticipation of renewed interest in the healthcare sector could have provided stock support, in the hope of a positive re-rating in valuations for the sector.

No competition from Novena suites. Parkway Pantai’s 333-bed Mount Elizabeth Novena Hospital is expected to open next month with 180 beds operating initially and the rest to come on-stream by the end of the year. Though this marks one of the biggest increases in private hospital beds in more than 10 years, we do not expect any major negative impact on RMG as the new hospital targets the high-end segment of the market.

Cost containment manageable. RMG’s greatest challenge lies in managing staff cost, which is estimated at 48% of its total revenue. The Singapore government intends to increase healthcare professionals’ wages by an average of 20% by 2014. RMG would need to respond correspondingly with a competitive compensation structure to retain and attract staff. Nevertheless, we note that it still has room to raise its charges and intends to do so, given that its average surgical cost is lower than that of Singapore General Hospital, a public hospital.

Strongest balance sheet. RMG has the strongest balance sheet among its peers, being the only one in a net cash position. Even after accounting for capex for its expansion plans, we expect it to remain in a net cash position, helped by its strong operating cash flow generating capability. Upgrade to BUY.

Due for a Re-rating

Cheapest hospital stock now, upgrade to BUY. The 11% dip in share price from its February high of SGD2.44 has resulted in Raffles Medical Group (RMG) emerging as the cheapest hospital stock in the region. We believe that the defensive nature of its hospital earnings is a strong attribute in an uncertain market. We upgrade our recommendation from HOLD to BUY, given its widening valuation discount relative to peers. Our DCF-based target price is lowered marginally to SGD2.71 after some minor adjustments.

Premium valuations intact. Despite the recent sell-off in equity markets, hospital stocks have managed to hold on to their premium valuations, trading at above-market average PERs of about 26x. Aside from defensive earnings, anticipation of renewed interest in the healthcare sector could have provided stock support, in the hope of a positive re-rating in valuations for the sector.

No competition from Novena suites. Parkway Pantai’s 333-bed Mount Elizabeth Novena Hospital is expected to open next month with 180 beds operating initially and the rest to come on-stream by the end of the year. Though this marks one of the biggest increases in private hospital beds in more than 10 years, we do not expect any major negative impact on RMG as the new hospital targets the high-end segment of the market.

Cost containment manageable. RMG’s greatest challenge lies in managing staff cost, which is estimated at 48% of its total revenue. The Singapore government intends to increase healthcare professionals’ wages by an average of 20% by 2014. RMG would need to respond correspondingly with a competitive compensation structure to retain and attract staff. Nevertheless, we note that it still has room to raise its charges and intends to do so, given that its average surgical cost is lower than that of Singapore General Hospital, a public hospital.

Strongest balance sheet. RMG has the strongest balance sheet among its peers, being the only one in a net cash position. Even after accounting for capex for its expansion plans, we expect it to remain in a net cash position, helped by its strong operating cash flow generating capability. Upgrade to BUY.