Welcome 2008

Recently, we visited Thomson Medical Center. After we obtained further updates from Thomson’s management, we found that Thomson’s fundamentals continue to remain sound. The average number of babies delivered every month at hospitals managed by Thomson over the past four months has surpassed 700, compared to the average deliveries of 639 in FY07. We believe the growth of child deliveries in Thomson will support well Thomson’s top line and bottom line growth in 2008. Due to weak market conditions, we have seen Thomson’s share price slide to S$0.62, which provides a good entry point to buy into this counter. However, we only recommend long- term investors to take a position due to the short term uncertainty of market.

Postponement of upgrade of two more wards. As the Group has seen increasing number of child deliveries, it could postpone the announced upgrading of two wards to 2H08. As there are just 1.5 months left in 1H08, we would expect that 1H08 will be less affected by upgrading and thus is likely to show a better than expected growth in 1H08. Overall, we retain our target for FY08 and FY09.

Reputable winner of the Singapore Prestige Brand Award 2007. Thomson has won the Singapore Prestige Brand Award once again in year 2007, the award honoring home-grown brands that have been established between 6 to 30 years ago. This recognition demonstrates outstanding performance in the communication and marketing of Thomson’s brand, and has explained why Thomson has taken a bigger bite of the shrinking pie.

Valuation! We maintain our forecast for FY08 and FY09 with net profit SGD 10.5 mln and SGD 12.0 mln. We still peg our PE at 24x FY07, and reach a fair value of 78.5 cents. Given that healthcare sector is more defensive during economic downturns, we feel it is worthwhile to consider Thomson during this time. Re-iterate Buy!

There’s demand, but where’s the space?

2008 outlook

Higher baby deliveries and inpatient admissions expected in 2008, on the back of: 1) increased patient loads seen by tenant specialists, peripheral specialists and the network of Thomson Women’s Clinics, with another clinic to be added in 1H08; 2) TMC’s strong branding and reputation as the only private women’s and children’s hospital in Singapore; 3) the government’s marriage and procreation incentives; 4) an immigration boom, especially of skilled professionals of reproductive age; and 5) a still-healthy Singapore economy and relatively robust regional economies.

Room to raise rates. TMC renovated two wards this year and will be renovating another two in FY08. After renovation, it will be positioning one as a premium ward. With its fees among the lowest of the private hospitals, there remains much potential for fee hikes, particularly with its enhanced facilities.

Still room to grow? TMC’s hospital is near full occupancy at more than 80%. While it has actively rationalised space to create additional capacity and increased patient admissions by encouraging patients to be discharged earlier, we remain cautious that capacity constraints could limit its longer-term growth.

Recurring fee income from Vietnam project. We expect the group to receive US$0.5m and US$0.3m in consultancy fees in FY08 and FY09 respectively. Upon completion in 2009, the group will manage the Vietnam hospital for five years with the option for another five. Hospital management fees are typically 2-4% of revenue and 3-5% of net profit. We have not imputed fee income from hospital management in our forecasts as details are not yet available. Further upside could come from the exercise of a second option to take an equity stake of up to 25% within three years from the commencement of operation. In addition, management announced in Nov 06 that it would be undertaking project-consultancy contracts for two more greenfield women’s and children’s hospitals within the next 18-36 months on an exclusive basis.

Valuation and recommendation

Target price reduced to S$0.77 from S$0.88; downgrade to Neutral from Outperform. We have reduced our earnings estimates by 5-10% for FY09-10 on the back of potential capacity constraints (lower number of beds assumed). Following this, our target price has been lowered to S$0.77 from S$0.88, based on 15x CY09 P/E, still a 15% discount to the peer average. Stock catalysts could come from: 1) regional hospital projects and management consultancy contract wins; and 2) significant capacity expansion.

All set to deliver

A celebration of life

Target audience: women and children. Thomson Medical Centre (TMC) focuses on specialist care for women and children by offering a comprehensive range of services in obstetrics & gynaecology and paediatrics. Its flagship 190-bed Thomson Medical Centre at Thomson Road was established in 1979. The hospital generates recurrent revenue from the provision of inpatient services such as accommodation, nursing procedures and use of facilities like operating theatres and labour suites.

TMC provides assisted reproductive programmes, such as in-vitro fertilisation, Intrauterine Insemination and Intracytoplasmic Sperm Injection, through Thomson Fertility Centre. Subsidiary Thomson Pre-Natal Diagnostic Laboratory helps parents in early detection of chromosomal abnormalities like Down Syndrome and Thalassaemia. The company also operates a network of seven women and children clinics in Singapore.

More babies and better margins. Deliveries at TMC reach record of 7,665 babies in FY07, an increase of 6.9%. This is achieved through promotion of the Thomson Medical brand, increased patient load seen by tenant specialists and referrals from Thomson Women’s Clinics. TMC has also recognised S$0.35m consultancy fee in FY07 for the hospital consultancy project in Vietnam. Net margin has expanded from 14.6% in FY06 to 18.1% in FY07 due to improved operating efficiencies and increased patient volume. This was achieved despite closure of two wards for renovation.

Upgrading Thomson Medical Centre. TMC plans to increase the number of tenant specialists and has completed the renovation of Level 3 and Level 5 inpatient wards to cater to increased patient volume. Level 5 is positioned as a premium ward offering differentiated services. TMC plans to add another two operating theatres for increased volume of surgical procedures. TMC has 3,200 members under the First Born Incentives (FBI) and Subsequent Born Incentive (SBI) programmes. Members, who are mothers-to-be, are entitled to retail and medical services privileges. These programmes build brand loyalty.

Expanding Specialised Services. Thomson Fertility Centre sees increased patient load both locally and regionally. Foreign patient numbers has doubled over the past year. TMC and partner Hanh Phuc will work together on an exclusive basis to develop women and children hospitals in Vietnam. . It is also exploring opportunities for providing fertility treatments in Vietnam. TMC will set up another Thomson Women’s Clinic in Ang Mo Kio Hub in 1H08.

Annual birth rate in Singapore increased 825 or 2.2% to 38,317 in 2006. The country needs 60,000 babies a year to replace the population. The Government is reviewing marriage and pro-creation incentives, such as increasing subsidies for child care services, extending maternity and paternity leave and instituting better work-life balance in companies, to encourage Singaporeans to have more babies.

TMC has stated dividend policy of 50% payout on net profit. The company paid total dividend of 2.5 cents/share for FY07, representing dividend yield of 3.6%.

Delivering results

• In line. FY07 net profit of S$9.5m (+40% yoy) is within consensus and 2% above our expectations. Growth was led by increased deliveries, a higher patient load and better contributions from specialist services.

• Revenue rose 13% yoy to S$52.4m, driven by Hospital Operations (+11% yoy) and Specialised Services (+22% yoy). Revenue from Hospital Operations rose to S$41.8m on the back of higher baby deliveries (+7% yoy to a record 7,665 babies) and inpatient admissions from patient referrals from its tenant specialists, peripheral specialists and network of Thomson Women’s Clinics. Revenue from Specialised Services increased to S$10.5m on higher contributions from all its subsidiaries. The hospital consultancy project in Vietnam is progressing as scheduled, with S$0.35m in consultancy fees recognised in FY07.

• Margin improvements. Despite higher staff costs and the closure of two wards for renovation, gross and net profit margins came in at all-time highs of 43% and 18% (17% excluding divestment gains) respectively, thanks to improved operational efficiencies and lower finance costs.

• Record dividend payout of 77%. The group will be paying out a dividend of 1 Sct for 2H07. It paid a total of 1.5 Scts in ordinary and special dividends in 1H07.

• Expansion plans. The group plans to renovate two levels of inpatient facilities and add two operating theatres in FY08. It will further rationalise space to add three medical suites for new specialists and set up another Thomson Women’s Clinic in Ang Mo Kio Hub in 1H08. Both developments are expected to generate patient referrals for its hospital facilities and services. The group is also exploring opportunities to establish a fertility centre in Vietnam to capitalise on Vietnam’s high demand for fertility treatment. Other initiatives introduced in FY07 included the launch of its Enhanced First Born Incentive, Subsequent Born Incentive and Thomson Junior Angels Club programmes to build brand loyalty, as well as the introduction of a Korean service to serve the Korean community in Singapore.

• Maintain Outperform with target price raised to S$0.88. We have raised our FY09 earnings estimate by 6% to reflect stronger contributions from Specialised Services (additional Thomson Women’s Clinic and fertility centre) and introduced FY10 assumptions. We have also raised our target price to S$0.88 from S$0.87, after rolling forward our target basis to CY09 from CY08. Our new target is now based on 16x CY09 P/E (previously 20x CY08 P/E), still maintaining a 15% discount to the peer average.