• 1H19 EBITDA and Core PATMI were below our expectations due to the drag in Starmed’s gestation costs.
• Excluding the impact from StarMed, 1Q19 EBITDA and core PATMI expanded by 4.9% YoY and 15.5% YoY.
• Revenue rose 10.9% YoY, boosted by the higher patient load (+6.8% YoY) and higher outpatient bill size (+4.8% YoY).
• An interim dividend of RM1.0 cents declared (1H18: RM1.0 cents).
• New investment of an initial S$4.2mn for a 28% stake in a chain of 16 primary care clinics in Singapore to expand its healthcare network in Singapore.
• Maintain BUY with an unchanged DCF-derived TP of S$0.77.

The Positives

• Higher patient load. Mahkota (Mahkota Medical Centre) and Regency (Regency Specialist Hospital) combined saw a 8% YoY increase in patient load to 122.4k in 2Q19. It was driven by growth in both outpatient and inpatient load. The boost in patient load was mainly due to more sub-specialist doctors recruited in the two hospitals, which attracts more referrals and increased marketing to the community and corporate clients. Local patient load grew while foreign patient load dipped due to a weakening rupiah. Foreign patient load accounted for 20% of the total patient load (2Q18: 23%).
• Bill size and complex treatment rising. Average bill sizes continued to grow with higher revenue intensity and increasingly complex surgeries. Average inpatient bill size remained stable while outpatient bill size rose 5.0% YoY.
• Bed occupancy spiked to 63% (2Q18: 55%) while the total number of operational beds remained stable at 437. HMI continues to increase their bed capacity due to fully occupied beds at mid-day even though majority of the patient load comes from outpatient. At Regency, the new extension block has begun construction and its targeted commissioning expected in 2021. It will increase Regency’s bed count to 380 with the potential to expand to 500.

The Negative

Starmed’s gestation costs to weigh down PATMI in the next 2 to 3 years. Core PATMI of RM14.6mn fell 28.4% YoY, making up 44.3% of our full-year estimate, below our expectations. The weakening of the Malaysian ringgit resulted in FOREX losses of RM3.0mn (2Q18: +RM0.1mn). Distribution and marketing expenses rose RM0.9mn due to increased marketing to the community and corporate clients. Administrative expenses spiked RM6.2mn due to Starmed and rising operating costs in the Group. Finance costs rose by RM0.8mn due to reduced finance costs from restructuring activities offset by RM1.2mn mortgage financing incurred by Starmed. Profit attributable to NCI rose RM1.7mn due to contribution made to the remaining 30% of Starmed’s shareholders.  Starmed’s loss in 2Q19 is around RM5mn with negligible revenue.

Outlook

We remain positive on the outlook for HMI due to its resilient hospital operations and growth trajectory to meet the growing demand.

1. Mahkota (Melaka)

Progressive upgrading and refurbishing of older wards to maintain a new and consistently upgraded facility for the patients.

2. Regency (Johor)

Construction of Regency’s new extension block has begun and with its targeted commissioning in 2021, Regency will become a 380-bed tertiary hospital, with the potential to expand capacity to 500 beds.

3. Competitors to join the fray in 2019

KPJ Bandar Dato Onn (Johor) and Columbia Asia South Key (Johor) expected to open within next 6 to 12 months, with each commissioning with an initial phase of 100 beds. Regency would face increasing competition for specialists, staff and patients.

3. StarMed Specialist Centre (StarMed)

Starmed started operations in 1Q19 after obtaining its license with the official launch expected in the second half of this year. HMI owns 70% of StarMed with the remaining 30% owned by doctors. StarMed’s gestation costs is estimated to drag down margins for 2-3 years before it breaks even. HMI currently owns the 5^th-7^th floor while renting the 8^th floor. HMI has entered into agreements to purchase additional units (1^st, 8^th and 9^th floors) with an aggregate area of 10,602 sqft. Key growth drivers for StarMed will be higher insurance-holding population, ageing population and medical tourism. We factored in RM1.6-2.2mn in EBIT loss p.a. for each of the first three years of operations.

4. New investment in Primary Care – Plus Medical Holdings Pte Ltd (Plus)

HMI announced an initial S$4.2mn investment for a 28% stake in a chain of 16 primary care clinics in Singapore. HMI’s stake to increase over time subject to further requests for funding and satisfaction of certain conditions. Despite intense competition in the primary healthcare space HMI believes that acquiring Plus is viable due to its (i) efficiency, (ii) high patient load, (iii) affordability and (iv) greater outreach into the community will be beneficial for Starmed to obtain referrals.

Maintain BUY with an unchanged DCF-derived TP of S$0.77.

We maintain our view that HMI will benefit from the socioeconomic tailwinds arising from (i) public and private initiatives to improve infrastructure and regional connectivity; (ii) increasing domestic insurance take-up rate; (iii) favourable demographics; and (iv) cost competitive pricing compared to regional peers. Potential risks include (i) greater competition; (ii) disadvantageous regulatory changes; and (iii) longer than expected gestation period.