• 25-year dental-health brand returning to organic growth through 20% annual expansion in clinic network in Singapore and Malaysia and increased patient spending.
• New earnings drivers from laboratory testing and sale of Covid-19 PCR test kits in and beyond Singapore. Record earnings expected from clinic expansion, increased patient spend and new PCR test kit operations.
• Initiate coverage with BUY and target price of S$0.70. Healthcare service sector valuations can rise to almost 40x PE. Historical normalised PE for Q & M averages 38x, with a low of 26x. We peg Q & M at 20x FY21e PE for its core business. This gives us S$0.67. Another 3 cents has been added from the market value of Aoxin. Our TP implies a 50% discount to historical and industry PEs. We see opportunities for a narrowing of the discount if the company executes on expansion and new virus test kits take off as planned.

Company Background

Established in 1996, Q & M is a household dental chain with the largest network of private dental outlets in Singapore and Malaysia. Through its 42.8%-owned listed associate, Aoxin Q & M (S$0.186, Not Rated), it is building a chain of dental hospitals and polyclinics in China. Q & M was listed on the SGX on 26 November 2009. As of June 2020, it operated 114 dental clinics in Singapore (80), Malaysia (33) and China (1) with the support of more than 230 dentists. We estimate its revenue market share of private dental clinics in Singapore at 10%, at the very least. More details in Appendix 1.  

Investment Merits

1. Organic growth resurgence. Before 2019, Q & M added six dental clinics on average a year. New clinic additions are now expected to jump to 26 a year from 2021 to 2022, representing 20% growth p.a. The pandemic had stalled expansion last year to an expected nine new clinics only, for 8% growth. New clinics are a more sustainable and lower-risk mode of growth than acquisitions of existing clinics. The group can avoid high valuations, integration risks and peak earnings. Dentists are attracted to the Q & M brand as it can draw patients and enable them to focus on their practice rather than administrative, human resource and financial matters. Border closures and work-from-home arrangements have also increased dental visits and patient spending.
2. New opportunity in PCR testing. In September 2020, Q & M’s 51% venture – Acumen Diagnostics – received approval to offer PCR testing of Covid-19 in Singapore. Q & M can both sell its proprietary PCR diagnostic kit called Acu-Corona® 2.0. and provide lab-testing services. We assume a 3% share of daily PCR tests with a 25% net margin from FY21e. No guidance has been provided by the company. It will account for around 13% of our FY21e PATMI.
3. Attractive valuations with other potential catalysts. Based on normalised earnings, PE averaged 38x in the past seven years. Healthcare stocks such as hospitals trade from 40x to 80x PE. We believe 20x PE is fair as we have incorporated a large 50% discount. We believe the discount may narrow as growth materialises. Other earnings drivers not incorporated in our model are PCR test kits sold globally and Aoxin’s return to profitability.

We initiate coverage with a BUY rating. Our target price is S$0.70, based on 20x FY21e PE for its core operations and market cap valuations of its listed associate Aoxin.

REVENUE
Revenue includes fees from clinical consultation, treatment and the sale of medicine and oral-care products. As dental services cannot be advertised in Singapore, Q & M’s clients are either walk-in patients, referred patients or employees on corporate accounts. Around 80% of its patients are private. The balance are from corporate and government accounts sourced directly by its in-house marketing team. Q & M is considered a household name in Singapore with a pull factor for people seeking dental tretment. Other important factors for its success are its prominent logos and good locations in HDB estates, shopping malls and at MRT exchanges. The intangible of a successful clinic is doctors’ management and communication with patients.
By geographical split, 90% of its revenue comes from Singapore. Another 9% comes from Malaysia. 1H20 revenue declined 14% YoY due to the circuit breaker in Singapore and movement control in Malaysia. This was when aesthetics and complex treatments were restricted. There was a sharp recovery when the lockdown in both countries eased. Q & M reported 20% and 15% YoY jumps in revenue in Singapore and Malaysia respectively in June 2020.

EXPENSES
Gross margins after deducting for raw materials such as consumables and dental supplies range from 82% to 89%. The largest cost item, at around 60% of revenue, is employee expenses (Figure 2). These are namely fees shared with the dentists. Q & M’s dentists are not paid fixed salaries but a share of the company’s gross profits, at 40-50% depending on the seniority of the dentists. With the pandemic, rental costs are expected to trend lower in malls as landlords prefer to retain large and established tenants such as Q & M. In general, medical procedure margins are higher than medicine sales due to the service and consultation provided. Dentistry is also a resilient form of healthcare service as there are no self-medicating alternatives.

ASSOCIATE & OTHER INCOME
Q & M has two categories of other income:

1. 1. Other gains. In the past five years, it chalked up other gains of S$57mn. In 2016, it booked a S$21.3mn gain from the conversion of Aidite from subsidiary to associate. Another S$17.4mn gain was recognised in 2017 from Aoxin’s listing on SGX’s Catalist. A partial disposal of a stake in Aidite in 2019 led to an S$11.6mn gain. In January 2021, Q & M fully disposed of its 9% stake in Aidite for a gain of S$5mn.
2. Associates. The largest earnings contributor used to be Aidite, whose 9.19% stake was entirely sold in January for S$18mn. Q & M’s main associate is now 42.8% owned Aoxin Q & M. Aoxin booked a loss of RMB10.4mn or S$2.1mn in 1H20 following a total shutdown of its operations in China from February to March 2020. On 27 December 2020, four of its dental centres were also temporarily suspended from operations due to a Covid-19 outbreak in Shenyang.

BALANCE SHEET

Assets. Based on 1H20 results, almost 40% of its assets were intangibles and right-of-use assets. Of its S$57mn goodwill, around S$27mn was related to its acquisition of TP Dental Surgeons in 2015. Another S$8.6mn was from its acquisition of Lee & Lee Dental in 2016. TP Dental was founded in 1973. Its S$28.6mn acquisition marked Q & M’s entry into premium dental practice. The clinic has its own in-house laboratory for the production of personalised dental appliances.

Another third was made up of cash and associates. Fixed assets were minimal at 11% of total assets. The balance 14% of assets was working capital. Q & M’s underlying dental business is asset-light. Intangible assets are from previous acquisitions while right-of-use is capitalised rental expense. Associates have been loss-making after the disposal of Aidite. In short, the bulk of the assets on its balance sheet is not relevant to its dental business except working capital and equipment which is around 30% of current assets. 1H20 inventories more than doubled over six months due to stockpiling of personal protective equipment and consumables because of the pandemic.

Liabilities. 1H20 total liabilities were S$147mn. Almost 60% was bank loans totalling S$82.9mn. Net debt was S$105mn, excluding S$42mn cash in hand. Other major liabilities were lease liabilities from right-of-use assets, totalling S$45mn. These were essentially capitalised rent commitments for Q & M.

CASH FLOW

Operating cash flow. Aoxin was a subsidiary until 2018. Operating cash flows in 2018 and 2019 averaged S$20mn per year or S$18mn if we deduct interest expenses. The business generates high cash flows with little drain on working capital. Other receivables were lumpy in 2019 due to pending sales proceeds from its Aidite sale. 1H20 operating cash flow was a negative S$3.5mn due to build up in inventory and trade receivables.

Capital expenditure. Capex in 2018 and 2019 averaged S$5mn a year. We are expecting higher capex from equipping its new PCR laboratory testing operations. FCF averaged S$15mn per annum for a yield of 4%.

NEW GROWTH DRIVER: sale of Covid-19 PCR test kits and laboratory testing

In September 2020, subsidiary Acumen Diagnostics* secured a Healthcare Institution Licence from the Ministry of Health to offer clinical laboratory testing services for Covid-19. Such labs face high barriers in securing licences, given the dangerous handling of highly infectious viruses, the need for skilled laboratory technicians and high equipment costs involved in molecular testing. Acumen will use its proprietary SARS CoV-2 RT-PCR test kit, Acu-Corona® 2.0 (Figure 7), which had received Singapore’s Health Sciences Authority’s (HSA) Provisional Authorisation for clinical use in March 2020, to provide testing services. These test kits are manufactured in Singapore.

There is limited financial data available. The government had targeted 40,000 tests a day by November 2020. The latest data point suggests an average of 27,200 tests daily in September. In our assumptions, we estimate 20,000 tests done per day in Singapore. Of this 20,000, we assume 3% will be handled by Acumen. This implies 600 tests a day, potentially yielding S$32mn of revenue in 2021e. The retail selling price of a PCR test is around S$200. We assume net margins of 25% on a selling price of S$150 for Acumen. This translates to a net profit of S$8.2mn or S$4mn for its 51% stake. Because Acumen manufactures and uses proprietary test kits, we expect margins to be even higher. We can only get better clarity in 1H21 results which will be reflected in minority interest in the income statement.

What is polymerase chain reaction (PCR) test?
PCR tests detect the genetic material of the coronavirus from a swab sample. After swabbing the back of the nostril, specimens are sent to Acumen Diagnostics’ lab. PCR test results will be available 1-2 days later.

What is Acumen Diagnostics’ business model?
Neither Acumen nor Q & M is involved in the swabbing of patients. Instead, Acumen will receive swab specimens from the authorities – under the testing operation control of the Ministry of Health – or private clinics. Acumen will generate revenue from the sale of its Acu-Corona® 2.0/3.0 test kits and laboratory charges in testing the specimens. When we checked the HSA website there were 74 other PCR test that we approved.

Who needs a PCR test in Singapore?

1. All travellers would need to take a Covid-19 test upon arrival in Singapore.
2. Covid-19 tests are part of Singapore’s stay-home-notice (SHN) requirement at SHN dedicated facilities.
3. Pre-departure testing for travellers travelling out of Singapore within 48-72 hours – depending on destination – of departure.
4. Pre-registered one-off Covid-19 testing for stallholders, their assistants, cleaners and food delivery personnel since October 2020.
5. Rostered routine testing (RRT) every 14 days for:
   • The construction sector & personnel required to support the sector
   • The marine offshore & process sector and personnel required to support the sector
   • The maritime sector and personnel required to support the sector
   • Manufacturing and service workers living in dormitories
   • Frontline workers in targeted sectors
6. Physician-referred individuals who exhibit acute respiratory infections tested at Public Health Preparedness Clinics (PHPC).
7. Close contacts of suspected Covid-19 individuals before quarantine.
8. Individuals who voluntarily request to be tested at approved private testing partners/clinics.

How long is PCR test need in Singapore?

We think at least in 2021 and 2022. So long as the virus is present globally, we expect PCR test to continue. There may be less RRT but as travel reopens, PCR will be best arrivals into Singapore. Other unknowns are the durability of the vaccine, effectiveness of vaccine to new strains and whether vaccinated individuals can transmist the virus.

INDUSTRY

The dental industry and other medical services* in Singapore have a market size of around S$3.3bn, according to operating receipts in 2018. Dental forms around 18% of the healthcare service industry, with hospitals accounting for the bulk at S$10.1bn. Dental has been enjoying resilient growth with 3-year and 5-year CAGRs of 6% and 10% respectively (Figure 8).

There are around 1,097 dental clinics in Singapore, of which 246 are public and 851 private (Figure 9). In 2019, Q & M operated 79 clinics in Singapore. This implies a 7% share of all clinics in Singapore and 9% share of private clinics. Due to its large number of specialists who can provide higher-value-added work, we can assume Q & M has at least a 10% share of the private dental market. Furthermore, a single Q & M dental clinic may incorporate multiple disciplines which many small GP dental clinics do not provide.

In terms of industry patient volumes, when the circuit breaker was implemented, attendance to dental clinics dropped to a low of 8.1k, down 91% YoY. Volumes have picked up (Figure 10), with the latest November number being 71.7k. This was still a 3% YoY decline and below 2019’s average of 89k.

Investment Merits

1. Organic growth resurgence. Prior to 2019, Q & M added an average of six dental clinics per year in the past three years. Additions are now expected to jump to 26 (+20%) a year from 2021 to 2022. The pandemic stalled expansion plans last year to only nine new clinics, or 8% growth. New clinics are a more sustainable and lower-risk mode of growth than the acquisition of existing clinics. They allow Q & M to avoid high valuations, integration risks and peak earnings. Dentists are drawn to the Q & M brand as it can attract patients and enable them to focus on their practice rather than administrative, human resource and financial matters. Border closures and work-from-home arrangements have also resulted in increased dental visits and larger patient spending.

   New clinics can be housed by graduate or practising dentists. There are multiple reasons for dentists to join the Q & M dental chain, including its established brand, the dentists’ ability to focus on their core expertise and even achieve a better work-life balance. As medical services cannot be advertised, the ability to attract walk-in customers is critical. For smaller clinics, new customers come from word-of-mouth recommendations, clinic reputation and location. For Q & M, not only does it have all the appeals of an established and reputable brand and prominent locations with visible signages to draw new walk-in customers, it also offers a large pool of dentists and specialists to serve the varied needs of patients. To give impetus to its organic growth, a new business development team has been formed, dedicated to recruiting new dentists to the Q & M group.

   

2. New growth opportunity in PCR testing. In September 2020, Q & M’s 51% venture – Acumen Diagnostics – received approval to offer PCR testing of Covid-19 in Singapore. Q & M can both sell its proprietary PCR diagnostic kits called Acu-Corona® 2.0. and provide lab testing services. We assume a 3% share of daily PCR tests with 25% net margins. No guidance has been provided by the company.

   The Acu-Corona® series of SARS CoV-2 RT-PCR tests are manufactured in Singapore and are already being used in countries like Malaysia and Indonesia. In July 2020, Q & M announced an exclusive distribution agreement with Azion Healthcare Sdn Bhd for Azion’s exclusive sale and distribution of Acu-Corona® 3.0 Covid-19 PCR test kits in Mexico for six months, provided Aizon purchases 5mn tests within three months of obtaining regulatory approvals from the Mexican authorities. We have not incorporated the Mexico contract in our forecasts as there has been little update since the announcement.

Valuation

We initiate coverage with a BUY rating and target price is S$0.70. Peers (Figure 13) trade in a wide band with hospitals valued at 30-45x PE. Q & M’s 7-year PE has varied from 26x to 65x, with an average of 38x. We are ascribing a large 50% discount to both hospitals or sector and its historical average PE, to reflect the huge variance in valuations for healthcare services. This gives us 20x PE for its core operations, or S$0.67/share. We added another S$0.03 from the market value of listed associate, Aoxin. We build in a 20% discount buffer to account for any volatility in its share price.