KPJ Healthcare. Investment merits

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1 PP16832/01/2012 (029059) Malaysia Initiating Coverage 30 November 2011 Buy (new) Share price: Target price: RM4.18 RM5.10 (new) Yeak Chee Keong, CFA (65) Wong Chew Hann, CA (603) Stock Information Description: The largest private hospital operator in Malaysia. It also runs 2 hospitals in Indonesia. Ticker: KPJ MK Shares Issued (m): Market Cap (RM m): 2, mth Avg Daily Volume (m): 0.89 KLCI: 1, Free float (%): 23.0 Major Shareholders: % Johor Corp 41.0 EPF 13.4 Nomura Asset Management 8.7 Skim Amanah Saham 8.7 Kumpulan Waqaf 8.0 Key Indicators ROE annualised (%) 14.5% Net cash (RM m): (187.1) NTA/shr (RM): 1.64 Interest cover (x): 8.7 Historical Chart Dec-09 Apr-10 Aug-10 Dec-10 Apr-11 Aug-11 Performance: 52-week High/Low RM4.72/RM3.67 KPJ MK Equity 1-mth 3-mth 6-mth 1-yr YTD Absolute (%) (1.2) (9.1) Relative (%) KPJ Healthcare Niche specialist with regional dreams Initiate coverage with BUY and target price of RM5.10. KPJ is wellpositioned to benefit from the fast-growing healthcare sector in Malaysia. This sector has been identified as one of the 12 key pillars in the country s Economic Transformation Programme and is expected to contribute USD10.4b to the Gross National Income by As a defensive play, KPJ also offers limited revenue downside given its domestic dominance and a wide array of positive demand factors. Entrenched market leader. KPJ operates 20 private hospitals in Malaysia, the largest network among local private hospital operators, and has a 19% share of total private hospital beds. As the leader of the domestic market, it stands to reap the greatest benefits from the rising healthcare needs of the local population. Limited revenue downside. The ever-growing demand for private healthcare services in Malaysia limits the downside risk to revenue for KPJ. This relatively inelastic demand is underpinned by structural factors such as the increased number of elderly people, growing population, higher per capita income and strain on public-sector healthcare system. New hospitals, new foreign patients. KPJ plans to add 1-2 hospitals each year in its efforts to expand its hospital network. By end-2013, KPJ could have added up to five new hospitals, and expanded its bed capacity by up to 35%. We also expect the company to compete more aggressively for foreign patients in the medical tourism sector. Its education business could also serve as another thrust for growth. Cheapest valuation, highest dividend yield. KPJ is the cheapest hospital stock vis-à-vis its regional peers, trading at FY12F PER of 18.1x vs the peer average of 22.3x. Nevertheless, it offers the highest yield at 2.4% net. We expect revenue growth of 13-18% over FY11-13 as its hospital network expands and it becomes a bigger player in medical tourism. Corresponding net profit would grow by 8-19% over the same period. Initiate coverage with BUY and TP of RM5.10, based on 22x PER on FY12F fully diluted EPS, pegged to peer average. KPJ Healthcare Bhd Summary Earnings Table, Kim Eng FYE Dec (RM m) Revenue FY2009 1,456.4 FY2010 FY2011F FY2012F FY2013F 1, , , ,495.9 EBITDA Recurring Net Profit Recurring Basic EPS (Sen) Recurring Diluted EPS (Sen) EPS growth (%) 29.5% 4.3% -2.8% 19.0% 17.7% Net DPS (Sen) PER (x) - diluted EV/EBITDA (x) Net Div Yield (%) 1.8% 2.7% 2.4% 2.7% 3.2% P/BV (x) Net Gearing (%) 35.6% 26.3% 16.9% 19.7% 16.5% ROE (%) 18.3% 17.0% 15.8% 16.7% 17.2% ROA (%) 8.4% 7.8% 7.4% 8.0% 8.3% Consensus Net Profit (RM m) n.a. n.a SEE APPENDIX I FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS

2 Investment merits Premium valuation set to lift. Healthcare operators in Asia command a premium valuation as the region s growing population and increasing affluence fuel the need for healthcare services. There also exists a scarcity premium by virtue of the limited number of such listed stocks. Khazanah Nasional, Malaysia s sovereign wealth fund which privatised Singapore s Parkway Holdings, is planning to relist its healthcare unit, Integrated Healthcare, in the next 1-3 years. If this eventuates, it could stir up further interest and the valuations of healthcare operator stocks would be primed for a lift. Stable base for scaling up foreign patient market. KPJ s niche has been in the domestic private sector, owning the largest network of community hospitals. It has thus been shielded from the more volatile medical tourism market. With this stable and established base in the domestic market, we believe the time is ripe for the company to move to a higher plane and play a bigger, if not more aggressive role in medical tourism. Asset-light structure a boon to ROE. KPJ s modus operandi involves selling its hospital assets to Al- Aqar REIT and leasing back the buildings for its operations. This allows the company to maintain an asset-light structure, which, in turn, enhances its ROE. The proceeds from the disposals also provide a stream of cash to enable continued investment and expansion of its hospital network without straining its balance sheet. Good risk-reward proposition; initiate with BUY and target price of RM5.10. The defensive nature of hospital stocks makes them attractive investments in the current volatile equity market. In our view, KPJ offers an appealing risk-return proposition premised on its stable earnings from a strong domestic market focus and growth opportunities in the medical tourism arena. The stock currently trades at the lowest FY12F PER of 18.1x among regional peers and yet offers the highest gross dividend yield of 3.2% (2.4% net). We initiate coverage with a BUY recommendation and target price of RM November 2011 Page 2 of 22

3 Cheapest hospital stock by far Premium valuation for Asian healthcare stocks. In Asia, long-term positive structural factors pointing to an increasing demand for quality healthcare have enabled the region s healthcare stocks to enjoy premium valuations. Stocks of hospital operators offer one of the purest plays on such a theme. Recent M&A activities saw hospital stocks (Parkway Holdings and Thomson Medical) being acquired at 23-32x PERs, reaffirming their premium valuation. At the same time, such stocks should also command a scarcity premium. Parkway Pantai, formed by a merger of Singapore s Parkway Holdings and Malaysia s Pantai Group, is seeking a possible relisting under its parent, Integrated Healthcare, and this could spark more interest in the sector, thereby lifting valuation. Moving to a higher plane. A study of the valuations of regional hospital stocks over the past five years shows that KPJ has been trading at much lower PERs compared with its peers. Although the valuation gap is closing over the past two years, its PER is still trailing behind its peers. We guess the reason for the discount is its domestic market focus, while other hospital stocks offer the potential to benefit from medical tourism. But KPJ now has a strong domestic base, which it can leverage to grow its foreign patient volume more aggressively. We believe this will push the company to compete on a higher plane. In our opinion, KPJ offers one of the most attractive risk-reward propositions. Figure 1: Regional hospital stocks historical PER at a glance Source: Bloomberg 30 November 2011 Page 3 of 22

4 Healthcare in Malaysia A two-tier system. Malaysia operates a two-tier health system, split between the public and private sectors. Public healthcare is provided and managed by the Ministry of Health (MOH) and funded by the tax system. It is also heavily subsidised by the government and is used by the majority of its 28m population. The private system, on the other hand, is user-charged and demand is mainly driven by the more affluent who seek shorter waiting time as well as a higher quality of care and service. The private sector is beginning to play a more important role in alleviating the strain on the public system. Private versus public sector. In terms of the number of hospital beds, the private sector accounted for about 26% of the 50,087 licensed hospital beds in Malaysia last year. Admissions-wise, the private hospitals recorded about 29% of total hospital admissions. However, a disproportionate split became apparent in the distribution of resources, as evidenced by human resource allocation and hospital expenditure. About 45% of doctors were employed in the private sector in 2008 despite the sector having only 22% of total hospital beds. Expenditure in the private sector also exceeded that in the public sector by about 10%. Figure 2: Distribution of resources, 2008 Figure 3: Distribution of beds Source: Ministry of Health, Malaysia Source: Ministry of Health, Malaysia Large burden on government. Government expenditure on healthcare in Malaysia comprised 44% of the total national health expenditure in The figure seemed reasonable vis-à-vis other countries. However, if the social security portion of the expenditure were excluded, the healthcare burden on the Malaysian government would appear to be rather high at 43%, compared to less than 20% for uppermiddle income and above nations. In fact, in the latter, a large part of the government spending on healthcare is funded by social security schemes, which Malaysia currently lacks. Hence, the large burden on government spending. We understand that the government is seeking to address this asymmetry by encouraging growth in the private sector. Room for more healthcare spending. According to data from the Ministry of Health, total national health expenditure in 2008 formed about 4.8% of total GDP (WHO measured it at 4.3%). Though this figure might be higher than some of its neighbouring countries, it was significantly below that of the more developed nations. The US, for example, spends about 15% of its GDP on healthcare while the global average is about 8% in This suggests that Malaysia has room to raise its healthcare expenditure. 30 November 2011 Page 4 of 22

5 Figure 4: Worldwide healthcare expenditure as a % of GDP, 2008 Source: World Health Organisation Table 1: Health expenditure data General government expenditure on health as % of total expenditure on health Social security expenditure on health as % of general government expenditure on health Health expenditure ratios General government expenditure on health (excl. social security) as % of total expenditure on health Private expenditure on health as % of total expenditure on health General government expenditure on health as % of total government expenditure Per capita health expenditures Per capita total expenditure on health (PPP int. $) Per capita government expenditure on health (PPP int. $) Member states Malaysia Singapore India Indonesia Thailand US Range of values Minimum <1 2 Median Maximum Income group Low income Lower middle income Upper middle income High income Global Source: World Health Organisation (PPP int. $) = Purchasing Power Parity International $ 30 November 2011 Page 5 of 22

6 Bigger role for private sector Public system experiencing strain. While Malaysia s public healthcare system has progressed over the years, the rising demand for healthcare services has put a strain on it. Long waiting times and high bed occupancy rates are some of the problems plaguing the system. As a result, middle-income earners who have the means are increasingly turning to private healthcare. This presents opportunities for private healthcare operators to step up its role in alleviating the stress on the public healthcare system. Regular checks on service and cost. To ensure quality service and rein in medical costs, the government regularly monitors the private sector. The regulatory environment is strengthened by the passage of the Private Healthcare Facilities and Services Act A key regulation is the zoning regulation limit, which requires a general 20km distance between private hospitals unless one is a centre of excellence. A centre of excellence focuses on a specialised field of medicine. The Act helps to curb competition while promoting a more even distribution of private hospitals in the country. The Act also involves a doctors fee schedule, which caps the maximum amount of fees that doctors can charge, thereby controlling medical costs. Government lending support Figure 5: GNI contribution from Heathcare National Key Economic Area Source: PEMANDU, a unit of Malaysia s Prime Minister s Department Ultimate vision for healthcare sector. The Malaysian government launched the Economic Transformation Programme (ETP) on 25 October 2010 in a bid to transform the country into a high-income economy by Healthcare is one of the 12 National Key Economic Areas (NKEAs) identified as a driver of economic activity. The ETP would identify private sector opportunities to reframe health as an economic commodity as well as a social right. The ultimate vision is to have the healthcare sector contribute an incremental GNI impact of RM35.3b in 2020 with an additional 181,000 jobs by the same year. One of the strategic opportunities identified in the Healthcare NKEA is health travel or medical tourism. 30 November 2011 Page 6 of 22

7 Next goal: international medical tourism An emerging player in medical tourism. Travelling abroad for medical treatment is a rapidly growing phenomenon in recent years. The high cost of medical procedures in many developed countries, coupled with rising medical standards in Asia, has attracted patients to come to the region. This trend is also emerging as a lucrative business proposition as affluence and mobility increases in Asia. In Malaysia, medical tourism grew at a steady rate of 38% pa from 2003 to 2008 but suffered a contraction in Last year, the market was estimated at RM350m, still relatively small compared with that in countries like Singapore, Thailand and India who were the forerunners. However, Malaysia has its plans to gain a slice of the pie. Attracting 1.9m health tourists by The Malaysian government has set up the Malaysia Healthcare Travel Council (MHTC) in December 2009 to spearhead efforts to market the country as a preferred healthcare destination. The target is to attract 1.9m health tourists by 2020, from about 400,000 last year, with planned investment of RM335m in infrastructure and human capital. Table 2: Cost comparison of selected medical procedures Procedure (US$) US India Thailand Singapore Malaysia Heart bypass 130, ,000 11,000 18,500 9,000 Heart valve replacement 160,000 9,000 10,000 12,500 9,000 Angioplasty 57,000 11,000 13,000 13,000 11,000 Hip replacement 43,000 9,000 12,000 12,000 10,000 Hysterectomy 20,000 3,000 4,500 6,000 3,000 Knee replacement 40,000 8,500 10,000 13,000 8,000 Spinal fusion 62,000 5,500 7,000 9,000 6,000 Source: Patients beyond borders 2008 by Josef Woodman Accreditation required to be competitive. The Joint Commission International (JCI) accreditation is arguably the gold standard for international credentialling. Although individual countries have their own accreditation systems, such as the Malaysian Society for Quality in Health (MSQH) in Malaysia, possessing a JCI accreditation will find favour with more international tourists. We understand that two of KPJ s hospitals are in the process of seeking the JCI accreditation. However, most of its hospitals already have the MSQH accreditation. Hospitals appointed for health tourism. The MHTC has appointed several hospitals (Table 3) to participate in attracting foreign patients to the country. 11 of KPJ s current portfolio of 20 hospitals are in the MHTC list. Hospitals owned by Parkway Pantai, Columbia, Prince Court and Sime Darby all have the JCI accreditation. 30 November 2011 Page 7 of 22

8 Table 3: Cost comparison of selected medica procedures Private hospital No. of Quality certification* beds 1 Assunta Hospital, Selangor 344 ISO, MSQH 2 Columbia Asia Hospital, Bukit Rimau, Selangor 84 3 Gleneagles Hospital Kuala Lumpur, Wilayah Persekutuan - Kuala Lumpur 330 JCI, ISO, MSQH 4 Gleneagles Medical Centre, Pulau Pinang 227 MSQH 5 Hospital Fatimah, Perak 223 ISO, MSQH 6 HSC Medical Center, Wilayah Persekutuan - Kuala Lumpur 7 7 Island Hospital, Pulau Pinang 7 8 KPJ Ampang Puteri Specialist Hospital, Selangor 230 ISO 9 KPJ Damansara Specialist Hospital, Selangor 250 MSQH 10 KPJ Ipoh Specialist Hospital, Perak 260 ISO, MSQH 11 KPJ Johor Specialist Hospital, Johor 206 ISO, MSQH 12 KPJ Kajang Specialist Hospital, Selangor KPJ Penang Specialist Hospital, Pulau Pinang KPJ Selangor Specialist Hospital, Selangor 173 MSQH 15 Lam Wah Ee Hospital, Pulau Pinang 422 ISO, MSQH 16 LohGuanLye Specialists Centre, Pulau Pinang 265 ISO, MSQH 17 Mahkota Medical Centre, Melaka 365 ISO, MSQH 18 Mawar Renal Medical Centre, Negeri Sembilan Mount Miriam Cancer Hospital, Pulau Pinang 40 ISO 20 National Heart Institute (IJN), Wilayah Persekutuan - Kuala Lumpur 270 JCI, ISO, MSQH 21 NCI Cancer Hospital, Negeri Sembilan 0 ISO 22 Normah Medical Specialist Centre, Sarawak 130 MSQH 23 Pantai Hospital Ayer Keroh, Melaka Pantai Hospital Ipoh, Perak Pantai Hospital Kuala Lumpur, Wilayah Persekutuan - Kuala Lumpur 332 JCI 26 Pantai Hospital Penang, Pulau Pinang 180 ISO, MSQH 27 Penang Adventist Hospital, Pulau Pinang 216 JCI, MSQH 28 Prince Court Medical Centre, Wilayah Persekutuan - Kuala Lumpur 300 JCI, MSQH 29 Puteri Specialist Hospital, Johor Putra Specialist Hospital, Melaka 225 ISO 31 Sabah Medical Centre, Sabah Sentosa Medical Centre, Wilayah Persekutuan - Kuala Lumpur 135 ISO 33 Sime Darby Medical Centre Subang Jaya, Selangor 393 JCI, ISO, MSQH 34 Sunway Medical Centre, Selangor 240 ISO, MSQH 35 Taman Desa Medical Centre, Wilayah Persekutuan - Kuala Lumpur Tawakal Hospital, Wilayah Persekutuan - Kuala Lumpur 158 ISO, MSQH 37 Timberland Medical Centre, Sarawak Tropicana Medical Centre, Selangor 70 ISO 39 Tun Hussein Onn National Eye Hospital (THONEH), Selangor Tung Shin Hospital, Wilayah Persekutuan - Kuala Lumpur 247 ISO 41 UM Specialist Centre, Wilayah Persekutuan - Kuala Lumpur 60 Private healthcare facilities in Malaysia are required to be licensed under the Private Healthcare Facilities and Services Act Joint Commission International (JCI) and Malaysian Society for Quality in Health (MSQH) are two accreditations that many of the private hospitals have. Both are recognised members of the International Accreditation Federation Council (IAFC), a body under the umbrella of the International Society for Quality Healthcare (ISQuA). These accreditations ensure a minimum level of quality. Source: Association of Private Hospitals 30 November 2011 Page 8 of 22

9 Positive structural factors Population growth and demographic shift. Malaysia s total population stood at about 28.3m in 2010, having grown at an annual rate of 2.0% in the past decade. Longer life spans also resulted in a larger number of people aged 65 and above. As at last year, they accounted for about 4.7% of the total population and are still growing. This demographic shift will underpin the factors fuelling the everincreasing need for healthcare services. Rising national income. In the meantime, Malaysians are getting wealthier as income levels rise in tandem with the country s progress. Better education, longer life span and a desire for a better lifestyle also make them more willing to spend on healthcare. As evidence, per capita expenditure on health has increased along with higher income levels over the years. Admission rates on the rise. Rising admission figures from data released by the MOH support our notion. Inpatients and outpatients are growing in both the public and private sectors. However, the statistics also show that admission figures in the private sector are growing at a much higher rate than in the public sector. Figure 6: Population growth Figure 17: Ageing population Source: Department of Statistics, Malaysia Source: Ministry of Health, Malaysia Figure 8: Rising GNI per capita Figure 9: Rising per capita expenditure on health Source: World Health Organisation Source: World Health Organisation 30 November 2011 Page 9 of 22

10 Figure 10: Public-sector admission figures Figure 11: Private-sector admission figures Source: Ministry of Health, Malaysia Source: Ministry of Health, Malaysia Leader in the domestic market Figure 12: Share of private hospital beds Largest private hospital network. KPJ is the market leader in privatesector healthcare in Malaysia. It has the largest network of private hospitals, comprising 20 hospitals and 2,505 beds. As at 2010, it accounted for 19% of the total private hospital beds and about 26% of private inpatient admissions in Malaysia. In terms of average ward charges, it ranks slightly below Pantai Group s hospitals but we suspect that Pantai may have relatively higher revenue intensity due to its focus on medical tourism and more complex medical procedures. KPJ, on the other hand, concentrates more on community-based hospital services. The company also runs two hospitals in Indonesia with 140 beds. Figure 13: Average single-bedded ward charges websites, Kim Eng websites, Kim Eng Revenue-sharing business model. Under KPJ s model, doctors can use the KPJ brand name while engaging in their own private practice. They are free to charge their own fees but must pay an undisclosed percentage of the fees to KPJ. In return, KPJ provides the medical facilities as well as necessary services, such as a centralised dispensing, billing and collection system. Domestic focus but can scale up foreign patient base. KPJ s market is predominantly domestic in nature with foreign patients accounting for less than 10% of revenue share in FY10. The network of community hospitals that it operates is its niche market and shields it from the vagaries of the medical tourism market, particularly in an economic downturn. Nevertheless, KPJ s small base of foreign patients means the potential for scaling up business in this segment is huge. The company is actively participating in government-led initiatives to attract more foreign patients. 30 November 2011 Page 10 of 22

11 Hospital expansion on the cards. KPJ is operating at high occupancy rate of about 70-75% and will need to expand its capacity to cope with the increasing demand in the sector. It intends to add 1-2 hospitals each year to its network. Since 2005 when it had only 15 hospitals, it has established another five by last year to take the number of hospitals to 20. In the pipeline, there are already plans for seven more new hospitals, one replacement hospital and an expansion plan for the existing Penang Specialist hospital. By end-2013, we could see its hospital bed capacity expand by up to 35%. We believe its revenue intensity would also rise in tandem with the opening of more subspecialist hospitals/centres of excellence. Going by its past cash flow trends, it may not be necessary for KPJ to raise much money to fund these expansion plans. For one, its operating cash flow is robust. Secondly, there would be cash generated from the sale of its hospitals to Al- Aqar REIT. Finally, the company currently has a cash position of RM219.4m as at end-9m11. Table 4: Hospital expansion plans Hospital name/location No. of beds Estimated Completion Remarks Bandar Baru Klang Specialist Hospital 200 End-2011 Muar Pasir Gudang New Sabah Medical Centre Replacement Tanjung Lumpur, Kuantan :30 JV with Pasdec Corp KPJ Perlis Specialist Hospital 90 End :40 JV with Yayasan Islam Perlis Bandar Datuk Onn Specialist hospital in Klang n.a Acquired 1.8 acres of land for construction Penang Specialist hospital n.a. End 2014 Expansion of existing hospital Entering the Australian retirement market. In September last year, KPJ announced plans to venture into Australia s retirement/aged care market through an agreement to buy a 51% stake in Jeta Gardens Waterford Trust (JGWT) for cash consideration of RM19m. JGWT owns and operates a 64-acre retirement village called Jeta Gardens, in Waterford, Queensland, Australia. The retirement village includes a 108-bedded aged care facility, 23 retirement villas and 32 apartments located between Brisbane and the Gold Coast. At the same time, Al- Aqar REIT announced the acquisition of the assets owned by JGWT, which include 14.75ha of properties, for RM134.9m. JGWT was still running a loss in FY Jun09, with a net loss of A$3.1m and net liabilities of A$1.8m as it was probably in a gestation period, having only started operating 3-4 years ago. The injection of these assets into the REIT could turn it around as losses were mainly due to high financial charges from borrowings incurred in starting the business. Education arm a second thrust for growth. KPJ also has a healthcare education arm through KPJ International University College of Nursing and Health Sciences (KPJIUC). KPJUC s main campus is located in Nilai, Negeri Sembilan and has branches in Johor Bahru and Bukit Mertajam. The institution was awarded university college status in July this year. The college and hospitals play complementary roles the former supporting the clinical staff KPJ requires and the latter providing the training ground for the undergraduates. KPJ intends to spend about RM$120m to expand the college in two phases. It is targeting 5,000 students in three years and 10,000 in five years from about 2,500 currently. 30 November 2011 Page 11 of 22

12 Risks Competition from other hospitals. KPJ faces competition from other hospitals with established networks. Its two largest rivals are Pantai Group and Columbia Asia. There are also many other small players in the market. It would also face more competition from regional players as it begins to compete for foreign patients. Liberalisation of the healthcare sector. Healthcare is one of the three services sector (the others being education and professional services) which is heading towards liberalization to raise its overall competitiveness. Some of the recommendations announced in the government s Strategic Reform Initiatives in July 2011 are the removal of restrictions to foreign equity participation in setting up specialised private hospitals if they meet a minimum number of beds and the relaxation of entry restrictions for foreign specialists such as doctors and dentists. Shortage of healthcare professionals. Malaysia faces a shortage of doctors and nurses. Expanding the capacity of a hospital or building new ones would require a corresponding increase in the number of doctors and nurses to operate it. In the event that KPJ fails to engage such professionals to support its expansion plans, it may not be able to achieve optimal operation. Conversely, if it fails to retain such professionals and an exodus occurs, its operations would also be affected. Price pressure by insurance companies. The insurance industry in Malaysia has grown bigger and more established. This has enhanced its bargaining power in negotiations for more discounts for medical procedures and treatments. This development could negatively affect pricing. Delay in expansion plans. We expect KPJ to pursue its expansion plans to continue to grow its hospital network, which would in turn lead to an overall increase in patient volume and revenue. Any delay in expansion would retard the pace of growth that we have assumed. Cost overrun for building new hospitals poses further risk. 30 November 2011 Page 12 of 22

13 Financials Double-digit revenue growth. KPJ reports its revenue under four major segments as illustrated in Figure 19. Last year, the bulk of the revenue came from Malaysia with less than 1% from Indonesia. Over FY06-10, revenue grew by strong double-digit CAGR of 19% as patient volume swelled on hospital network expansion and increase in revenue intensity. Future base revenue growth would be driven by the expansion of hospital network via acquisitions or building new hospitals, thereby increasing revenue intensity and foreign patient numbers. Figure 14: Revenue and profit history Figure 15: FY10 segmental revenue, (RM 000) Figure 16: Patient volume growth Figure 17: Margin trends Figure 18: COGS breakdown for FY10 30 November 2011 Page 13 of 22

14 Stable margins and cost trends. Gross margins have been stable at 29-30% over the past five years with net profit margins trending up from 4.9% in FY06 to 7.2% in FY10 due mainly to lower net interest expense. Going forward, we expect gross margins to remain stable at the 30-31% level. Medical consultants fees and material cost are the 2 major cost components, making up about 75% of total COGS. KPJ has managed to keep these cost increases in tandem with revenue growth, thereby maintaining its gross margins and we expect that it would continue to do so going forward. Cash flows. KPJ has generated increasingly strong operating cash flows in tandem with the growth in revenue. The investment cash flows mainly reflect its acquisition of hospitals, facilities as well as proceeds from the disposal of its hospital assets to Al- Aqar REIT. Going forward, KPJ intends to continue to expand its hospital network by acquiring or building 1-2 hospitals a year. We estimate that this would require about RM m capex per year. In addition, it has capital commitments of RM19m for the acquisition of Jeta Gardens, RM120m for its university expansion and we forecast it would need about RM35m yearly for maintenance capex. However, the sale of more hospital assets to Al- Aqar REIT would generate about RM83.3m of positive cash flow for KPJ. Table 5: Future investing cash inflows/(outflows) Purpose (RM m) Jeta Gardens (19) University Expansion (10) (30) (30) (30) Hospital Expansion Plans (150) (150) (150) (150) Sale of hospitals to REIT 83.3 Purchase of land in Klang (23.8) Maintenance capex (35) (35) (35) (35) (130.7) (238.8) (215) (215) Source: Kim Eng estimates Figure 19: Historical cash flows Figure 20: Improving gearing Table 6: Working capital efficiency FY06 FY07 FY08 FY09 FY10 Inventory days Receivable days Payable days Cash conversion cycle (18.1) (31.2) (28.8) (21.9) (19.1), Kim Eng 30 November 2011 Page 14 of 22

15 Favourable working capital cycle and improving gearing. With short inventory days and long payable days, KPJ s cash conversion cycle is favourable at about negative days. Gearing has also improved with net gearing decreasing from 0.63x as at end-fy06 to 0.20x as at end-9m11. Other than strong cash flows from its business, the disposal of its assets to Al- Aqar REIT contributed to the improved gearing. Our cash flow projections derive a strengthening gearing level. We expect net gearing to reduce further to 0.17x by end-fy13. REIT injection. KPJ makes it a point to dispose of its hospital assets to Al- Aqar REIT, resulting in a lean balance sheet structure which enhances its ROE. The Al- Aqar KPJ REIT is the world s first Islamic healthcare REIT and was established on 27 June 2006 to invest in Syariah acceptable properties. It was listed on the Main Board of Bursa Malaysia on 10 August KPJ injects its hospital assets into the REIT in order to maintain an asset-light structure. To date, it has injected three tranches of assets into the REIT. A fourth tranche consisting of three properties at a sale price of RM139m is in progress. KPJ is expected to receive 56.6m units of Al- Aqar REIT as part of the consideration for the sale, which it intends to distribute in specie or sell in the open market to maintain its stake in the REIT at below 50%. KPJ currently has a 49% stake in the REIT and by keeping it below 50%, its assets and debts will be accounted for off-balance sheet. Table 7: Assets disposed to Al- Aqar REIT Asset Book value Sale price (RM m) (RM m) Status 1st tranche KPJ Ampang Puteri Specialist Hospital Completed KPJ Damansara Specialist Hospital Aug 2006 KPJ Johor Specialist Hospital 68.6 KPJ Ipoh Specialist Hospital 44.3 Puteri Specialist Hospital 35.0 KPJ Selangor Specialist Hospital nd tranche KPJ Perdana Specialist Hospital Completed Kuantan Specialist Hospital Mar 2008 KPJ Kajang Specialist Hospital 38.5 Kedah Medical Centre, Alor Star 44.8 Sentosa Medical Centre rd tranche KPJ Seremban Specialist Hospital Completed Taiping Medical Centre July 2010 Damai Specialist Hospital 13.1 Bukit Mertajam Specialist Hospital 10.3 KPJ Penang Specialist Hospital 21.7 Tawakal Hospital Existing Building 36.0 KPJ Tawakal Specialist Hospital 62.1 KPJ International University College th tranche Bandar Baru Klang Specialist Hospital In progress Kluang Utama Specialist Hospital 3.2 RS Bumi Serpong Damai, Jakarta (completed) 47.3 Table 8: Dupont analysis FY06 FY07 FY08 FY09 FY10 Net margin 4.9% 6.7% 6.8% 7.6% 7.2% Total asset turnover ROA 7.4% 6.4% 6.9% 8.4% 7.8% Financial leverage ROE 18.5% 15.6% 15.7% 18.3% 17.0% Dilutive warrants. KPJ completed a share split exercise on 15 January 2010 whereby each share was split into two shares. There was also a bonus issue of 105.5m new shares and 131.9m free warrants. The warrants have an exercise price of RM1.70 per share and are dilutive, being in-the-money. There were 80.8m warrants outstanding as at end- September this year. 30 November 2011 Page 15 of 22

16 Dividend payout. KPJ does not have a fixed dividend policy but based on historical trends, it has paid out between 28-68% of its net profits as dividends over FY It would also make additional payouts in specie, in the form of shares in Al Aqar REIT which it receives as part consideration for sale of its hospital assets to the REIT. In FY08 for example, it paid out dividend in specie of 23 REIT units per 100 KPJ shares. Revenue model and assumptions We forecast KPJ s revenue to grow by 13-18% over FY11F-14F, buoyed by total patient growth of 9-15% in the same period. We expect revenue growth to be driven by increased patient load from the addition of more hospitals to its network, as well as higher foreign patient volume as it actively participates in the medical tourism scene. Revenue intensity should also go up gradually from general healthcare cost increases and higher-quality earnings from the foreign patient portion. Table 9: Model assumptions FY05 FY06 FY07 FY08 FY09 FY10 FY11F FY12F FY13F Revenue (RM m) Hospital income Consultation income Sale of pharmaceutical, medical & surgical pdt Other hospital income Clinic rental Others Total , , , , , , ,495.9 Growth (%) 26% 33% 14% 15% 14% 13% 13% 18% Operating assumptions Malaysia No. of hospitals No. of licensed beds 1, Indonesia No. of hospitals No. of licensed beds Outpatients ( 000) 1,163 1,556 1,734 1,956 1,979 2,232 2,422 2,778 3,192 Inpatients ( 000) Total patients ('000) 1,280 1,715 1,913 2,153 2,186 2,458 2,670 3,056 3,518 Growth (%) 34% 12% 13% 2% 12% 9% 14% 15%, Kim Eng estimates Accordingly, based on our model assumptions, we derive net profit growth of between 8-19% over FY11-13F. KPJ reported its 9M11 results on 29 November 2011 with net profit of RM92.2m, which makes up about 72% of our FY11F forecast, and validating our growth expectation for the year. 30 November 2011 Page 16 of 22

17 Valuation and recommendation We initiate coverage on KPJ with a BUY recommendation and target price of RM5.10 based on 22x PER on fully-diluted FY12F earnings. This valuation is hardly expensive considering that some of its peers are trading as high as 29x PER. At its current price, KPJ is the cheapest hospital stock in the region in terms of PER valuation, trading at 18.1x FY12F PER compared with the peer average of 22.3x. It also offers the highest gross dividend yield of 3.2% (2.4% net yield) and one of the highest ROEs among its peers. With a stable domestic earnings base, we see limited downside to KPJ s earnings. Moreover, structural demand factors would provide further support and present vast opportunities for growth in areas such as medical tourism. Table 10: Peer comparison Mkt Net Rating TP Price PER (x) P/S P/B ROE NPM cap D/E Yld Company (lcl b) (lcl) (lcl) Hist Curr Fwd (x) (x) (%) (%) (%) (%) Raffles Medical Group SGD 1.1 BUY (29.5) 1.6 Healthway Medical Corp SGD 0.2 NR n.a Apollo Hospitals Enterprise Rs 80.5 NR n.a Fortis Healthcare India Rs 46.4 NR n.a Bangkok Dusit Medical Bt NR n.a Bumrungrad Hospital Bt 33.3 NR n.a KPJ Healthcare RM 2.4 BUY Average Average excl. KPJ Source: Bloomberg, Kim Eng 30 November 2011 Page 17 of 22

18 Company profile Overview. KPJ Healthcare Berhad is the largest private hospital operator in Malaysia, operating 20 hospitals and licensed for 2,505 beds. It also runs two hospitals in Indonesia with a total of 140 beds. KPJ maintains an asset-light structure by selling its hospital buildings to Al- Aqar REIT and then leasing them back. It owns a 49% stake in the REIT. Johor Corporation, a government-linked corporation of the Johor state and one of Malaysia s leading conglomerates, is the parent company of KPJ and holds a 41% interest in it. KPJ was listed on the Main Board of Bursa Malaysia, then known as the Kuala Lumpur Stock Exchange, on 29 November 1994 and remains the only listed hospital group on Bursa. Table 11: KPJ s hospital network No. of licensed beds No. of licensed beds Malaysia Johor Negeri Sembilan KPJ Johor Specialist Hospital 200 KPJ Seremban Specialist Hospital 130 Puteri Specialist Hospital 146 Kluang Utama Specialist Hospital 40 Perak KPJ Ipoh Specialist Hospital 250 Kuala Lumpur/Selangor Taiping Medical Centre 46 KPJ Ampang Puteri Specialist Hospital 217 KPJ Damansara Specialist Hospital 158 Penang KPJ Selangor Specialist Hospital 169 KPJ Penang Specialist Hospital 236 KPJ Kajang Specialist Hospital 110 KPJ Tawakal Specialist Hospital 147 Pahang Sentosa Medical Centre 135 Kuantan Specialist Hospital 72 Kelantan Sarawak KPJ Perdana Specialist Hospital 83 Kuching Specialist Hospital 80 Sibu Specialist Medical Centre 50 Kedah Kedah Medical Centre, Alor Star 98 Sabah Damai Specialist Hospital 43 Sabah Medical Centre 95 Total Malaysia 2,505 Indonesia RS Medika Permata Hijau, Jakarta 60 RS Bumi Serpong Damai, Jakarta 80 Total Indonesia 140 Total no. of beds 2, November 2011 Page 18 of 22

19 Figure 31: Corporate structure Key management Datin Paduka Siti Sa diah Sheikh Bakir, Managing Director. Datin Paduka has been the managing director of KPJ since March She graduated with a Bachelor of Economics from the University of Malaya and holds an MBA from Henley Management College, University of Reading, London. She is also the chairman of various hospitals and companies in the KPJ Group and sits as a director for various other companies in Malaysia. She has served as an independent nonexecutive director of Bursa Malaysia since 2004 and the president of the Malaysian Society for Quality in Health (MSQH) since Mohd Sahir Rahmat, Chief Financial Officer. Previously the group general manager, Mr Mohd took over the role of chief financial officer from Lee Swee Hee on 4 July He holds an MBA from Henley Management College, London, and has served as the executive director of Johor Specialist Hospital and Puteri Specialist Hospital. Amiruddin Abdul Satar, Chief Operating Officer. Mr Amiruddin is an accountant by profession and holds an MBA from Henley Business School, University of Reading, London. He is also an executive director of KPJ, having spent more than 15 years with the group and contributing in areas of hospital operations, finance, strategic planning and investment decisions. 30 November 2011 Page 19 of 22

20 INCOME STATEMENT (RM m) BALANCE SHEET (RM m) FY Dec FY2010 FY2011F FY2012F FY2013F FY Dec FY2010 FY2011F FY2012F FY2013F Revenue 1, , , ,495.9 Fixed Assets 1, , , ,513.6 EBITDA Other LT Assets Depreciation & Amortisation Cash/ST Investments Operating Profit (EBIT) Other Current Assets Interest (Exp)/Inc (6.4) (9.5) (12.0) (13.5) Total Assets 1, , , ,315.3 Associates One-offs ST Debt Pre-Tax Profit Other Current Liabilities Tax (41.7) (43.4) (62.0) (72.1) LT Debt Minority Intereset (7.3) (13.4) (18.3) (23.9) Other LT Liabilities Net Profit Minority Interest Recurring Net Profit Shareholders' Equity ,112.1 Total Liabilities-Capital 1, , , ,315.3 Revenue Growth (%) 13.6% 12.8% 13.5% 17.8% EBITDA Growth (%) 8.6% 19.1% 25.1% 21.0% Share Capital (m) EBIT Growth (%) 2.5% 19.5% 25.2% 20.4% Gross Debt/(Cash) Net Profit Growth (%) 7.2% 8.3% 19.0% 17.7% Net Debt/(Cash) Recurring Net Profit Growth (%) 7.2% 8.3% 19.0% 17.7% Working Capital (69.4) Tax Rate (%) 24.1% 22.7% 25.8% 25.3% CASH FLOW (RM m) RATES & RATIOS FY Dec FY2010 FY2011F FY2012F FY2013F FY Dec FY2010 FY2011F FY2012F FY2013F Profit before taxation EBITDA Margin % 12.3% 13.0% 14.3% 14.7% Depreciation Op. Profit Margin % 8.7% 9.2% 10.2% 10.4% Net interest receipts/(payments) Net Profit Margin % 7.2% 6.9% 7.2% 7.2% Working capital change (7.3) (9.7) ROE % 17.0% 15.8% 16.7% 17.2% Cash tax paid (37.1) (43.3) (62.5) (72.9) ROA % 7.8% 7.4% 8.0% 8.3% Others (incl'd exceptional items) (13.3) (17.2) (19.3) (22.0) Net Margin Ex. El % 7.2% 6.9% 7.2% 7.2% Cash flow from operations (32.2) (16.0) (39.1) (30.6) Dividend Cover (x) Capex Interest Cover (x) Disposal/(purchase) (227.5) (214.0) (238.8) (215.0) Asset Turnover (x) Others Asset/Debt (x) Cash flow from investing (36.6) Debtors Turn (days) Debt raised/(repaid) (199.5) (80.0) (204.4) (179.2) Creditors Turn (days) Equity raised/(repaid) 30.6 (13.8) Inventory Turn (days) Dividends (paid) Net Gearing % 26% 17% 20% 16% Interest payments (26.5) (63.3) (47.9) (72.5) Debt/ EBITDA (x) Others Debt/ Market Cap (x) Cash flow from financing 59.0 (67.7) 7.7 (13.3) Change in cash , Kim Eng 30 November 2011 Page 20 of 22

21 APPENDIX 1 Definition of Ratings Maybank Investment Bank Research uses the following rating system: BUY Total return is expected to be above 10% in the next 12 months HOLD Total return is expected to be between -5% to 10% in the next 12 months SELL Total return is expected to be below -5% in the next 12 months Applicability of Ratings The respective analyst maintains a coverage universe of stocks, the list of which may be adjusted according to needs. Investment ratings are only applicable to the stocks which form part of the coverage universe. Reports on companies which are not part of the coverage do not carry investment ratings as we do not actively follow developments in these companies. Some common terms abbreviated in this report (where they appear): Adex = Advertising Expenditure FCF = Free Cashflow PE = Price Earnings BV = Book Value FV = Fair Value PEG = PE Ratio To Growth CAGR = Compounded Annual Growth Rate FY = Financial Year PER = PE Ratio Capex = Capital Expenditure FYE = Financial Year End QoQ = Quarter-On-Quarter CY = Calendar Year MoM = Month-On-Month ROA = Return On Asset DCF = Discounted Cashflow NAV = Net Asset Value ROE = Return On Equity DPS = Dividend Per Share NTA = Net Tangible Asset ROSF = Return On Shareholders Funds EBIT = Earnings Before Interest And Tax P = Price WACC = Weighted Average Cost Of Capital EBITDA = EBIT, Depreciation And Amortisation P.A. = Per Annum YoY = Year-On-Year EPS = Earnings Per Share PAT = Profit After Tax YTD = Year-To-Date EV = Enterprise Value PBT = Profit Before Tax Disclaimer This report is for information purposes only and under no circumstances is it to be considered or intended as an offer to sell or a solicitation of an offer to buy the securities referred to herein. Investors should note that income from such securities, if any, may fluctuate and that each security s price or value may rise or fall. Opinions or recommendations contained herein are in form of technical ratings and fundamental ratings. Technical ratings may differ from fundamental ratings as technical valuations apply different methodologies and are purely based on price and volume-related information extracted from Bursa Malaysia Securities Berhad in the equity analysis.accordingly, investors may receive back less than originally invested. Past performance is not necessarily a guide to future performance. This report is not intended to provide personal investment advice and does not take into account the specific investment objectives, the financial situation and the particular needs of persons who may receive or read this report. Investors should therefore seek financial, legal and other advice regarding the appropriateness of investing in any securities or the investment strategies discussed or recommended in this report. The information contained herein has been obtained from sources believed to be reliable but such sources have not been independently verified by Maybank Investment Bank Berhad and consequently no representation is made as to the accuracy or completeness of this report by Maybank Investment Bank Berhad and it should not be relied upon as such. Accordingly, no liability can be accepted for any direct, indirect or consequential losses or damages that may arise from the use or reliance of this report. Maybank Investment Bank B erhad, its affiliates and related companies and their officers, directors, associates, connected parties and/or employees may from time to time have positions or be materially interested in the securities referred to herein and may further act as market maker or may have assumed an underwriting commitment or deal with such securities and may also perform or seek to perform investment banking services, advisory and other services for or relating to those companies. Any information, opinions or recommendations contained herein are subject to change at any time, without prior notice. This report may contain forward looking statements which are often but not always identified by the use of words such as anticipate, believe, estimate, intend, plan, expect, forecast, predict and project and statements that an event or result may, will, can, should, could or might occur or be achieved and other similar expressions. Such forward looking statements are based on assumptions made and information currently available to us and are subject to certain risks and uncertainties that could cause the actual results to differ materially from those expressed in any forward looking statements. Readers are cautioned not to place undue relevance on thes e forwardlooking statements. Maybank Investment Bank Berhad expressly disclaims any obligation to update or revise any such forward looking statements to reflect new information, events or circumstances after the date of this publication or to reflect the occurrenc e of unanticipated events. This report is prepared for the use of Maybank Investment Bank Berhad's clients and may not be reproduced, altered in any way, transmitted to, copied or distributed to any other party in whole or in part in any form or manner without the prior express written consent of Maybank Investment Bank Berhad and Maybank Investment Bank Berhad accepts no liability whatsoever for the actions of third parties in this respect. This report is not directed to or intended for distribution to or use by any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation. 30 November 2011 Page 21 of 22