KPJ Healthcare Berhad

KPJ: Defensive business and earnings

Demand for healthcare services is relatively recession-proof, so we do not expect KPJ Healthcare’s (RM4.28) earnings to be affected by the prevailing uncertainties and global economic slowdown.

10,000, including local and foreign students.

Longer-term venture into retirement village and aged care facilities

Over the longer term, KPJ is looking to expand its services to include retirement homes and aged care facilities — a market segment that is expected to grow rapidly. Indeed, this market is already a big business in most developed countries.

According to the latest Census 2010, there is a gradual shift in Malaysia’s demographics with the proportion of those below the age of 15 falling to 27.6% from 33.3% in 2000 while those aged 65 and above rose to 5.1% from 3.9% over the same period. At this pace, we will hit the definition of ageing population by 2015. The long-term uptrend in average life expectancy is another stronger driver for demand for aged care services.

To gain a first mover advantage, KPJ acquired a 51% stake in Jeta Gardens for RM19 million. Jeta owns and operates a 26ha retirement village in Queensland, Australia. The project is still only partially developed and currently consists of 23 retirement villas, 32 apartments and a 108-bed aged care facility. The longer-term plan is to develop it into a one-stop centre that includes an aged care nursing college and medical centre.

While earnings contribution from Jeta is expected to be minimal, the company intends to gain valuable insights and experience from this venture, a business model it hopes to emulate locally.

On track for steady earnings growth

The company’s latest earnings results for 3QFY11 were broadly in line with our expectations. Turnover rose 9% year-on-year (y-o-y) to RM476 million, underpinned by rising demand for healthcare services as well as the addition of Sibu Specialist Medical Centre to its network of specialist hospitals in April 2011.

In line with the higher turnover, pre-tax profit increased 11% y-o-y to RM47.9 million while net profit rose 14% to RM34.5 million. There were no major extraordinary items during the quarter. Net profit for the full-year is estimated at roughly RM124.8 million, up from RM118.9 million in 2010 (including one-off gains totaling some RM8.2 million).

Earnings are forecast to expand further to RM131.2 million in 2012. That prices the stock at roughly 20 times our estimated earnings for 2011and 19 times for 2012 and 22.2 and 21.1 times on a fully-diluted basis. Its valuations are higher those of the broader market. We suspect this is due to the company’s relatively defensive business as well as its positive longer-term growth prospects. We believe the stock will yield positive returns in the long run.

KPJ paid out roughly half of annual net profit as dividends in the past four years, on average. Assuming a similar payout ratio going forward, dividends are estimated to total 10.7 sen per share in 2011 and 11.3 sen in 2012. That translates into net yields of about 2.5% and 2.6% for shareholders over the two years. Its share will trade ex-entitlement for a third interim dividend of 2.5 sen per share on Dec 28.

Note that the company will receive some 56.6 million units in Al-’Aqar, worth roughly RM64 million at the current unit price of RM1.13, as part payment for the injection of three hospital buildings into the trust. It could distribute these units to shareholders as dividends in specie or sell them on the open market. This is so the company can maintain its stake at less than 50% to keep the REIT’s assets and borrowings off its balance sheet.

The company has some 78.1 million warrants outstanding. The warrants can be converted into ordinary shares at anytime up to January 2015 at an exercise price of RM1.70. At the prevailing price of RM2.54, the warrants are trading at a very slight 1% discount. Assuming full conversion, KPJ’s total share capital will increase to 659.6 million shares, from the current 581.6 million shares.