• FSTHC outperformed STI
• But sector looking less attractive
• Growth stories may be priced in

Rewarding sector but valuations seem stretched

While our local bourse has been rather lacklustre, the healthcare sector paints a starkly different picture as the FTSE ST Health Care Index (FSTHC) has delivered a 36% gain YTD compared to -2.1% by the STI benchmark. The often-quoted supportive long-term outlook for healthcare plays amid uncertain times has made them a comparably rewarding haven for investors. However, we note that broad-based valuations currently seem stretched as the index is trading above 1 s.d. of its two-year historical forward P/E average with a six-year historical high forward P/E of 25.8x. We keep our NEUTRAL stance on the sector as we think such premium valuations are warranted only to a certain extent, while a deeper look into specific companies suggest growth stories may already be priced in and a potential correction could be due.

Clear growth story for hospital players but margin pressure in near-term

We had previously covered several healthcare companies’ plans to expand in China given the attractive growth prospects, but also highlighted operational risks and early stage of plans as caveats for a more optimistic stance. Under our coverage, share price for Raffles Medical Group [HOLD, $4.17] has had a largely sustained runup since its confirmation on a Shanghai Hospital, which is slated for completion by mid-18. While this is a positive development, in the meantime, its 1Q15 results showed that higher expenses such as staff costs would likely be incurred due to other upcoming projects (Holland Village project to be ready by 1Q16 and Raffles Hospital extension by 1Q17). Peers such as IHH Healthcare Berhad [non-rated] could also face similar near-term pressures on operating margins due to on-going expansion plans in Malaysia and Turkey. With both stocks trading at more than 1 s.d. above their two-year historical forward P/E average, current valuations are becoming less attractive.

Are expectations running too fast?

We reiterate that a fundamental growth story would take time to materialise for Biosensors International Group [SELL, $0.60]. In addition, Boston Scientific’s Synergy stent may also take the lead, as it could be the first resorbable stent to receive FDA approval by end-15. The recent MERS outbreak in South Korea and depreciation of MYR against the USD have also led attention to healthcare suppliers, as Riverstone, UG Healthcare (UGHC) and Medtecs International [non-rated] have seen their share price rise to new levels, gaining 65%, 31%, 23% YTD respectively. We think the above factors are temporary while the companies’ own growth story may be priced in. As such, there could be some potential selloff ahead as peers like Hartalega have showed a hint of price correction.

Source: OCBC Research - 22 Jun 2015