• Raffles Medical Group’s 9M19 earnings decline due to gestation costs was expected. Key positives were better domestic topline growth and Chongqing’s tight cost execution.
• We think earnings could bottom in FY19F, premised on Chongqing’s narrowing loss in FY20F and a slight delay in opening of Shanghai hospital.
• Upgrade from Hold to ADD with higher EPS estimates and undemanding valuation (1 s.d. below historical average).

9M19 in Line; Expect a Seasonally Stronger 4Q19F

• Raffles Medical Group (SGX:BSL) reported 3Q19 core PATMI of S$13.6m, which fell 16.9% y-o-y, mainly due to gestation costs from its Chongqing hospital. 9M19 core PATMI of S$41.5m (-15.4% y-o-y) was 73%/69% of our/consensus FY19 forecasts, which we deem in line as 4Q is seasonally stronger. See Raffles Medical Announcements; Raffles Medical Latest News.
• Excluding the impact of the Chongqing hospital, 3Q19 EBITDA would have grown 12.1% y-o-y to S$26.8m and net profit would have improved by 4.8% y-o-y to S$17.2m.

Uptick in Domestic Growthwas Positive

• 3Q19 saw the strongest topline growth of 7.8% y-o-y since 2017, driven by a 9.5% rise in healthcare services (more insurance contracts and corporate clients), as well as a 7.0% increase in hospital services (higher local patient load).
• We think the ageing demographics of the resident population, coupled with higher rental income from Raffles’ new extension, could underpin profit growth from its Singapore operations.

Strengthening Its Foothold in China

• We believe Raffles Medical Group’s first overseas hospital continues to ramp up well in Chongqing, even as quarterly EBITDA losses crept up (1Q19: -S$1.8m, 2Q19: - S$2.3m, 3Q19: -S$2.6m) due to the hiring of additional staff, but this remains within management’s full-year guidance. This is supported by Raffles Medical Group’s network of corporate clients, tie-ups with embassies and insurers, as well as its expanding chain of clinics in key cities in Chinasuch as Beijing, Shanghai, Tianjin, Nanjing, Dalian Anshen and possibly Hangzhou.
• We also saw an improving patient load and case mix for Chongqing hospital in 3Q19, which could further benefit from Yibao volumes upon the official launch at end-2019 or early-2020.
• For the 400-bed Shanghai hospital (in which it holds a 60% stake), we understand that the building structure was completed in May 2019, with interior fit-out and purchase of major equipment expected to be finalised by end-2019. Recruitment for specialists and support staff has commenced, with possible dual-hatting or relocation of some 30-40 staff from the Chongqing hospital. This, coupled with a phased opening of 150 beds, could help Raffles Medical Group manage its start-up losses in FY20F.

Upgrade From Hold to ADD With Higher EPS and S$1.16 TP

• As we raise our FY19-21F EPS by 0.1-4.7% on lower opex assumptions, and roll over valuation to end-FY20F, our SOP-based Target Price is now higher at S$1.16. See Raffles Medical Share Price. See attached PDF report for SOP valuation details.
• While there is no change to the three-year EBITDA breakeven period for both its hospitals in China, we see upside potential to management’s initial guidance of S$8m-10m EBITDA loss for its first year of operations, and S$4m-5m EBITDA loss for its second year of operations, based on a faster ramp-up at the Chongqing hospital (higher patient volumes due to the implementation of Yibao) and a slight delay in the opening of the Shanghai hospital (possibly Mar/Apr 2020).
• We upgrade the stock from Hold to ADD, given that Raffles Medical Group currently trades at 30.8x FY20F P/E (1 s.d. below historical average) and earnings could bottom out in FY19F.
• Poor overseas execution and unfavourable policy changes could pose downside risks to our ADD rating.
• Potential earnings upside and share price catalysts could stem from stronger domestic growth, faster ramp-up of Chongqing operations, and a delay in the opening of the Shanghai hospital.

Source: CGS-CIMB Research - 29 Oct 2019