Thursday, 3 August 2017

Raffles Medical Q2 FY17

Raffles Medical (RM) just announced its Q2 2017 results.

Results Overview
At first glance, RM’s Revenue, Ops Income and Net Income for Q2 remained constant or showed marginal fall over Q1 respectively: 1%, -1.9%, -2.3%.

Its Net Cashflow from Ops of $23.6m is similar to the $23.8m in Q1.

Balance sheet remains strong, with $112m cash and only $53m loans and borrowings.

All in all, results seem fine.

But its share price is a different story. It dropped about 5% to $1.21 on 1 Aug, one day after its result release, and fell further to $1.185 on 2 Aug afternoon. That is about an 8% drop since result announcement.   

This piqued my interest. RM has been on my watch list for long and I am interested to know if this is a good chance to start accumulating the shares.

RM Traded at High Valuation
Market has high growth expectation on RM when its shares traded at an expensive PE ratio of 32x, based on share price of $1.3 before latest quarter results. It was priced very optimistically due to its growth prospect: soon-to-commence Raffles Hospital extension, RM’s 2 new hospitals in Shanghai and Chongqing etc. In other words, RM was expected to have a 32% growth in earnings in the coming year.

Compare this to the market benchmark STI ETF, which is only trading at PE ratio of 13x and its obvious that market was valuing RM richly.

Growth Momentum Losing Steam
So Q2 results showed stagnating growth. Management explained that this is due to softer than expected demand from foreign patients (I take this as the medical tourism trend slowing down), high staff costs and expenses for consumables used. Looking forward, management acknowledged that market conditions are challenging due to economic slowdown and increased competition.

We also read more specific details from analysts’ report. RHB shared that management opined the China hospitals could take up to 3 years before EBITDA turn positive. Despite full quarter rentals from RM Holland V, revenue from healthcare services fell 1.1%, implying bigger drop in healthcare service revenue.

Suddenly outlook turns murky and not so promising anymore.

I suspect the management is also caught off guard by the business slow down. Under point 9 in Q1 report where management was asked about any variance between forecast previously disclosed and actual results, management replied that ‘current financial period’s results showed a lower than expected revenue whilst the Group remains profitable’.

Let’s look at some numbers. The company’s growth momentum has indeed weakened considerably in recent quarters. If we look back 6 quarters, there is a clear trend of deteriorating revenue and profit from operations:

Q2 2017
Q1 2017
Q4 2016
Q3 2016
Q2 2016
Q1 2016
Revenue
120088
114915
118516
119280
118953
116859
Y on Y Growth (%)
0.95
-1.66
3.30
17.50
19.80
23.00
Profit from Ops
19578
18087
24705
18563
19953
18725
Y on Y Growth (%)
-1.88
-3.41
-2.24
0.30
4.10
6.01

Share price reacted by dropping big in last 2 days as mentioned above.

Such is the pitfall of investing in high growth company. All is well and share price will keep rising, so long as the company can sustain its growth. However, when company shows signs of a slowdown, market would beat the share price down. The seemingly constant revenue and earnings growth quarter after quarter give the illusion that such growth can go on indefinitely, but we never know when will the growth taper off.

Ability to Control Cost?
So where do Q2 results leave RM with?

The key thing is to find out whether RM can execute its expansion plan well to sustain its growth, and concurrently control its cost.

Firstly, managing cost. We look at past 5 FYs’ revenue and operating income to derive its operating margin. It seems that RM has been able to maintain its margin quite well around 21%, until FY15 when it started dropping to latest FY margin of 17%.   Also, manpower cost, the largest component of RM expenses, has been creeping up to 51% of total revenue in latest quarter.  

Q2 2017
Q1 2017
FY16
FY15
FY14
FY13
FY12
Revenue
120088
114915
473608
410535
374641
340989
311633
Ops Profit
19578
18087
81946
80604
80327
73939
66355
Ops Profit Margin (%)
16.30
15.74
17.30
19.63
21.44
21.68
21.29
Staff Cost
61682
60975
241736
203537
182094
170091
152275
As % of Revenue
51.36
53.06
51.04
49.58
48.60
49.88
48.86

It seems to me that manpower cost will continue to be the largest component. And keeping it manageable is critical in maintaining RM’s cost efficiency.

As for China, I am even less certain about it. It’s a new market after all. Start-up costs would definitely be high in the initial years. While RM can hire local doctors and nurses which may come cheaper, company needs to invest in extensive training to enhance their service to a level similar Singapore. RM may also need some time to finetune its medical charges to suite local market’s spending power.

The only comfort here is RM is still able to increase medical charges due to the industry dynamics of healthcare inflation, but has to do it at a measured pace.

However, on the grand scheme of things, RM does have a clear expansion plan well-drawn out, with hospital expansion strategy mooted few years back to address the increasingly competitive market today. Overseas expansion plan is spearheaded by acquisition of MC Holdings to establish presence in China, Vietnam and Cambodia, followed by hospital development in China.

So its really down to the management’s execution now. Can RM pull off a successful expansion internationally and subsequent integration into its core business?

My Take
RM has always traded at high PE and that held be back from buying its shares for quite some time.

Recent drop in price triggered by the result could have been an opportune time to establish a position, provided if we can ascertain that the negative result is just a blip in RM’s growth story caused by a one-time event. But it is clearly not the case this time round, as RM is facing real challenges and much uncertainty in its expansion plans and earnings can be muted for a few years before improving. Establishing a presence in a new foreign market and navigating around obstacles such as foreign regulations, local residents’ tastes and consumption patterns, incumbents’ competition can be really tricky.

Having said that, I would still want to buy RM at a comfortable price. This stems from my confidence in RM’s management capability in growing it into the largest private healthcare player in Singapore, with the key person Dr Loo still helming the company. The company is also fundamentally strong, shown through its stellar performance over the years. 

Furthermore, healthcare industry, is promising in Asia with the mega trend of increasing affluence, a growing middle class in SEA and China that is increasingly health conscious, and ageing population that needs more healthcare service. The market is there for RM to seize.

But I will need to manage my risk well by buying at a lower valuation to cushion against future negative results. And market should not be as shocked at future earnings fluctuation as it is now, given senior management guidance and recent slowing growth.

I reckon that a PE of around 25, which, based on latest full year EPS of 4.04c which means a price of around $1, will be a more comfortable price range. PE25 is also at the lower range of its PE for the past 5 years.

I will further manage my risk, by splitting my capital for RM into 3 portion. By entering in tranches, it allows me to lower my overall purchase cost should price drops further. 

2 comments:

  1. Great analysis. Enjoyed your post.
    What is your target price and how will you formulate your entry price for your tranches?

    ReplyDelete
  2. There isn't a target price here.. I am not able to forecast what the price might be in future.

    I just aim to buy at low enough price such that market has priced in its expansion risk, and any business improvement is likely to push the stock up.. subsequently i may have sell price depending on its quarterlt results.

    And the buy price is based on PE in comparison w other healthcare counters.. it's more of an art than science..

    And thanks for reading glad u enjoyed my post!

    ReplyDelete

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