Raffles Medical Group: Downgrade to HOLD; positives priced in (OCBC)

2Q11 results within expectations. Raffles Medical Group (RMG) reported its 2Q11 results with revenue increasing 14.3% YoY and 3.9% QoQ to S$67.0m. Net profit was up 10.1% YoY and 11.0% QoQ to S$11.6m. The improved performance was attributed to a higher patient load, wider range of medical specialty offerings and improved operating efficiencies. For 1H11, revenue was up 14.5% to S$131.4m, forming 47.5% of our full-year estimates; while net profit rose 12.6% to S$22.1m, making up 44.3% of our FY11 forecast. This was within expectations as 2H is seasonally a stronger half for RMG. A dividend of 1 S cent per share was declared, similar to 2Q10 and in-line with our expectations.

Continued growth from both core segments. Double-digit revenue growth was reported for both RMG's Healthcare and Hospital Services divisions (+12.2% and +14.5% YoY respectively). Prior to 2Q11, we note that RMG's net profit had consistently grown at a larger magnitude vis-a-vis its top-line growth for the previous nine quarters. This highlights the importance of operating leverage on RMG's earnings momentum. While this quarter was an exception, management attributed it to the following reasons: 1) effect of the jobs credit grants received in 2Q10; and 2) continued start-up losses relating to its medical centre in Shanghai which started operations from Jun 2010. Negating the impact of these two factors, net profit would instead have grown by 17.2% YoY. Hence we expect operating leverage to continue its role in RMG's growth.

Net debt position not a concern. RMG moved from a net cash position of S$71.0m (as at 31 Mar 2011) to a net debt position of S$3.2m after the S$83m payment for the balance outstanding amount on the Thong Sia Building acquisition. Nevertheless, we opine that RMG's balance sheet remains healthy as net gearing ratio is still comfortable at 1.0%, coupled with the strong operating cashflow generating nature of its business.

Downgrade to HOLD on valuation grounds. RMG's share price has appreciated 8.8% since we upgraded the stock from Hold to Buy on 22 Feb 2011, outperforming the broader market by 5.5 ppt in the process. While we remain sanguine on RMG's growth prospects and like its strong management and continued operating efficiencies, we believe that current market valuations have already factored much of these positives in. RMG's PER of 25.9x implies that it is now trading close to +1 standard deviation of its historical mean PER. We are retaining our estimates and fair value estimate of S$2.50. Given the limited upside potential of 6.4%, we downgrade RMG to HOLD.