Raffles Medical Group - Upgrade to BUY - value re-emerging (OCBC)

Upgrade to BUY

Previous Rating: HOLD

Current Price: S$2.22

Fair Value: S$2.50

Double-digit growth achieved for 2Q11. Raffles Medical Group's (RMG) recent 2Q11 results were within our expectations, with revenue and net profit growing 14.3% and 10.1% YoY to S$67.0m and S$11.6m respectively. As a recap, the group's improved performance was driven by better operating efficiencies, higher patient loads and revenue intensity. We are anticipating a stronger second half, which has traditionally been a better period for the group. While the strengthening SGD could impede medical travellers from seeking treatment in Singapore due to the relatively higher cost of treatment, management highlighted that RMG had not experienced this negative impact as foreign patient loads remain healthy. We reckon that RMG remains an attractive destination for wealthy medical tourists, given the relatively inelastic demand for healthcare services, coupled with the quality and complexity of procedures offered.

Likely positive effects from recent government initiatives. Singapore's Ministry of Health recently announced new initiatives to make healthcare costs more affordable for all Singaporeans, especially the needy and elderly. Some of these initiatives are expected to benefit private healthcare providers like RMG directly, such as increasing the Medisave withdrawal limit for outpatient treatment of chronic diseases from S$300 to S$400 per year. This would help to reduce out-of-pocket expenses for outpatients. There could also possibly be positive spill-over effects for the private sector when subsidies are increased for the needy. As waiting times in public healthcare establishments become longer, the middle-to-upper income group might be more incentivised to switch to private healthcare providers to reduce their waiting time.

Value has re-emerged; upgrade to BUY. RMG's share price has adjusted 5.5% downwards since we downgraded the stock to a Hold (purely on valuation grounds) after its 2Q11 results, underperforming the FTSE ST Health Care Index by 1.8 ppt during the period (although outperforming the broader market by 5.4 ppt). Moving forward, management guided that it would at least be maintaining its current level of dividends as a reward to its shareholders. We believe this is sustainable given the group's good growth potential and strong cashflow generative nature of its business. In light of increasing uncertainty over the macro economy, we believe that the defensive nature of RMG's earnings would provide a safety net for investors. Our fair value estimate of S$2.50 is based on 24x blended FY11/FY12F EPS, which implies a potential upside of 12.6%. As such we are upgrading RMG to BUY.