Malaysia's healthcare sector remains resilient, driven by higher patient volumes and sustained bed occupancy rates (BOR). While the proposed DRG (Diagnosis-Related Group) system aims to control medical claims costs, we believe the implementation is still in its infancy stage. Looking ahead to 2025, we expect the sector to benefit from continued growth in medical tourism and robust expansion plans by private hospitals. We maintain Overweight on the healthcare sector; reiterating Outperform on both KPJ Healthcare (KPJ) and IHH Healthcare (IHH) due to rising inpatient volumes and strong bed occupancy. We are also positive on Optimax's FY25 outlook, driven by its strategic expansion into Vietnam, and the commencement of its eye specialist center at Selgate Hospital. Meanwhile, we remain Neutral on Apex Healthcare (ApexH), given our cautious outlook on the slowing demand for its core respiratory illness products.

• A solid wrap up 9MCY24. Both IHH and KPJ exceeded our expectations, driven by higher inpatient and outpatient volumes and sustained BOR of 72-73%. KPJ saw improved average revenue per patient, while IHH benefited from higher revenue intensity through more complex cases. Optimax's revenue grew 16% YoY, supported by an increase in cataract and implant vision correction surgeries. Apex Healthcare faced weaker results, with a 24.3% YoY decline in earnings due to elevated expenses, normalised demand and export disruptions.
• The DRG system has been proposed by the Ministry of Health (MOH) to be implemented by the second quarter of 2025, to manage rising medical claims costs in Malaysia through categorising hospital services and applying fixed treatment rates. While it aims to control costs and improve efficiency, patients might face challenges such as shortened hospital stays, early discharges, and a shift away from personalised care. Private hospitals may prioritise simpler cases, increasing pressure on overburdened public hospitals. We view that the DRG system may be premature in Malaysia given challenges in capturing detailed cost data.
• Medical tourism and robust expansion plans. KPJ's health tourism revenue up 22% YoY in 9MFY24, and IHH expanding its footprint through the acquisition of Penang Island Hospital. Malaysia is also targeting medical tourists from China, India, and other regions, capitalising on cultural similarities and accessible flights. Both KPJ and IHH have robust expansion plans, with KPJ aiming an additional 1,200 beds by 2027 while IHH targeting 4,000 additional beds by 2028.
• IHH is our top pick. We favor IHH given its diversified asset base, robust expansion plans, and strong regional presence across key markets. We expect IHH's BOR to remain above 70% in FY25, supported by rising inpatient and outpatient volumes.

9MFY24 Results Wrap Up

• Private hospitals. Both Malaysia private healthcare providers under our coverage, namely IHH and KPJ have recorded results exceeding our expectations in 9MFY24. This is mainly driven by a higher influx of both inpatient and outpatient visits. BOR were well sustained at 72-73% levels. KPJ's average revenue per inpatients and outpatients improved 4-5% YoY. Meanwhile, IHH recorded higher revenue intensity from taking on more complex cases.
• Increasing eye treatment and surgeries. Optimax recorded a 16% YoY revenue growth to RM33.1m in 3QFY24, driven by increased cataract and implant vision correction surgeries. Notably, revenue contribution from foreign patients has grown to 10-15%, compared to only 5% during the pandemic. Looking ahead to FY25, Optimax plans to expand its footprint by establishing a satellite clinic in Vietnam, partnering with agents to boost medical tourism in Malaysia for eye treatments, and launching an eye specialist center at Selgate Hospital.
• Pharmaceutical. ApexH's 9MFY24 results fell short of both our and market expectations. The weaker bottom line, which declined by 24.3% YoY to RM18.4m, was primarily due to elevated operating expenses from new product launches and warehouse expansions. The outlook remains subdued, weighed by normalised consumer demand in the consumer healthcare (CHC) and over-the-counter (OTC) segments. Additionally, export disruptions from ongoing civil unrest in Myanmar and persistent market uncertainties further dampen sentiment. We remain cautious on the sector's recovery trajectory, as pandemic-related demand continues to normalise amidst a challenging operating environment. 050000 100000150000200000250000 1Q19 2Q19 3Q19 4Q19 1Q20 2Q20 3Q20 4Q20 1Q21 2Q21 3Q21 4Q21 1Q22 2Q22 3Q22 4Q22 1Q23 2Q23 3Q23 4Q23 1Q24 2Q24 3Q24 IHH Inpatient Admissions Malaysia Singapore Turkiye India

DRG (Diagnostic-Related Group) System

• Insurance premium hike. According to Bank Negara Malaysia (BNM) and the Ministry of Finance (MOF), approximately six out of ten revised Medical and Health Insurance and Takaful (MHIT) policies experienced premium increases of up to 20% in 2024. This aligns with findings reported by CodeBlue, which highlighted that the cumulative medical claims cost inflation surged by 56% between 2021 and 2023, significantly outpacing the 20% growth in MHIT premiums during the same period. The rising utilisation of treatments in private hospitals continues to drive the escalation of MHIT claims, further straining policyholders and insurers. As private healthcare costs increase, many individuals are expected to shift their reliance to government health facilities, further stretching overcrowded public hospitals.
• What is DRG system? To address the rising MHIT claims, the MOH has proposed the adoption of a DRG system. This case-mix complexity framework categorises hospital services based on patients' clinical diagnoses and applies fixed rates for treatment, aiming to better control healthcare costs and standardise reimbursement rates. By implementing this approach, the MOH seeks to balance cost management while maintaining quality healthcare delivery. DRG were first introduced in the US, starting in New Jersey in 1980 and later adopted federally for Medicare in 1983. Many countries have since incorporated DRG into their healthcare systems to control costs, improve efficiency, and standardise reimbursements.
• A deeper glance into DRG. Hospitals currently utilising the DRG system to classify patients into distinct groups based on clinical relevance and similar resource consumption patterns, enabling more standardised and efficient payment structures. Each DRG is assigned a specific cost weight or tariff, calculated using average treatment costs from prior data across hospitals. Depending on the system, hospitals receive either DRG-based case payments or budget allocations. Under this model, hospitals bear financial risk for costs exceeding the set rate but benefit from cost savings. This incentivizes hospitals to lower costs per admission and potentially increase admission volumes.
• Challenges in DRG. The DRG system faces several challenges, including concerns about shortened hospital stays, early discharges compromising patient care, and a shift away from personalised medicine due to standardised patient categorization. While it promotes cost-effective technological innovations, it discourages adoption of costlier advancements unless payment frameworks are updated. Moreover, private hospitals under fixed payment models may prioritize simpler cases, transferring high-risk or complex patients to public hospitals. Patients with diagnoses not within DRG categories may also be redirected to public facilities, further straining the public hospitals with longer waiting times and reduced overall treatment quality.
• Our thoughts. The DRG system offers a clinically meaningful framework for grouping patients with similar characteristics and resource consumption patterns, enabling more efficient hospital payment structures. However, if DRGs lack homogeneity in resource use, performance comparisons may become unreliable, leading to over- or under-reimbursement for a significant number of patients. We believe the implementation of DRG system is still at its infancy stage in Malaysia, given the challenges in capturing detailed cost and pricing data. A well-maintained DRG system is critical for balancing cost control with equitable hospital funding and patient care. Furthermore, successful adoption requires policymakers, hospital management, and clinicians to thoroughly understand DRG system, with comprehensive training to enable stakeholders to interpret DRG-based performance indicators and adapt internal processes accordingly.

Opportunities In Malaysia Healthcare

• Growth supported by medical tourism. The growth of medical tourism continues to support the healthcare sector, with KPJ's health tourism (HT) revenue reach RM168m 9MFY24, up 22% YoY. Meanwhile, IHH is positioned to capture larger HT market share through its acquisition of Penang Island Hospital, as Penang contributed 40% of Malaysia's medical tourism revenue in 2023. Despite Indonesia's efforts to improve healthcare infrastructure, including partnerships with institutions like Mayo Clinic and regulatory reforms, the country's low bed-per-capita ratio, limited physician availability, and inadequate specialty resources, particularly outside Java, leave affluent Indonesians seeking medical treatment overseas.
• Targeting other countries for HT. Apart from Indonesia, Malaysia is actively targeting medical tourists from China, India, Bangladesh, Cambodia, Myanmar, and the Middle East, leveraging high growth potential driven by limited healthcare facilities in these regions, cultural similarities, and accessible direct flight routes. Notably, the MHTC has positioned the country as a fertility hub, attracting Chinese mainland patients seeking services such as gender selection and IVF procedures not permitted under local guidelines.
• Robust expansion plans. KPJ is on track in opening its 30th hospital, KPJ Kuala Selangor Hospital, with a 68-bed capacity by 1QFY25. The group aims to increase its operational beds to 4,100 by FY24, up from the current 3,787, and targets reaching 5,000 beds within the next three years. Meanwhile, IHH plans to add approximately 4,000 beds (+33% capacity) by 2028 across Malaysia, Europe, Türkiye, India, Singapore, and Hong Kong, building on its current operational capacity of 12,220 beds.
• IHH is our preferred pick. We favor IHH Healthcare given its diversified asset base, robust expansion plans, and strong regional presence across key markets. The group continues to benefit from sustained demand for healthcare services, with its recent strategic acquisition of Island Hospital, Penang, showcasing its disciplined approach to growth. Notably, Penang accounts for 45% of Malaysia's health tourism revenue, driven by a steady influx of medical tourists from Indonesia. Our SOTP-based TP of RM8.64 for IHH, based on 20x FY25 EV/EBITDA valuation, presents an attractive buying opportunity amid the recent weakness in share price following the announcement of the DRG system. We expect IHH's BOR to remain above 70% in FY25, supported by rising inpatient and outpatient volumes.

Source: PublicInvest Research - 3 Jan 2025