We reiterate our OVERWEIGHT call for the healthcare sector underpinned by rising affluence and an aging population. Global healthcare expenditure is projected to grow at a CAGR of 3.5% to reach USD10t by 2026. We expect both domestic and international patient throughput to continue to grow while revenue intensity improves, driven by a high-yield case-mix with more acute cases and ramp-up of new beds. We believe the DRG-related regulatory impasse could gradually subside as stakeholders engage in more in-detail discussion and provide more clarity. Overhang is likely to persist at least into 2Q25. Pending further development on the DRG, we continue to remain positive, taking a view of longer-term growth prospects of the healthcare sector, which will continue to be underpinned by an ageing population, rising affluence and rising cases of chronic diseases globally. Our sector top pick is IHH (OP; TP: RM8.11).

1. Private Hospitals Global healthcare expenditure is projected to grow at a CAGR of 3.5% to reach USD10t by CY26, underpinned by rising affluence and aging populations (see chart on next page). The demand for healthcare, a basic necessity, is inelastic despite high inflation. Another key driver is rising chronic diseases across the globe. According to WHO, almost half of the global healthcare expenditures (USD4t) will be spent on three leading causes of death, namely: (i) cardiovascular diseases, (ii) cancer, and (ii) respiratory diseases.

Looking into 2025, IHH plans to add >4,000 beds (+30%) over the next five years across Malaysia, India, Türkiye and Europe. It expects earnings drag to gradually ease in Türkiye (the return of foreign patients), Singapore (nurse shortages resolved) and Hong Kong (economies of scale). IHH expects its earnings momentum to accelerate, underpinned by revenue intensity and rising demand in 2HFY24. We believe IHH has greater exposure to medical tourism by virtue of its vast overseas markets. Its earnings are less susceptible to DRG-related regulatory concerns due to its exposure to earnings in various overseas market it operates in.

We like IHH for its pricing power as the inelastic demand for private healthcare services allows providers such as IHH to pass on the higher cost amidst rising inflation, and its presence in multiple markets, i.e. Malaysia, Singapore, Türkiye and Greater China.

The share price performance of IHH has lagged its peers such as KPJ and SUNWAY. We consider the under-performance unwarranted. IHH trades at 13x EV/EBITDA discount compared to 20x that Columbia Asia paid for Ramsay Sime Darby Health Care. The valuation gap should narrow given IHH's sheer size in terms of profitability and dominant market position in the private healthcare space and easing operational challenges regionally. This is especially so as the locally focused KPJ (MP; TP: RM2.40) and SUNWAY (UP; TP: RM3.35) have seen their share prices rising 76% and 123% YTDCY24, respectively, vs IHH (+23%).

We also like KPJ (MP; TP: RM2.40) for its pricing power as a private healthcare provider and its strong market position locally with the largest network of 28 private hospitals (vs. 16 of the next largest player IHH). However, the fundamentals have been priced in the recent run-up in its share price. Looking into 2025, it will add >1,500 beds (>30%) bringing total beds to 5,000 over the next five years which we have already factored into our forecasts. In terms of bottom-line profitability, we expect earnings to gain momentum moving into FY25 on better operational efficiencies from its cost optimisation effort and overhead absorption rate as a result of a gradual ramp-up in opening new beds (+7%). With incremental revenue from higher patient throughput, Damansara Specialist Hospital 2 (DSH2), KPJ Perlis, KPJ Batu Pahat and KPJ Bandar Dato Onn have already turned EBITDA- positive in 9MFY24, except for Miri which we expect to achieve the same in CY25.

In our view, the government's recent proposal to introduce a Diagnostic-Related Group (DRG) payment system to regulate private healthcare costs may pose challenges which require extensive research and engagement form various stakeholders.

The health minister has said that the pricing system, which will regulate private hospital bills, is more likely to be made available by 2QCY25 given that the Private Healthcare Facilities & Services Act 1998 must first be amended. Generally, DRG is a payment system which involves paying a fixed amount based on the complexity of a case, rather than itemising each charge or commonly known as fee-for-service payment model. The idea of a fixed payment model is that it is expected to help limit excessive medical charges while providing optimum care. This could mean private hospitals is expected to manage their resources adequately to ensure a specific procedure is carried out within a pre-determined charge. Additionally, it aims to reduce lengths of stay and improved patient outcome. The drawback is it could restrict patients access to services in the event of a more complicated medical procedure is needed. In fact, hospitals under our coverage i.e. IHH and KPJ have been embarking on value based-healthcare, which is similar to the DRG system. Pending more development, we continue to remain positive on the long-term growth prospects of the healthcare sector which will continue to be underpinned by an ageing population, rising affluence and rising cases of chronic diseases globally. We believe the DRG-related regulatory overhang could gradually subside after stakeholders engage in more in-depth discussion and provide more clarity.

Key risks to our private hospitals call include: (i) regulatory risk, (ii) risks associated with overseas operations, and (iii) the lack of political will to roll out a national health insurance scheme.

Health Supplements and OTC Drugs Independent market researcher The Statista Consumer Market Outlook projects the OTC pharmaceuticals market in Malaysia to grow at a CAGR of 6% to an estimated USD715m (RM3.2b) by 2027 as consumers take a more proactive stance towards their health and well-being (including taking health supplements regularly), especially in the aftermath of the Covid-19 pandemic.

The trend augurs well for KOTRA (OP; TP: RM5.35) which manufactures and sells OTC supplements, and nutritional and pharmaceutical products under key flagship household brands such as Appeton, Axcel and Vaxcel. We also like KOTRA for: (i) its integrated business model encompassing the entire spectrum of the pharmaceutical value chain from R&D, product conceptualisation to manufacturing and sales, and (ii) the superior margins of its original brand manufacturing (OBM) business model (vs. low-margin contract manufacturing).

Meanwhile, NOVA (OP; TP: RM0.56) has been ramping up production at its new plant during the year. There is also earnings impact from the introduction of 15−20 new SKUs in FY23 (in addition to 35 in FY22), including skincare products, health supplements, and Activmax and Sustinex range of functional food products such as plant-based protein, including specialty Activmax for hospitals. We also like NOVA for its business model which encompasses the entire spectrum of value chain from product conceptualisation starting from R&D to manufacturing.

However, PHARMA (MP; TP: RM0.39) although not out of the Practice Note (PN17) woods yet, can expect a better outlook in the medical supply unit. The group anticipates further growth in the medical supply unit in 4QFY24 and in CY25, as the number of active products under the Approved Product Purchase List (APPL) is expected to increase from 655 products in 3QFY24 to 832 products by end-CY25. This expansion is projected to drive both sales and volume within the concession segment. A significant milestone was reached in its biopharmaceutical venture with the official launch of Malaysia's first local manufacturing plant on 9 Sept 2024. This facility exemplifies Pharmaniaga's capabilities in local manufacturing, supporting the government's efforts in import substitution and supply security. In addition to this, the group's flagship recombinant human insulin product received regulatory approval from the National Pharmaceutical Regulatory Agency (NPRA) in November 2024 and is expected to be supplied to government hospitals by 1QCY25.

Source: Kenanga Research - 14 Jan 2025