SI Research: 3 Reasons To Accumulate Raffles Medical Group

Over the past two weeks, the global stock market suffered a rout as investors succumbed to fears of escalating trade tensions between US and China after the two largest economies hit one another with their first round of trade tariffs. Adding to investors’ woes, the US Federal Reserve’s latest meeting minutes revealed a faster pace of interest rate hike which inherently means rising financing costs for businesses.

As if that was not enough, the Singapore government then sparked yet another bout of sell-off when it made surprising moves to cool the local property market which had only recently been touted to be in the cusps of recovery after a four-year decline. It feels as though Mr. Market is testing the will and resolve of investors as they were left licking their wounds.

But amidst the gloomy sentiments, value has emerged and embattled investors should not be blind to the silver lining. After all, while global growth is expected to ease, worldwide gross domestic product (GDP) is still expected to grow by a more-than-healthy rate of 3.9 percent in 2018, according to the International Monetary Fund (IMF).

In fact, despite the slew of negative news flooding the mainstream media, the IMF still maintains its forecast of 3.9 percent for the following year. Retail investors should appreciate a still-benign investing environment instead of cowering in fear. What could be a worse mistake to make is to completely avoid investing in China’s growth story. Listed on the Mainboard of the Singapore Exchange, Raffles Medical Group (RMG) offers exposure to the Chinese market and here are three reasons to start betting on it now.

A Safe Haven-Cum-Growth Stock

Amidst the trade uncertainties between the US and China, investors may find comfort in defensive stocks the like of RMG. Since people get sick whether the economy is doing well or not, RMG’s business is not subjected to cyclicality and hence more recession-proof. More importantly, the stock also offers a hedge against the current trade dynamics.

In addition, unlike pharmaceutical companies that depend on the developments and approvals of new drugs to drive growth, RMG as an owner and operator of hospitals and clinics has clearer earnings visibility as well as stability. Notwithstanding that, the group is also expanding its footprint into China, with two new hospitals RafflesHospital Chongqing and RafflesHospital Shanghai, slated to be opened in 4Q18 and 2H19 respectively.

The two new hospitals in China will add a total of 1,100 bed capacity – 400 in Shanghai and 700 in Chongqing – which will act as a major growth driver for the group. The establishment of the two new hospitals in China will allow the group to tap on the rising demand for better medical services, along with the rising affluence of the Chinese middle class.

Apart from that, RMG has also expanded its flagship Raffles Hospital in North Bridge Road. The newly added capacity will allow RMG to increase its patient load and address the rising demand for medical care brought about by the local ageing demographics.

Pristine Balance Sheet Supports Growth

While RMG is in a phase of starting-up two new hospitals in China, investors are wary about the impending start-up losses that the group could incur. At onset, when a hospital opens, RMG would need to purchase equipment, medical consumables and hire medical professionals. Notwithstanding other various related start-up costs, demand would have to pick off from zero.

To match revenue with costs and to contain upfront losses, the opening of hospitals will likely happen progressively in phases. For the Chongqing hospital, Executive Chairman Loo Choon Yong expects startup costs to be about $8 to $10 million in its first year, but analysts are slightly more cautious. On the street, startup losses for the two new Chinese hospitals are forecasted to be between $14 million to $21 million in their first two years of operations.

For RMG, the ability to invest in its future growth will largely be dependent on the strength of its balance sheet. At the same time, the group must also be able to generate enough cash to meet its operational needs and financial obligations. In a show of confidence, the group paid an interim and final dividend, raising its total payout by 12.5 percent to 2.25 Singapore cents in FY17.

In the latest quarter of 1Q18, the group still maintained a rather healthy balance sheet, with cash amounting to $94 million against total borrowings of $71.7 million. This translates to a net cash position of $22.3 million. In the period, RMG’s total debt-to-equity ratio was just 9.3 percent and its low level of debt also meant that the group’s borrowing costs will not be significantly impacted as interest rates continue to rise.

Cash-flow wise, RMG continued to display strong cash generating abilities, registering a positive flow of $24 million from operating activities in 1Q18. This was aided by the fact that RMG managed to maintain a healthy net profit margin of about 13.2 percent, on its revenue of $120.2 million in the same period.

Valuation At Multi-year Low

Since peaking at $1.65 in July 2015, the former growth darling has lost favour among local investors. Currently, the stock has shed over 40 percent from its peak and is now trading at a five-year low of $0.99 per share. Based on its trailing 12-month earnings-per-share of about $0.04, RMG is trading at just about 24.8 times its earnings. The indicative yield based on last year’s dividends is 2.3 percent.

To put things in perspective, RMG’s upcoming Chinese hospitals have much larger capacity than its local flagship hospital. Potentially, RMG’s China play could see earnings grow exponentially in the forthcoming years. Considering that the stock had traded above 40 times price-to-earnings in its heydays, the current cheap valuation is rather attractive in retrospect.