3Q23: Weaker Performance As Margin Pressure Builds
RFMD’s 3Q23 net profit fell to S$12.4m (-67.4% yoy) on the absence of COVID-19 related revenue, higher insurance claims and rising costs, missing our expectations. While its TCF at the Expo has been extended, we note that margins have been eroded due to competitive bidding. We expect margins to contract further as a result of gestation losses from its China operations, higher insurance claims and elevated operating costs. Downgrade to HOLD with a lower PE-based target price of S$1.15.
• 3Q23 earnings missed expectations. Raffles Medical Group’s (RFMD) 9M23 revenue (-14.7% yoy) and net profit (-25.6% yoy) formed 78.1% and 68.8% of our full-year forecasts respectively, with net profit below our expectations. 9M23 was dragged by a weak 3Q23 whereby quarterly revenue (-24.6% yoy) and net profit (-67.4% yoy) moderated sharply yoy. As mentioned in our previous update, the yoy decline in top- and bottom line performance was mainly due to the absence of COVID-19-related revenue from the healthcare services segment, higher insurance claims and increased inflationary cost pressures. This led to a fall in profitability and significant margin erosion with 3Q23 net margin contracting 10.0ppt yoy to 7.7%. The rate of margin erosion was much larger than our expectations, leading to the net profit miss against our full-year estimates.
• Falling margins. Moving forward, we expect overall revenue to soften further in 4Q23 as we estimate that there is S$10m-15m of embedded COVID-19-related revenue left. Also, we expect rising operating costs such as manpower costs/utilities, coupled with gestation losses from RFMD’s China hospitals and higher insurance claims to continue to drag margins going into 2024. Management noted that the ongoing domestic nursing shortage has started to improve since 1H23. However, in our view, stiff competition from Australia and New Zealand would likely continue to pressure manpower costs. As a recap, we expect 1H23 staff costs as a percentage of turnover of 43.7% to normalise back to the historical average of 50%.
• TCF operations extended. RFMD’s 3Q23 business update confirmed the extension of RFMD’s current transitional care facility (TCF) at the Expo to Feb 25. Given that the extension was through a competitive tender, we note that margins for the TCF extension are lower than before.
• Healthcare services: Strong and profitable. Although no segmental information was provided, it was noted that the drops in RFMD’s top- and bottom lines were largely due to absence of COVID-19-related revenue from the healthcare services segment. Excluding COVID-19-related revenue, management noted that core operations remained robust with higher patient footfall at its healthcare clinics.
• Hospital services (domestic): Sluggish recovery. 3Q23 overall hospital services revenue grew yoy, driven by higher patient visits to RFMD’s domestic and Chinese hospitals. However, due to the strong Singapore dollar as compared to regional currencies, we understand that foreign patient visits have not returned back to pre-pandemic levels. In addition to increased medical bills, elevated hotel and transport expenses have likely deferred some of RFMD’s higher-billing foreign patients to cheaper alternatives such as Malaysia and Thailand, leading to permanent demand loss and lower margins for the segment. Nonetheless, we maintain our expectations that the hospital segment would face a slow and gradual recovery instead of a V-shaped recovery. Potential upside may come from a weaker Singapore dollar in 2024.
• China: Gestational costs persist. With the removal of China’s COVID-19 restrictions earlier this year, patient visits to RFMD’s China hospitals have increased. While this has lifted hospital segment revenue, Raffles Hospital Chongqing and Raffles Hospital Shanghai continued to incur gestation losses, both of which we reckon are significant contributors to the fall in overall 3Q23 margins. To recap, the EBITDA breakeven timeline for both its Chinese hospitals had been pushed back to 1Q26 due to then-existing COVID-19 restrictions in China. With a ramp-up in operations, we opine that this has led to increased
operating/gestation costs. However, to combat falling margins, management has since initiated measures to improve the cost efficiency of their operations.
• Vietnam: New exciting market. RFMD’s acquisition of a majority stake in American International Hospital in Ho Chi Minh, Vietnam is expected to be completed by 4Q24/1Q25. The valuation of the hospital is US$45.6m and the acquisition is likely to be funded internally by cash. RFMD has about S$240m in cash as of end-9M23. RFMD has also entered into a management services agreement to manage AIH operations. Given the growing demand for private healthcare in Vietnam, we expect additional acquisitions in the medium-long term. Management also mentioned that they are looking at potential regional opportunities such as in Indochina.
• We slash our 2023-25 net profit estimates, on the back of lower overall margins assumptions. We lower our 2023-25 net profit forecasts to S$86.1m (S$105.8m previously), S$74.6m (S$94.2m previously) and S$79.3m (S$93.1m previously) respectively.
• We downgrade to HOLD (BUY previously) with a lower PE-based target price of S$1.15 (S$1.47 previously), pegged to the same 29x PE multiple, RFMD’s long-term average mean PE, to 2024F PATMI estimates. Although we are bullish on RFMD’s expansion in China/Vietnam and potential new acquisitions in the medium to long term, we only expect an inflection point sometime in 2025. Given an ongoing short-term normalisation in earnings and margins, we see limited upside potential in share price performance and reckon that RFMD is fairly valued at current price levels.
SHARE PRICE CATALYST
• Ramp-up of Chinese hospitals’ operations.
• Recovery in foreign patient load.
• Earnings-accretive M&As.