An undervalued healthcare stock that is worth looking at

Singapore Medical Group provides a wide range of specialist healthcare services

Singapore Medical Group (SMG) has an established network of private specialist providers across diverse segments, which can be broadly classified into: (1) Diagnostics & Aesthetics; and (2) Health. SMG takes pride in its Women and Children’s Health business, which is one of the largest in Singapore’s private healthcare sector. Its clinics (Figure 1) are found in both the central and suburban areas of Singapore.

Table 1: SMG operates across various key specialist verticals

Figure 1: Clinics under SMG

Source: Singapore Medical Group

SMG derives around 66% of its revenue from the Health business segment (Figure 2). Close to 34% is derived from the Diagnostic and Aesthetics business segment, while the remaining comes from group-level corporate services, as well as business consultancy functions and telemedicine services.

Figure 2: SMG derives majority of its revenue from the Health business segment

The major shareholder of SMG is CHA Healthcare, which is an international subsidiary of leading Korean comprehensive healthcare group CHA Health Systems. CHA is South Korea’s leading integrated healthcare provider and one of the world’s most respected names in reproductive medicine, women’s health, stem cell research, and wellness care.

While healthcare is a defensive sector, SMG is not immune to the negative impact from COVID-19

Against the backdrop of COVID-19, there have been disruptions to SMG’s business. Firstly, due to the border and travel restrictions to curb the spread of COVID-19 in the region, medical tourism (which contributes approximately 15% to 20% to SMG’s revenue) is expected to remain poor in the short-term.

Secondly, with the implementation of the ‘circuit breaker’ measures in April, non-essential medical clinics were forced to close temporarily. They have since re-opened in Phase 2 (19 June 2020). This includes SW1 Clinic, which specialises in aesthetics, and SMG’s other clinics that provide Lasik, health screening, and non-emergency dental services. We understand that such non-essential services constitute around 10% of SMG’s revenue.

In view of the challenging operating environment, SMG has undertaken various cost-cutting measures, such as a reduction of senior management salaries by up to 30%. We believe that, to a large extent, the COVID-19 pandemic has brought about a negative impact on SMG in the short-term.

Favourable trends driving long-term demand for private healthcare specialists

Looking beyond COVID-19, the long-term growth story of SMG remains intact. According to market insights firm Fitch Solutions, private healthcare expenditure in Singapore is forecasted to grow at a compound annual growth rate (CAGR) of approximately 5%, from SGD 11.4 billion this year to SGD 18.8 billion in 2029.

One of the largest drivers underpinning the demand for private healthcare is the rising affluence in Singapore. The median gross monthly income for Singaporeans has grown by more than 50% in the past 10 years to SGD 4,563 (Figure 3). This increases the affordability of better private healthcare services with shorter waiting times, as compared to public healthcare services.

Figure 3: Growing affluence is likely to drive demand for private healthcare specialists

Moreover, an ageing population increases the demand for certain health services that treat ageing conditions and chronic diseases, such as oncology, ophthalmology, and cardiology. Growing older is among the biggest risk factors of contracting cancer – the principal cause of death in Singapore (Table 2). Hence, an ageing population would likely increase the demand for oncology services as more efforts will need to be taken in cancer prevention.

Table 2: Cancer is the principal cause of death in Singapore in 2018 (latest data)

SMG’s business has been expanding rapidly

In recent years, SMG has been rather aggressive in expanding its business organically and inorganically. This has contributed to the strong growth in the Group’s revenue and gross profit (Figure 4).

Figure 4: Revenue and gross profit have been on an uptrend

In recent years, SMG has opened nine new clinics (Table 3). As of FY2019, the Group now has 35 clinics in Singapore. As compared to FY2015, the number of clinics have grown by a CAGR of approximately 11%.

Table 3: New clinics that were opened in recent years

Moving forward, the management wishes to open more clinics in suburban areas. Suburban clinics, especially those that are focused on Women & Children’s Health, are likely to be able to attract more patients as compared to clinics in the central areas. In 4Q 2020, a new Women’s Health and Paediatric clinic will be opened in the suburbs.

Having more suburban clinics is also one area where SMG distinguishes itself from its peers. Currently, at least half of SMG’s clinics are located in suburban areas. This is much higher compared to its peers like Singapore O&G (SGX:1D8).

In tandem with the number of new clinics, the number of specialists has also been increasing at a robust CAGR of 17% over the same time period. Despite the disruptions caused by COVID-19, the management has indicated that there will be an addition of four more specialists this year. This represents a growth of approximately 8% year-on-year.

Last but not least, as part of its “buy and grow” strategy, acquisitions have been made since 2016. Major acquisitions that were made includes Lifescan Imaging, Astra Women’s Specialist Group, Kids Clinic, and SW1 Clinic. Going forward, SMG will remain aggressive in seeking out earnings accretive acquisitions.

With the slowdown in medical tourism in Singapore due to high medical inflation and increasing competition from neighbouring countries, SMG will continue to expand its regional footprint and will be targeting markets that were traditional sources of medical tourism in Singapore.

Adequate cash to safeguard financial position

In view of the COVID-19 situation, SMG has taken efforts to preserve cash. After slashing its maiden dividend by half from SGD 0.008 to SGD 0.004, the management has conserved an additional SGD 1.9 million in cash. Barring unforeseen circumstances, we think that this dividend cut is likely to be a one-off event caused by COVID-19.

In February 2020, SMG announced a formal dividend policy of a target payout ratio of not less than 20% of the Group’s core earnings excluding the share of results of joint ventures and associates. The initial maiden dividend of SGD 0.008 would have represented a payout of around 28% of net income (which includes share of results of joint ventures and associates). The final dividend of SGD 0.004 represents a payout of 14% of net income and a dividend yield of 1.6%.

SMG’s financial position does not seem too bad. As at 31 December 2019, it has reported a debt-to-equity ratio (total borrowings to total equity attributable to shareholders) of 22.0%. It has since repaid a Convertible Loan on 8 May 2020, hence reducing the debt-to-equity ratio to approximately 15.6%.

However, due to the adoption of the new accounting standard SFRS(I) 16 on 1 January 2019, the debt-to-equity ratio was higher than that in FY2018. The debt-to-equity ratio in FY2018 was around 13.8%. If we exclude the impact from SFRS(I) 16, debt-to-equity ratio in FY2019 would have remained relatively stable year-on-year.

SFRS(I) 16 requires lessees to capitalise all leases (except for short-term and low value leases) on the statement of financial position. All leases including operating leases are treated as finance leases, and are recognised as ‘lease liabilities’ on the liabilities side. Correspondingly, the leases will be recognised as “right-of-use assets” on the other side of the balance sheet. Thus, the adoption of SFRS(I) 16 affects key financial metrics such as the debt-to-equity ratio.

SMG also has a net debt of around SGD 4.5 million and a net debt-to-equity ratio of around 3.1%. Excluding the impact from SFRS(I) 16, it would have maintained its net cash position of around SGD 5.1 million (FY2018: SGD 2.1 million), resulting in a net debt-to-equity ratio of around -3.5%.

In comparison to its peers (Table 4), SMG has a higher financial leverage. This could be attributable to the Group’s aggressive expansion, resulting in more debt.

Nonetheless, with SGD 8.5 million of undrawn committed borrowing facilities, there is little liquidity risk and sufficient debt headroom to support its inorganic growth opportunities.

Key investment risks

Ability to attract and retain specialists: SMG’s market presence and reputation are dependent to a significant extent the skills and experience of its specialists. Most specialists are employed on fixed contract terms, and some others are visiting consultants. The failure to retain specialists without a suitable and timely replacement could have a material impact on its business.

Litigation risk: Specialist healthcare providers are exposed to the risk of having legal actions taken against them and their medical specialists for professional misconduct. This may lead to negative publicity and affect its business.

Potential upside of more than 30%

Looking beyond the negatives stemming from COVID-19, we believe that SMG is undervalued based on its current price. As shown in Table 5 below, it is currently trading at a lower 2021E PE of 9.7X compared to its peers.

Table 5: SMG is undervalued compared to its peers

We believe that SMG should be trading at a multiple that is closer to its peers, who are also small and medium-sized players in the specialist healthcare space.

We assign a 2021E PE multiple of 14.0X to Singapore Medical Group (SGX:5OT), which represents a target price of SGD 0.35. This translates to an upside potential of 34.6% based on the closing price of SGD 0.26 on 22 July 2020.

Our estimated dividend yield for 2020 and 2021 is 2.8% and 3.4% respectively. Hence, investors can potentially receive a total return of approximately 40.8%.

Table 6: Earnings growth

In our next article, we will be providing more insights about the Group’s business.

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.