My stock analysis of Raffles Medical Group

Have you bought Raffles Medical shares recently? Since my last coverage on this counter on 24 August 2017, the share price of the private healthcare service provider had a 10% correction. What is happening? Should shareholders run for their lives?

To add value to readers, I will share my stock analysis of Raffles Medical Group. Through this, I hope readers will learn how to perform a basic evaluation on stocks and sign up as members of SG Wealth Builder.

Circle of Competence

When it comes to stock investing, the best approach is to invest within your “circle of competence”. This means that you don’t have to be an expert in every company in order to succeed. Instead, invest in an area in which you have a significant knowledge than the rest of investors. For example, if you are a healthcare worker, you are likely to know the trend of the healthcare industry, the market leaders, the demand and supply, and the key developments in the medical field. Thus, it is likely that you would be familiar with Raffles Medical Group and how it has fared in recent years.

But what if you don’t have the circle of competence? Then the risk should be mitigated by the understanding of business model. In short, the business should be something simple enough for you to understand in one sentence. For example, most Singaporeans would know that Raffles Medical Group is one of the largest private integrated healthcare providers in Singapore.

If you can meet either of the above two criteria, then half the battle will be won and you would know the underlying reasons for a stock’s performance. Let’s use Raffles Medical Group as an example. Even though the company occupies a niche area and healthcare is an evergreen industry in Singapore, the business model is affected by several key factors.

Healthcare landscape

Firstly, as a private healthcare provider, Raffles Medical’s business is sensitive to economic conditions because patients can opt to go for treatments in public hospitals, which offer heavily subsidized treatments. This means that it needs to offer a suite of services and venture overseas to ward off competition from local public hospitals.

Secondly, as Singapore market is too small, Raffles Medical Group must be able to attract foreign patients to its facilities in Singapore. This means that apart from competitors in Singapore, it must compete against foreign healthcare providers in the region. In recent years, there were reports that Singapore is losing its attractiveness as a regional medical hub because neighboring countries are now able to offer quality medical treatments at a fraction of the cost here. Against this backdrop, Raffles Medical has no choice but to expand into the Chinese market in a bid to capture revenue growth.

Investment Moats

Raffles Medical Group biggest rival is IHH, which operates the Gleneagles Hospital, Parkway East Hospital and Mount Elizabeth Hospital in Singapore. Ideally, one should invest in the number one or two player in the industry. But I prefer Raffles Medical because it is a homegrown company established since 1976 while IHH is a conglomerate from Malaysia. While Raffles cannot match IHH in terms of size, revenue, market share and profit, I like its strong brand and consistent growth story through the decades.

RafflesMedical continues to expand its network of clinics in 2017 with the opening of new clinics at Changi Airport Terminal 4 and Transit 4 in the fourth quarter of 2017. Two new in-house clinics in Dover and Tampines were opened in August 2017. Northpoint City re-opened in September 2017 after the mall’s retrofitting.

RafflesHospital continues to grow its patient base, in line with the expansion and growth of the Group. With the planned opening of RafflesHospital Extension by the fourth quarter this year, RafflesHospital will have capacity to serve more patients and corporate clients.

Despite the expansion of RafflesHopsital, it should be noted that IHH’s three private hospitals in Singapore represent a formidable challenge to Raffles Medical Group and is likely to continue to exert pressure on the profit margin. Probably because of this, the Group has no choice but to venture overseas. Constructions of RafflesHospital Chongqing and RafflesHospital Shanghai are progressing according to plan. These hospitals are targeted to be operational by second half 2018 and second half 2019 respectively.

Share Price Performance

Apart from decreasing market share and declining business from medical tourism, another key factor for the sudden drop in share price could be concerns over start-up costs in China. Raffles Medical Group is building not one, but two hospitals at one go in China. Funding for the expansion is expected to impact cash flow for the short-term.

When reviewing the financial statements, readers should focus on the balance sheet and cash flow statement of a company. For Raffles Medical Group, the cash from operating activities for Q3FY17 was $24.4 million while there was payment of S$30.9 million for investment properties under development. This means that the cash generated from its existing operations was not able to meet the start-up costs in China. This means that there may be a need for management to dip into the cash holding, which amounted to $114 million.

Building a hospital requires substantial capital. The amount of capital required could pose a significant risk for the healthcare risk given that Raffles Medical is also working on the RafflesHospital Extension, which is scheduled to open by the end of the year. To address the cash flow issue, one possible means is to raise capital through rights issue in the stock market. However, in doing so, this would drive down the stock price.

Special situation?

Usually, I am not against companies going through short-term cash flow issues or borrowing to fund business expansion. However, Raffles Medical Group is at a special situation whereby it faces the dilemma of “damn if you do, damn if you don’t”. If it did not initiate growth initiative projects like Raffles Holland V, RafflesHospital Extension and building new hospitals in China, it will face a serious threat from local and foreign competitors. On the other hand, with the current balance sheet, aggressive expansion mode could lead to potential liquidity issue if not managed prudently.

In my opinion, the management made the right call in pursuing the current overseas expansion drive. The Return on Equity (ROE) has declined consistently from 19.7% in FY2013 to 10.4% in FY2016. ROE measures how well the management generates returns for shareholders. A declining ROE indicates that growth is slowing for the healthcare service provider. To reverse the trend, it is imperative that management be more proactive in engineering topline growth.

The latest financial results confirmed that growth has stagnated. Q3FY17 recorded revenue of $119.5, a marginally increase of 0.3% compared to previous year. Profit after tax was $15.8 million, also a marginally increase of 0.5% compared to previous year.

My investment strategy

On the basis of the latest financial results and the expected surge in investment expenses for the China hospitals, there could be headwind for the share price. In my previous articles on Raffles Medical Group, I have shared my target price for this counter. Several readers had raise doubts over my entry price but with the current form, it is likely that the share price will soon reach the level that I had forecast.

In stock investing, it is important to take care of the downside risk and set an entry price. With a track record of 40 years, the fundamentals of Raffles Medical Group remain intact and I don’t see significant long-term risks. The bearish share price could be caused by loss of confidence among investors who may be concerned over management ability to execute the business initiatives which are aimed at spurring growth. Nonetheless, such correction is a healthy one. Since 2008, the shares of Raffles Medical Group, went on a rampage bull run, rising from $0.56 to almost $5.00 in 2015.

I will not reveal my target price and strategies for Raffles Medical Group as they are contained in my previous articles. The links to the articles are below. To access them, readers need to register as members of SG Wealth Builder.

1. Raffles Medical shares under siege!
2. Raffles Medical share price
3. Raffles Medical Group’s Return on Equity (ROE)
4. Analysis on Raffles Medical Group
5. Raffles Medical shares power ahead
6. Raffles Medical Group stable growth
7. Raffles Medical Group’s proposed stock split

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Magically yours,

SG Wealth Builder