Raffles Medical is one of the stocks that has baffled me for quite some time. It is in a defensive industry, Singapore is one of the top medical tourism destinations in the world, we have an ageing population and healthcare costs are always on the rise. But why does its share price not reflect the growth story? If you were to buy Raffles Medical 7 years ago in 2013, you would have made a 0% gain excluding dividend returns. Is there something wrong with the financial performance? Or could there be a hidden gem that the market has failed to see? Let’s check it out in this article.
Overview Business of Raffles Medical
Raffles Medical was founded in 1976 and it’s two main business segments are Raffles Medical and Raffles Hospital. This is their main revenue driver.
Raffles Medical is those standard general practice clinics you see around the malls in Singapore. They offer similar General Practice (GP) services such as health check, immunisation, health screening and etc. It has a network of 100 multi-disciplinary clinics located at major cities of China, Hong Kong, Cambodia, Japan and Vietnam. The other business segment is the 24-hours Raffles Hospital which is the flagship of Raffles Medical Group. Opened in 2002, Raffles Hospital provides a wide array of specialist services that combines the latest advancements in medical technology. Similar to other hospitals, you have the heart department, eye, lungs, Ear Nose & Throat (ENT), urology, women, diabetes, orthopaedic, surgery and many more.
Financial Overview of Raffles Medical
Let’s have a quick look at how they make money.
As you would imagine, Hospital services ($306m) make up more than half of the group’s revenue followed by Healthcare services ($239) and lastly investment holdings. Total revenue for 31 Dec 2019 came in at $522m. That is half a billion.
If we were to break down revenue and look at it by geographical segment, 88% of the group revenue came from Singapore followed by China 8%, and Rest of Asia 4%. While China makes up only 8% of the group’s revenue currently, the CEO has ambitious plans for China and it is expected that China would account for almost half of the group’s total revenue by 2025.
Loo, executive chairman and co-founder, has mentioned that he has waited 34 years for this day. He has studied China’s system and walked through hundreds of hospitals in China, making friends with hospital presidents and etc. With Dr Loo’s influence, Raffles Medical has managed to penetrate into China’s lucrative healthcare market. They are in an envious position as getting into China’s is not an easy feat. Many foreign hospitals have been eyeing to gain a piece of that market share but have failed to obtain the necessary permits and approvals.
Raffles Medical’s Growth Story in China
Raffles Medical Group has 2 Raffles Hospital in China. The first one is a 700-bed hospital located in Chongqing, China. It was officially opened in Jan 2019 and the start-up cost was approximately $159m, one-third of the group’s total revenue in FY 19.
Recently, it has obtained approval to be one of the designated hospitals covered under China’s social health insurance (Yibao). This is positive news as more local patients would visit Raffles Hospital Chongqing given that they can now claim the medical expenditures incurred.
The second hospital is a joint venture with Shanghai Lujiazui Group to build a 400-bed hospital in Shanghai’s Qiantan International Business District. Construction is already completed but the official opening date has been delayed due to the Covid-19 pandemic. As compared to Chongqing, Shanghai is a tier-1 city and there is a large community of affluent expatriates who have the budget to afford a higher quality of health care services.
The group is betting big on China and many analysts expect these two hospitals in China to break even somewhere in their third year of operations. Each hospital is expected to incur a loss of between $8-$10m during the first year of operations, followed by a loss of $4m-$5m during the second year of operations. Whether or not the growth story in China plays out well for Raffles Medical remains to be seen. But at least we know there is a potential catalyst beyond the saturated market in Singapore.
I have analysed the financials of Raffles Medical by organising them into bite-sized themes. All figures are based on S&P Capital IQ and the charts are plotted out in excel and python.
Firstly, let’s look at a brief overview of high-level financial items such as revenue, operating profits (EBIT) and net income. Do take note that the net income I used refers to the “normalised” net income. This would better reflect the underlying performance of Raffles Medical as it strips off unusual line items such as asset write down, restructuring charges or goodwill impairments.
#1 Operating Costs rising FASTER than Gross Profits
Revenue has been growing pretty strongly over the past 17 years. However, gross profit, EBIT and normalised net income have not been able to keep pace with the growth in revenue. If we remove the scale of revenue, here is how the bottom-line figures would look like.
Gross profits are relatively still in line with revenue, but EBIT and net income have stagnated since 2015. This means that while revenue and gross profits have been increasing, operating costs have been putting pressure on their margins, in particular staff costs.
Staff costs have historically made up approximately 50% of the group’s total revenue. The hefty fees to hiring doctors, specialists and nurses to operate hospitals and clinics come as a challenge if we factor in the annual wage inflation. For example, FY 2019’s bottom-line results were hit by an increase of 8.4% increase in staff cost to $266.9m. That is 51% of its revenue of $522m. To see this visually, we can compare the growth in gross profits against operating expenses.
The chart above shows the year-on-year % growth for both gross profits and operating expenses. In the green box, you can see that gross profits are growing much faster than operating expenses. Ever since 2015, that trend has reversed, and the growth in operating expenses have outpaced the growth in gross profits as seen in the red box. This explains the stagnation of their operating profits and perhaps also share price.
While revenue has been impressive, it is not a good sign to see a flattish financial performance over the past consecutive years. Ultimately, what interest shareholders are net income and not revenue.
#2 Declining Profitability Margins (Or a Reversal?)
As a result, you can see that despite a stellar revenue performance, gross profit margin, operating income margin and net income margin have been declining steadily since the peak in 2014. Again, not a good sign to see that happening.
However, the margins in 2019 include the gestation losses of $9.2m from Raffles Hospital Chongqing. This was within the management guidance of $8m to $10m. If we were to exclude Hospital Chongqing from the group, this is how their financial performance would look like.
The figures are directly taken from Raffles Hospital financial results release. For the full year in 2019, there has been an improvement in the EBITDA margin of 11.8%. Net profit for the group was down 15.2% to $60.3m. But net income margin excluding Chongqing was not reported.
Nevertheless, without Chongqing, the group would see higher profit margins. What that means is that its business in Singapore is showing signs of upticks. Now the interesting question is what if Chongqing and Shanghai Hospital become profitable three to four years later? Profitability margins would propel upwards and shareholders would enjoy the fruition.
#3 Sustainability of Dividend Payouts
Raffles Medical paid out a dividend of $0.025 per share. Taking the last closing price of $1.03, that would translate to a dividend yield of about 2.43%. Is that sustainable? Let’s compare the dividends per share against the normalised basic earnings per share and see how it looks.
The good news is dividends per share has increased consistently over the past 17 years. The bad news is the spread between normalized basic EPS and dividends per share is converging. Again, you could say 2019, 2020 and 2021 is an exception because of losses from their China hospitals.
How about looking at the sustainability of dividend payouts from a different angle. We would compare the Free Cash Flow (FCF) and dividends since cash flow is a better representative of economic reality.
Similarly, you see the same convergence at the end of the chart. The FCF to dividend spread has sunk into the negative. What does that mean? It means that in the year 2019, Raffles has paid more dividends than it earned in free cash flow. To be specific, they paid $2.95m more, which is still acceptable as long as it is temporary. They have a cash pile of $152m in their balance sheet to buffer through the spread. The reason why FCF has fallen so sharply is due to the increase in CAPEX to expand into China. At least we know that is a one-off occurrence and not from poor financial performance.
#4 Comparing the FCF Yield vs 10-Year Bond Yield
Free Cash Flow (FCF) yield is calculated by taking the free cash flow of a business divided by its enterprise value. The idea is to imagine if you were to buy over the entire company and you are the business owner of Raffles Medical, how much cash is the business generating for you? What is the yield of this economic machine that you own?
Then compare the FCF yield against the risk-free rate. An FCF yield that is lower than the risk-free rate would make no sense as you are taking on the equity risk of owning a business when you can get the same or even higher return elsewhere, risk-free. This is one of the filters from the 52-week low formula which I have adopted in my own investment analysis.
In the above charts, Raffles Medical have failed this filter. Then again, we are going to say 2019 is a year of exception. But if you look at the historical trend over the past 17 years, it has been sliding downwards from a high of 10% to now 1%. Even if we exclude Chongqing Hospital in 2019, it doesn’t change the fact that its underlying performance in Singapore has been weak and lacklustre.
#5 Below Average Return on Invested Capital (ROIC) Returns
Another filter from the 52-week low formula is the Return on Invested Capital or ROIC. This calculates how efficient the management is generating after-tax operating profits from its capital investment. The idea is to compare this against the weighted-average cost of capital and evaluate how efficient they are in allocating capital. For example, if I am borrowing at 4% but am making a 12% return on investment, then I am doing a good job of managing money.
How do we calculate the average cost of capital (WACC)?
This is just a quick ballpark figure calculation which I came up with and is purely based on subjective assumptions. Raffles Medical’s capital structure as of FY2019 is 81% equity and 19% debt. We first need to find out what is the cost of equity and cost of debt.
Cost of equity is based on the Capital Asset Pricing Model (CAPM). The average equity return is based on the 10-year average STI index return and the risk-free rate is based on the 10-year government bond yield. Plugging in the inputs would give us approximately 4.49%.
As for debt, I calculate the average interest rate by taking interest expenses divided by short-term debt + long-term debt. It is about 3% over a period of 17 years.
Finally, we can find WACC by taking (81% * 4.49%) <This is the equity component + (19% * 3%) <This is the debt component and it would give us about 4.21%.
ROIC is about 6%~ and WACC is 4.21%. This means that Raffles Medical is making a thin spread of 2.26%. Of course, the WACC is just a subjective ballpark figure. But it does give us an idea of the range and margin.
A more concerning observation is the declining ROIC since 2014. Raffles Medical has been underperforming below its historical average of 12.5% for the past few years.
Management has not been very efficient in investing capital and it is likely due to the first reason that we have highlighted, high operating costs to run hospitals and clinics.
#6 Strong Cash Flow but Long-Term Debt Risks Arise
The positives of Raffles Medical is that it has a relatively low level of debt. Total debt as of FY 2019 stands at approximately $200m. This is in contrast with the total equity of $841m. Total debt as a % of total capital is 19% and the debt to equity ratio is around 23.4%.
Both current and quick ratio is 1.1x and the interest expense is negligible. EBIT interest coverage is 38.5x and EBITDA interest coverage is 53.6x.
Their cash flow is pretty strong and consistent too. There is a good margin between the operating cash flow and the CAPEX. (excluding 2018 & 2019) The only concern is that the ratio of cash flow from ops. to current liability is about 0.5x for the past couple of years. This means that they only have $0.50 for every dollar of current liability.
Another alarming observation is its long-term debt to free cash flow ratio. This is also one of the filters from the 52-week low formula. Long Term Debt to FCF calculates the number of years it takes for a company’s free cash flow to fully repay its long-term debt. The lower the number the better.
Generally, 5 years or less would be a good measure and 3 years to be conservative. You can see some blanks in between because there were no long-term debts during those years. However, Raffles Medical has recently shore up a huge pile of long-term debt standing at $157m. This is in pale contrast to the $15m they have in free cash flow as of FY 2019. The number of years it takes for their free cash flow to relief its long-term obligations is about 10 years.
#7 Relative Valuations
If we look at the PE ratio of Raffles Medical. It is not cheap. It is trading near the highs of 30 and the average PE is about 23. The red-dotted lines represent the mean and standard deviation above and below the mean. If we were to take its FY 2019 earnings per share multiply by the average PE, the fair value of Raffles Medical would be about $0.70. It seems that current valuations are pricing in future increase in net profits from China.
Alright, we have covered seven different themes in Raffles Medical’s Business. Some look good and some don’t. Hopefully, it gives you some insights about the company.
Final Commentaries and Risk Factors
Firstly, most investors fixate their attention to the growth story in China. That is where all the buzz and excitement is. When results are disappointing, we attribute it to temporary losses from China but conveniently forgetting that the lion share of the group’s revenue is derived locally.
Raffles Medical core business is in Singapore and most of its assets are all located in Singapore. The strength of this company should be based on the financial and operational performance in Singapore. As seen from the above few charts, results have not been really exceptional.
China should be seen as a bonus booster rather than a saviour. One good example is Sheng Shiong. It’s Singapore business is strong and it is looking to expand outside for further growth. But if China fails, they can still do well back at home. But what if China fails for Raffles Medical? Does it have an economic moat that is strong enough to justify a sound business for investment?
Secondly, competition is tough. Despite healthcare and medical being a necessity, there are a ton of options available for consumers. There are 19 acute hospitals, 8 community hospitals, 20 public polyclinics and 2,222 private clinics. MOH plans to build another six to eight new polyclinics by 2030.
Singapore only has a population of 5.8 million. The hospitals they decide to visit on is based on their budget, convenience and insurance coverage. The health care costs of Raffles Medical is somewhere in between public government hospitals and private hospitals. Those who have extensive coverage would probably go to Mount E. or Gleneagles. Those budget-conscious would go to government hospitals. There isn’t any particular customer segmentation that falls in between.
Thirdly, about 35% of Raffles Medical’s patients are from international countries. Not only it has to face competition from local hospitals and clinics, but they are also facing stiff competition from neighbouring countries like Thailand and Malaysia. A strong Singapore dollar and the recent covid-19 virus has put off some of the international patients from visiting Raffles Medical.
Fourthly, the favourable macro outlook is a growing ageing population in Singapore & China.
This would progressively increase the demand for healthcare services a couple of years down the road. It is expected that the elderly would account for a quarter of Singapore’s population by 2030.
Lastly, the financial results look pretty mixed. While revenue growth is staggering, bottom-line figures for its Singapore’s business are flattish. They are hinging on China’s success to lift share prices up. Their venture has to work because they have a $157m debt to pare. Failing to do so would spell a financial disaster for the company. China is a go big or go home narrative for Raffles Medical.