Raffles Medical - Health For You And Me, What About For Our Portfolios?

Introduction

In recent times, we've seen the rather fierce comeback of REITs, evident from the fact that the iEdge S-REIT index rebounded by approximately 14% from its recent October 26 lows. If you ask the average Singaporean investor, they'll tell you that the Singapore stock market is only renowned for two assets: The trio of banks, alongside S-REITs. However, with the recent run S-REITs' prices have undergone, I can't help but wonder if there are any other quality stocks our little red dot can offer. After all, we don't want our portfolio to simply consist of real estate and financials now, do we?

Raffles Medical Logo (Source: Capitaland Mall Website)

Now, I'd like to implore you to take a moment and consider Raffles Medical, a healthcare stock that is more likely than not, no stranger to you. The company has numerous outlets offering a variety of different medical services, all dotted across the island. It is certainly not uncommon to see a Raffles Medical outlet located right at your local mall or even below HDB void decks, and I'm sure a good number of Singaporeans have patronised their services. 

So what exactly does the company do? All this talk about healthcare and medical services, but those are terms so broad that they encompass such a wide array of different services. 

Raffles Medical Business Segment Breakdown & Definitions by Revenue (Source: Raffles Medical FY22 Report)

Raffles Medical Geographical Segment Breakdown by Revenue & Assets (Source: Raffles Medical FY22 Report)

I was only able to obtain figures from the annual reports put out by the company, so for now, the data we have is rather outdated, but I do believe it is sufficient to gain a grasp on the business composition of the company, given that from what I've observed, the numbers do not deviate much.

It is rather interesting to note that by revenue, Singapore is the largest market for the company, whereas, in terms of assets, Greater China consists of approximately 50% as much as Singapore. I will touch on this later down the line. 

To help you better unpack some of the terms within the above images, let me break down some of the terminologies used:

Nutraceutical products are essentially your supplements, such as Vitamin C tablets or Iron pills. Pharmaceutical products encompass drugs to address symptoms arising from your illness or treatment such as Panadeine or Esomeprazole. Diagnostic equipment would be your imaging systems such as MRI scans, CT scans, and PET scans, and can even range to physical tools such as scopes. 

The way I see it, you can boil down Raffles Medical's core business segments into two groups: 

1. General medical care that is suitable for the majority of situations that require surface-level attention, mild injuries, falling sick due to the flu, headaches, etc. 

2. Infrastructure and personnel used when you need to go to a specialist, checking and subsequently treating the underlying, potentially long-term condition. 

Additionally, it seems that Raffles Medical has created a decent talent acquisition pipeline for itself, evident from the presence of its graduate programs.

What I Like About The Business Model

One thing I like about Raffles Medical's business model is the fact that the company has a very large patient funneling network arising from its numerous partnerships and contracts with third-party organisations. The Raffles Medical Group owns a subsidiary, Raffles Health Insurance that partners with well-established parties such as NTUC Income, Bupa Global, and China Life Healthcare Investment Company to provide health insurance solutions across the world. Naturally, with a higher population of insured individuals, more patients will be "locked in" with Raffles Medical to be able to reap the benefits of their insurance plans. 

An additional point I'd like to mention is the existence of the Emergency Care Collaboration (ECC) which is a partnership between the Ministry of Health (MOH) and Raffles Medical where emergency cases sent in by SCDF Ambulances are sent to Raffles Medical's Emergency Care facilities to be rendered medical care. That's right, dialling 995 might land you in a Raffle Medical facility. 

Raffles Medical's Wide Range of Services Provided, Allowing For Consumer Retention During The Entire Treatment Process (Source: Raffles Medical's Website)

Typically, this is how the conversion process would work: An insured person (or perhaps someone who simply prefers the conveniences of a private healthcare institution) visits a GP/Specialist under Raffles Medical. The GP may become that person's regular go-to doctor given that patients tend to prefer to stick to a regular doctor. If any long-term illnesses are discovered during their trip to the specialist, the patient will most likely stick to the same healthcare institution for the entire process of diagnosing, consulting, and treating their respective ailment. The same goes for the general populace that gets sent due to an emergency. Overall, the potential consumer stickiness of the business is extremely attractive, with the regular medication patients purchase yielding higher-than-average margins.

If you're worried about whether the government will aim to replace/outcompete Raffles Medical, I think that as of now, that fear is rather unfounded. According to Mr. Chan Chun Sing, Minister of Public Service, he has stated that "The public sector generally outsources specific services or functions when the private sector is better placed to provide these, due to its deeper expertise or greater efficiency" 

At the very least, I believe we can expect the government to work in conjunction with the private sector to tailor individualised health care solutions to all. 

Raffles Medical's Balance Sheet Health

We don't want a company we invest in to overleverage themselves and go insolvent, so I will be doing some analysis regarding Raffle Medical's Balance Sheet.

Raffle Medical's 1H FY23 Balance Sheet Position (Source: Raffle Medical's 1H FY23 Business Update)

From a quick cursory glance at the company's balance sheet, it is evident that the group has a strong balance sheet, with current assets exceeding the total amount of current liabilities. 

Raffle Medical's 1H FY23 Balance Sheet Health Metrics

I was rather surprised when I reviewed the metrics calculated for Raffles Medical, given the fact that the Non-Cash Working Capital is negative. This implies that Raffles Medical benefits from having a negative cash conversion cycle (Suppliers finance the operations of the business) which is rather desirable. I understand that this is not typical for a healthcare stock so I'm not sure if this number has arisen due to accounting "magic" or if Raffles Medical genuinely has a superior cash conversion cycle to other companies. Nevertheless, I will take it at face value. 

Current, Quick, and Debt-To-Equity Ratios are all in a good range, with Raffles Medical having little to no problem meeting its short-term debt obligations. I would consider the Debt-To-Equity ratio to be rather low, exemplifying the management's conservative nature. 

In conclusion, Raffles Medical's balance sheet is healthy and shows no red flags. 

Raffles Medical's Business Performance

Raffles Medical's Business Performance FY18-FY22 (Source: Raffle Medical's FY22 Annual Report)

Raffles Medical's Consolidated Statement of Profit or Loss (Source: Raffles Medical FY22 Annual Report)

Raffles Medical's business has benefitted substantially from the COVID-19 pandemic, as evidenced by the fact that revenue drastically shot up from 2020 to 2021, and subsequently 2022. Interestingly, ROE shot up from 8.8 to 14.1% from FY21 to FY22. This could be explained by the fact that the transition from FY21 to FY22 regarding COVID-19 projects to organic core business growth resulted in higher margin services being rendered, alongside the reduced manning requirements for the COVID-19 projects (PCR, Swabbing, and Vaccination Services). 

Moving forward, I believe that we will continue to see Raffles Medical's growth performance normalise to that of pre-COVID era levels, reaffirmed by the fact that Singapore is increasingly adopting a "normalisation" stance which means that COVID will simply be treated like any other virus or bug passed around within the population. If you extrapolate the growth rate of Raffles Medical's revenue from FY18 to FY20, we should start to see the company's revenue resume growing by FY24. 

Calculation of Raffles Medical WACC

Just as a quick growth check, I calculated Raffles Medical's WACC using the following assumptions:

1a. Risk Free Rate used was the 10Y Singapore Treasury Yield of 2.710%

1b. Equity Risk Premium was calculated using S&P500 10Y CAGR of 12.04%

1c. Corporate Tax Rate of Flat 17%

1d. Beta of 0.800

2. ROIC of FY19 was used since I felt there was a significant artificial increase in ROIC brought about by the COVID-19 pandemic. (Note: ROIC is extremely high from FY20 onwards, the ROIC was roughly stable before this)

Since the WACC calculated is actually below ROIC, we can conclude that the company is generating sufficient value for its shareholders. 

Key Growth Drivers & Catalysts

Upon reading the company's annual reports over the years, it is rather clear to see that the company is placing its bets on China being the key growth driver moving forward. Currently, Raffles Medical has a total of 8 healthcare facilities in China, being located in cities ranging from Shanghai, and Chongqing to Shenzhen. Currently, the majority of the company's China facilities are suffering operational losses because they have not transitioned away from their gestational period and are still in an early stage of development. It is important to note however, that the company's facility in Beijing is operationally profitable, and hence, it should not be a concern whether the business model in China is a sustainable one. Raffles Medical's bet on China will continue to be the main key driver in terms of growth, with shorter-than-expected gestational periods serving as a catalyst. 

In terms of organic growth for the company's Singapore business segment, I think it is rather mature at this point. A quick Google Maps search would straight away lead to the conclusion that there's not much room left in Singapore for productive outlet expansion. Organic growth will be driven by the increasing necessity of healthcare services. Hence, I believe we can more or less project the revenue growth in a conservative manner using the formula below:

Revenue Growth = (Elderly Proportion of Population x Elderly Projected Growth Rate) x (Non-Elderly Proportion of Population x Singapore Population Growth Rate) x (Projected Core Inflation Rate) 

Using this formula, and after eyeballing some numbers, I believe the projected revenue growth would be around a 7% CAGR, which I believe is a reasonable growth rate. I don't believe that margins will experience compression due to the high barrier of entry for such a business in Singapore. I simply feel that there is no space for new competitors to just pop up. Besides, healthcare services are of high necessity which results in low price elasticity of demand. In terms of catalysts, I suppose it would be a higher degree of partnership with the Singapore government, which I do believe is likely given the good reputation of the company. Another point to note is that an increase in the amount of medical tourists from China may also serve as an impetus for the company to fare better, given the fact that China tourists visiting Singapore have not recovered to pre-pandemic levels. 

Key Risks & Headwinds

The supposedly bright future of the company hinges on the fact that the company can grow its China business and generate enough profit to make the venture worthwhile. As I alluded to in the introduction of this post, over 30% of the company's non-current assets have been allocated to the China segment of the business, albeit only generating 6% of the revenue. If the China business fails, then all those invested assets would have been for naught, which may result in the company writing off a significant portion of its assets. Even if the business manages to barely cling to profitability, then the money would have been better off distributed to shareholders, coupled with the share price crashing due to actual performance not being able to meet the lofty growth expectations set by investors. 

In terms of the Singapore business segment, I believe its main headwinds would simply be higher staff cost/competition and consequently eroding profit margins. It is no secret that doctors, being the main providers of Raffles Medical's services, are extremely well-paid in Singapore. The company's competitors, such as IHH Healthcare, Thomson Medical and perhaps even the government itself, may offer higher salaries, resulting in either talent being poached, alongside the consumer base the doctor has built or simply rising staff costs, increasing COGS and reducing overall profitability.

Management

The Chief Executive Officer, Dr Loo Choon Yong, cofounded Raffles Medical back in 1976, studying both Law and Medicine, sticking with the company the entire way. I couldn't find any concise biography about the man I believe the results speak for themselves. Dr Loo Choon Yong built Raffles Medical into the huge healthcare conglomerate that it is today, all from a humble duo of clinics. If he can scale a humble business to the massive billion-dollar corporate entity that it is today, then I believe he can continue to take the company to further heights using his ample experience of being a doctor himself. Additionally, I find the China growth strategy implemented to be a logical one, since the economic engine that is China has the largest total addressable markets in the APAC region with a rather affluent population capable of easily affording Raffle Medical's services. 

Both Dr. Lu Liangjian and Dr Sarah Lu Qinghui, executive managers of Raffles Medical, are the children of Dr Loo Choon Yong and are both rather accomplished in their own right. I assume that Dr Loo Choon Yong has groomed them from childhood to take over and manage the company, which bodes well for future management should Dr Loo ever step down. I am not aware of either being Dr Loo's appointed successor, but I'm not sure whether it would cause any internal strife within the company. 

It is to be noted that the average tenure of the management team is 3.5 years, which is considered experienced. However, this may signify the fact that a significant proportion of the management is used to benefitting from a COVID environment, which seems to not be the case for the foreseeable future. 

Raffles Medical's Dividend History (Source: Raffles Medical Investor Relations Website)

In terms of dividend policy, I find it to be in fact rather excessive. It is apparent that the company aims to pay out approximately 70% of its annual core earnings to shareholders, which shows that the management is willing to distribute value back to shareholders. I hope the company retains more earnings to quickly gain a strong foothold in the China market. Share buybacks are also occasionally conducted when the company finds its shares being undervalued by the market, improving the per share metrics of the company. 

SGX Healthcare Industry ROA Comparison 

Despite being in the same industry/competitors, Raffles Medical is ahead of the curve with a ROA of almost double its peers. I have used ROA since it is a capital structure-neutral metric. Hence, we can conclude that the management is utilising funds more efficiently. 

Valuation

Given the fact that Raffles Medical is a growth company, it is only appropriate that we use a Discounted Cash Flow model to arrive at an intrinsic value of the company. 

Discounted Cash Flow Exercise for Raffles Medical Arriving At $1.35 Per Share

Oh boy, this was a rather large undertaking for me so I'll begin to unpack the assumptions I used for this model. 

1a. For EBIT, I used a projected growth rate for FY24 - FY28 of 10%. I believe that a growth rate of 10% is rather reasonable given the fact that the Singapore business segment would already yield 7% growth (assuming margins remain constant) coupled with the fact that the China arm of the business would experience high levels of growth due to transitioning from the gestational period to operating at full capacity after absorbing the initial capital expenditure used to open the facilities. 

1b. The Tax rate used is a flat corporate tax rate of 17% (Singapore's tax rate). This is just to simplify calculations although I acknowledge that China imposes a 25% corporate tax rate. Since I cannot project the EBIT mix by geographical segment accurately, I used a 17% tax rate coupled with the conservative aforementioned projection of 10% EBIT growth per year in hopes of balancing the two out. 

1c. For D&A and Change in Non-Cash Working Capital, I used the following Google Sheets formula: 

I used a random function that uses the historic low of the metric (B17) multiplied by the compounded growth rate of 10% in EBIT times the period as a base. Subsequently, the random function adds a number within the range of the highest and the lowest historical metric. This formula takes into account the variability of the metric, the overall range of the metric, and additional funds needed to sustain the EBIT growth rate, albeit perhaps a bit archaic since there is no "single" set value achieved.

1d. For CAPEX, I simply increased CAPEX by the same rate as the EBIT growth rate of 10%. The reason why I use such a low projected CAPEX as compared to FY17 - FY20 is because it includes capitalised expenditures for the construction of the company's new China properties. Since the overall construction period is approximately 5 years, coinciding with the forecasted period, and there are no indications of building a new facility, I find it reasonable to assume no additional CAPEX to fund further facilities. 

1e. Terminal Growth Rate was set at 2.6% pegged to Singapore's historic inflation rate.

2. For FY23 figures, the variables have been annualised using different financial reports. It is simply a guide to help me grasp the overall historical figures of the company. For the sake of clarity, I used Q3 FY23 results to annualise EBIT and D&A since I believe that Q3 takes into account the normalisation of EBIT without COVID-19 to a greater degree whereas CAPEX & Change in Non-Cash Working Capital was annualised using 1H FY23 figures since they would more or less be constant regardless of the normalisation of the business. 

3. The number of Shares Outstanding was calculated by using the given historical CAGR with the assumption of there being no equity fundraising, which I think is a rather reasonable assumption to make due to the company's history of having no rights issue. Hence, any fluctuation in shares outstanding would be due to stock-based compensation and share buybacks.

In terms of extrinsic valuation, I believe using historical Prices / Sales and Price / Earnings ratios would be useful given the fact that Raffles Medical is regarded as a growth stock.

At the time of writing, Raffles Medical is currently trading at a P/E of 14, at a price of $1.08 with a TTM EPS of $0.08. With a median P/E of 28.05, it doesn't necessarily mean the stock price should be double. This year's P/E ratio is artificially high due to the abnormally good TTM net profit from FY22, if we normalise earnings using FY20 EPS of 3.97 cents, a P/E ratio of 28.05 would yield a stock price of $1.11. If we use the median P/S of 4.19 using TTM Revenue per share of 0.39, that would yield a stock price of $1.63. 

If we were to use all of the information above, a blended value of $1.36 per share would be obtained, which is rather close to the DCF Intrinsic Value of $1.35 per share.

There is actually a rather interesting fact I would like to point out regarding the staff's view on the current share price:

Exercised Options' Share Prices (Source: 1H FY23 Raffles Medical Financial Statement)

The majority of options were exercised at the $1.09 mark, with some even being exercised at $1.31 and $1.42. Although share options may be exercised for a multitude of reasons, I believe the insiders of the company have the greatest idea of the company's outlook. Investing is a war of information, every time you buy, there's another investor on the other side thinking it's a good price to sell. If the insiders think it's a decent price, then it may be something worth noting. 

Overall Conclusion

I believe Raffles Medical is overall the best healthcare stock in the SGX market. It has an integrated healthcare business that covers all bases, creating an extremely powerful "funneling" effect. Sure, it's not as big as IHH Healthcare, but I opine that Raffles Medical is the better-managed and overall less bloated company in the long run. 

Raffles Medical's current 3+% dividend is also a nice bonus, not leaving your returns entirely to the market. But I must confess that the execution risk for Raffles Medical is extremely high. If the China business fails, then be prepared for the share price to languish. Not to mention the fact that if the China business does indeed succeed and becomes a core part of the business, then Forex risk is indeed a concern in the future. Personally, if I initiate a position in Raffles Medical, it would be a mid-sized one with a long investment horizon. This stock is the type where you'll have to slowly accumulate while waiting painstakingly for your investment to bear fruit. 

Using the blended target price of $1.36 per share and with a margin of safety of 30% due to the stock being of higher risk, I believe 95.2 cents per share is approximately where I'll consider entering. All in all, initiate a BUY for Raffles Medical at $0.95 per share and HOLD at $1.36 per share. 

Author's Note: This has been a massive article for me, coupled with the fact that I found Raffles Medical to have a very hard business to evaluate. Please forgive me if there's certain methods or approach I have used that you find problematic, and do let me know your thoughts in the comments, thank you!

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I have no stock, option or similar derivative position in any of the companies I have mentioned, and no plans to initiate any such positions within the next 72 hours. All content published by me should not be construed as any sort of financial or investment advice and is simply for informational purposes. Although all research and figures are accurate and calculated to the best of my ability, I am not liable for any decisions made based on inaccurate information.