The Motley Fool

Is This Seemingly Expensive Share Actually a Cheap Bargain?

Healthcare services provider Raffles Medical Group Ltd. (SGX: R01) had just released its third quarter earnings yesterday. For the quarter, Raffles Medical saw healthy year-on-year growth of 11.1% and 11.3% for its revenue and profit, respectively. For the nine month period ended 30 September 2014, growth was a shade paler – though certainly still respectable – as Raffles Medical’s revenue had ticked up by 8.6% while profit increased by 9.2%.

Period Revenue Profit
Quarter ended 30 Sep 2014 S$94.5 million S$15.4 million
Nine months ended 30 Sep 2014 S$274.6 million S$45.6 million

Source: Company filings

Such figures, when taken on their own, seem to indicate a healthy company, especially considering that Raffles Medical ended the first three quarters of 2014 with net-cash (total cash minus total borrowings) of S$119 million on its balance sheet.

Healthy growth… but not enough

But, a healthy company need not be a healthy share. When Raffles Medical’s year-to-date growth rate in earnings of ‘just’ 9.2% is compared against its trailing price/earnings (PE) ratio of 25, it seems to indicate a company trading at an expensive valuation.

Indeed, Raffles Medical’s current valuation also does not compare favourably against that of the market average; the SPDR STI ETF (SGX: ES3), an exchange-traded fund which tracks Singapore’s market bellwether, the Straits Times Index (SGX: ^STI), is valued at less than 14 times its earnings.

In addition, a look back at history also suggests that Raffles Medical is not trading at a valuation that could deserve the tag “cheap”:

Raffles Medical Group PE ratio

Source: S&P Capital IQ

The chart above plots Raffles Medical’s PE ratio going back to the start of 2004. And as you can see, its current PE ratio of 25 is actually a tad higher than the average figure of 23.

But just looking at Raffles Medical’s valuations the way I’ve done – without context regarding its corporate future – can’t give us the full picture. As investor Ric Dillon once wrote:

“On the behavioural-finance side, one of many inefficiencies comes from people anchoring on the past. People assume something is cheap, say, just because it hasn’t traded at such a low valuation for five or ten years. But that doesn’t matter, what matters is what will be [emphasis mine].”

In other words, Raffles Medical may look pricey now. But the high valuation could be justified if its corporate future warrants great optimism.

An apple a day, keeps the doctor away

With Raffles Medical, management has been busy paving the way for future growth – and that’s a strong reason for optimism.

Raffles Medical’s in the business of providing healthcare services and it does so through two main business segments: Healthcare Services; and Hospital Services.

The latter typically accounts for around two-thirds of the company’s annual revenue; Raffles Medical’s flagship Raffles Hospital is the main driver for the segment. Meanwhile, Healthcare Services takes up one-third of annual sales for Raffles Medical, and is driven by the company’s network of medical clinics and centres (103 across Singapore, and four in Hong Kong and Shang Hai) and other ancillary services like providing healthcare insurance and selling nutraceutical products.

In Raffles Medical’s latest earnings release, the company gave updates on two of its important growth drivers. Here’s what I had written about it previously:

Investors in Raffles Medical might be happy to note the progress of two of the company’s important growth initiatives: 1) The expansion of Raffles Hospital; and 2) the construction of a medical/retail centre near Holland Village in Singapore.

For the hospital expansion, Raffles Medical has “finalized the development plans” and groundbreaking for the project “is scheduled to take place by end 2014.” The extension will see the company’s flagship Raffles Hospital expand its gross floor area from 300,000 square feet to 520,000 square feet upon completion.

As for the medical/retail centre, works are “in progress.” The centre would have a total gross floor area of 65,000 square feet, of which 9,000 has been earmarked for the company’s medical and specialist services. The rest of the space would be occupied by DBS Bank, “upmarket retail” stores, and “reputable food and beverage tenants.”

The increase in the company’s ability to help treat even more patients plays into an important trend in medical spending in Singapore. Research outfit Frost and Sullivan has forecasted total medical tourism spending in Singapore to grow at a compounded annual rate of 13.0% between 2014 and 2020. With analyst reports pegging medical tourist spending at around S$1.1 billion in 2013, the projected growth rates places the spending figure in the ballpark of around S$2.3 billion by 2020.

That’s some significant opportunity for Raffles Medical to tap into considering that only one-third of the company’s Hospital Services’ revenue of S$215 million in 2013 came from foreign patients.

In addition, Singapore’s aging and growing population would also likely increase the demand for healthcare services here and thus provide a growing market for Raffles Medical.

Last but not least, the company’s stellar balance sheet (S$125 million in cash with just S$5.6 million in borrowings as of 30 September 2014), gives it the financial muscle to take advantage of opportunities to grow the business.

Foolish Bottom Line

There are things to like about Raffles Medical’s future. But, there are also risks to consider with the company.

Competition is a big issue as there are a slew of public and private hospitals coming online – according to analyst reports, as of August 2014, seven new hospitals are slated to be completed by 2020 with a total of 3,770 beds. This increase in supply could prove to be a formidable challenge to Raffles Hospital.

Succession plans could be another source of worry with Raffles Medical. The company’s Co-Founder and Executive Chairman, Dr. Loo Choon Yong, is already in his mid-sixties. He has led Raffles Medical for a long time (Loo has been Executive Chairman since 1997) with great success (the company’s earnings had grown by 715% between 2003 and 2013). When he steps down, would his lieutenants be capable enough to be the ones steering the ship?

These are just some of the risks investors have to consider with Raffles Medical. All told, investors would have to weigh the risks and rewards with the company in order to come up with an intelligent investing decision.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing owns shares in Raffles Medical Group.