Equity Analysis /
Saudi Arabia

Saudi German Hospital: Attractive valuation given potential expansions; Overweight, PT: 30.6

    SNB Capital
    30 May 2019
    Published by

    We resume coverage on SGH with an Overweight rating and a PT of SAR30.6: We believe the worst is largely behind it and expect SGH’s earnings to improve with the Dammam, Makkah and Riyadh expansions and easing of the expat exodus. Given the strength of its business model, we expect SGH’s margins to be back on track as it overcomes near-term headwinds. We forecast net income to dip in 2019f, due to a decline in patient volumes, but pick up thereafter driven by a recovery in utilisation rates. We believe the risks pertaining to patient volumes, margin contraction and accounts receivables are priced in at current levels. Although the stock appears expensive at 2019f P/E of 28.5x, on a normalised basis, it trades at a 2020f P/E of 20.0x offering an attractive value proposition in our view.

    Long-term earnings outlook strong despite near-term headwinds: SGH has aggressive expansion plans with two greenfield projects in Dammam (completion Q3 19) and Makkah (completion Q3 21) and one brownfield project in Riyadh (completion Q4 21), which would increase its bed capacity by 59% to 1,610 in 2022 from 1,013 currently. Although, we expect revenues to dip 4.4% to SAR1.3bn in 2019 attributed to lower patient volumes, we see a pick up thereafter given significant capacity addition and easing of the expat exodus. We expect revenues to grow at a CAGR of 9.5% in 2018-23f driven by an increase in patient volumes and better contractual terms. SGH has posted strong gross margins historically reflecting its robust business model. With the ramp-up of Dammam and Makkah operations and the new management’s focus on controlling staff costs and growing revenues, we expect gross margins to gradually improve from 33.2% in 2019f to 45.2% by 2023f. We expect net income to decline 52.4% to SAR82mn in 2019f and grow thereafter reflecting a CAGR of 23.5% in 2018-23f driven by a recovery in margins.

    Receivables management is the key: SGH’s cash cycle remains among the highest in the industry at 194 days vs 110 days for Mouwasat and 154 days for AlHammadi. With accounts receivables standing at SAR989mn as of Q1 19, 34% of total assets, a significant amount of cash is locked up in receivables. According to management, c59% (cSAR583mn) of receivables pertain to MoH and c25% are overdue by more than a year. We believe management would step up its collection efforts resulting in receivables days declining from 257 days in 2018 to 200 days by 2023f.

    Capex requirement to be met through further drawdowns: Given the tight liquidity position, SGH utilised its working capital facility in Q1 19 to partially meet its capex requirements. The company recently increased the limit of its working capital facility with Samba Financial Group to SAR150mn. We believe the company will continue to drawdown from its working capital facility to meet capex requirements towards renovations and expansion projects. This would result in higher financing costs but this should be manageable with the expected improvement in gross margins.

    Valuation seems attractive given potential expansions: We are Overweight on the stock with a PT of SAR30.6 reflecting a 20.7% potential upside. Although the stock appears expensive at a 2019f P/E of 28.5x, on a normalised basis, it trades at 2020f P/E of 20.0x offering an attractive value proposition. The company withheld dividends in 2018 due to tight liquidity position. Resumption of dividend payouts from 2019 would also be a material positive for the stock price.