Stretched valuations threaten outperforming healthcare players

Growth stories are already priced in.

Stretched valuations and near-term margin pressures threaten outperforming healthcare companies, which have delivered a solid 36% gain year-to-date.

OCBC analyst Jodie Foo noted that the FTSE ST Health Care Index is now trading at a six-year historical high forward P/E of 26.5x, and broad-based valuations currently seem stretched.

"We think such premium valuations are warranted only to a certain extent, while a deeper look into specific
companies suggest growth stories may already be priced in and a potential correction could be due," Foo noted.

Here's more from the report:

We had previously covered several healthcare companies’ plans to expand in China given the attractive growth prospects, but also highlighted operational risks and early stage of plans as caveats for a more optimistic stance.

Under our coverage, share price for Raffles Medical Group has had a largely sustained run-up since its confirmation on a Shanghai Hospital, which is slated for completion by mid-18.

While this is a positive development, in the meantime, its 1Q15 results showed that higher expenses such as staff costs would likely be incurred due to other upcoming projects (Holland Village project to be ready by 1Q16 and Raffles Hospital extension by 1Q17).

Peers such as IHH Healthcare Berhad [non-rated] could also face similar near-term pressures on operating margins due to on-going expansion plans in Malaysia and Turkey. With both stocks trading at more than 1 s.d. above their two-year historical forward P/E average, current valuations are becoming less attractive.