Indonesia Healthcare Services, Underserved, Growing Indonesian Hospital Market

We initiate coverage on Indonesia’s hospital sector with an Overweight
Despite Indonesia’s growing healthcare spending, its hospital sector is still largely underserved compared to its ASEAN peers. With the increasing middle income class and the push of the Indonesian Government for a universal healthcare coverage, the structural growth opportunity for Indonesia’s hospital sector is tremendous as its hospital infrastructure is undergoing upgrades and a fast expansion. Our BUY calls are Mitra Keluarga Karyasehat and Sarana Meditama Metropolitan.

Solid structural growth. Indonesia’s current USD27bn healthcare market is still at an early stage of development. Indonesia’s ratio of health expenditures/GDP of 3.1% in 2013 is low when compared with similar ratios from higher income countries which are above 7.0%. As such, we estimate a long-term growth outlook for the Indonesian healthcare sector.

Rising health expenditure per capita. As the world’s fourth-most populous nation with c.250 million people, Indonesia has witnessed its healthcare spending per capita grow from a mere USD17 in 2001 to USD107 in 2013, a CAGR of 15%. However, Indonesia’s healthcare spending per capita ratio is still low when compared to similar ratios of ASEAN peers, such as those of the Philippines (USD122), Thailand (USD264) or Malaysia (USD423).

The Indonesian hospital market is seriously underserved… Indonesia has low ratios of hospital beds per 1,000 population of 0.6 and only 0.2 doctors per 1,000 population. For comparison in 2012, on average, among the countries in the Organisation for Economic Co-operation and Development (OECD) the average ratios of hospital beds per 1,000 population and average doctors per 1,000 population were much higher at 4.8 and 3.2, respectively.

…and also fragmented with the total number of beds of the top four private hospitals, amounting to only 8.9% of all private hospital beds in FY14.
Our BUY calls are Mitra Keluarga Karyasehat (MIKA) and Sarana Meditama Metropolitan (Sarana Meditama). MIKA has the best operating cash flow generation, strongest balance sheet and highest ROIC compared to its listed peers. Sarana Meditama is an undervalued small-cap stock and the operator of the emerging OMNI Hospitals.

Key risks are the limited supply of specialists and obtaining operation.

Executive Summary

Solid structural growth
Indonesia’s current USD27bn healthcare market is still at an early stage of development. Compared to similar ratios in high income countries with health expenditure/GDP above 7% and in low-to-middle income countries of 4.0%-5.5%, Indonesia’s health expenditure/GDP ratio was only 3.1% in 2013. Therefore we estimate a long-term growth outlook for the Indonesian healthcare sector.

Rising health expenditure per capita
As the world’s fourth-most populous nation with c.250 million people, Indonesia has witnessed its healthcare spending per capita grow from a mere USD17 in 2001 to USD107 in 2013. However, Indonesia’s healthcare spending per capita ratio is still low when compared to similar ratios of its ASEAN peers, such as those in the Philippines (USD122), Thailand (USD264), or Malaysia (USD423).

Seriously underserved market
The recent Indonesian healthcare developments have centered in major cities while rural areas remained underserved. Indonesia has the lowest ratios of hospital beds per 1,000 population of 0.6 and of doctors per 1,000 population of 0.2 (Figure 6 and 7). For comparison, the 2012 average ratios of countries in the OECD of hospital beds per 1,000 population and doctors per 1,000 population were at 4.8 and 3.2, respectively.

Large hospital groups, such as Siloam Hospitals (SILO IJ, Neutral, TP: IDR13,000), are focusing their expansion plans in second-tier cities due to the favorable prospects there such as a low bed-to-population ratio, large unfulfilled demand and lower cost of land acquisition compared to that of first-tier cities such as Jakarta.

Fragmented Indonesian hospital market
Not only it is underserved, the Indonesian hospital market is also very fragmented with the total number of hospital beds in the top four private hospitals amounting to only 8.9% of all private hospital beds in FY14.

Rising middle income
Although Asia’s emerging economies are slowing, the rise of their middle-income classes continues. The Boston Consulting Group (BCG) estimates the Indonesian middle income population would grow to 168.0 million by 2020F from 109.2 million in 2012. As the living standards of the middle income class of Indonesians continues to improve, they would request higher quality healthcare services, including access to preventive medicines and food/dietary supplements

Private hospitals outgrow public hospitals
In addition to the growing middle income class that has become more health conscious, and the overall market in Indonesia which is seriously underserved, over the past two years vigilant private healthcare players have taken advantage of this opportunity and built private hospitals faster than the government did. As of FY14, the number of private hospitals constituted 33.5% of total hospitals in Indonesia.

Our BUY calls are Mitra Keluarga Karyasehat (MIKA) and Sarana Meditama Metropolitan (SAME)
MIKA has the best operating cash flow generation, strongest balance sheet, and highest ROIC compared to its listed peers. SAME is an undervalued small-cap stock and the operator for the emerging OMNI Hospitals, which are constructing new hospitals in Cikarang and Balikapapan.

Valuation & Recommendation

We value the hospital stocks under coverage using the DCF valuation methodology, with consistent parameters applied such as a risk free rate of 8.25%, a terminal growth of 5.0% and a market risk premium of 5.0%. All other parameters used are based on each company’s unique circumstances. We used as corroborative valuation the peer comparison approach.

Mitra Keluarga Karyasehat (MIKA) (MIKA IJ, BUY, TP: IDR3,150) is the best listed private hospital operator in Indonesia with the strongest operating cash flow generation, strongest balance sheet and highest ROIC compared to its listed peers. It aims to add seven hospitals by FY19F and 384 hospital beds for its existing hospitals by FY19F.

Sarana Meditama Metropolitan (SAME or Sarana Meditama) (SAME IJ, BUY, TP: IDR3,300) is the operator of the OMNI Hospitals in Pulomas (East Jakarta) and Alam Sutera (West Java). OMNI Hospitals won the Frost & Sullivan 2014 Indonesia Emerging Hospital Award. Sarana Meditama is building a third OMNI Hospital in Cikarang (West Java) with a target operation in 2016 and planning a fourth OMNI Hospital in Balikpapan (East Kalimantan), which it expects to complete by 2017.

Siloam International Hospitals (SILO) (SILO IJ, NEUTRAL, TP:IDR13,000) is the largest and fastest-growing private hospital operator in Indonesia, with a strong financial support from its parent, Lippo Karawaci (LPKR IJ, NEUTRAL, TP:IDR1,460). Siloam has been opening roughly four new hospitals each year since FY11. We believe Siloam, with its new hospital expansion plan, is more appropriate for the long-term investors.

Investment Thesis

Solid structural growth envisioned
Indonesia’s current USD27bn healthcare market is still at an early stage of development. As evidenced in Figure 2, high income countries have health expenditure/GDP ratios above 7% while low-to-middle income countries’ health expenditure/GDP ratios are 4.0%-5.5%. With Indonesia’s health expenditure ratio of only 3.1% in 2013, we estimate a long-term growth outlook for the Indonesian healthcare sector.

Rising health expenditure per capita
As the world’s fourth-most populous nation with c.250 million people, Indonesia has witnessed its healthcare spending per capita grow from a mere USD17 in 2001 to USD107 in FY13. However, Indonesia’s healthcare spending per capita ratio is still low (Figure 4) when compared to ratios of several of its ASEAN peers, such as the Philippines (USD122), Thailand (USD264) or Malaysia (USD423).

Seriously underserved market
Recent healthcare developments in Indonesia have centered on major cities while rural areas remained underserved. As evidenced in Figures 6 and 7, Indonesia’s healthcare is still a truly underserved market as proven by these two figures: it has the lowest ratios of hospital beds per 1,000 population ratio of 0.6 and doctors per 1,000 population ratio of 0.2. For comparison, in 2012, the average ratios for OECD countries in terms of hospital beds per 1,000 population and doctors per 1,000 population were at 4.8 and 3.2, respectively.

Large hospital groups, such as SILO, are focusing their expansion plans in second-tier cities due to the favorable prospects such as low bed-to-population ratios, large unfulfilled demand, and lower costs of land acquisition compared to first-tier cities such as Jakarta.

Fragmented hospital market
Not only it is underserved, the Indonesian hospital market is also very fragmented with the total number of beds for the top four private hospitals amounting to only 8.9% of all private hospital beds in FY14

Rising middle income class
Although growth in Asia’s emerging economies is slowing, the rise of their middle class is continuing. In a similar fashion we expect Indonesia’s middle income class will continue to grow. BCG forecasts (Figure 10) the Indonesian middle income population size may grow to 168.0 million by 2020F from 109.2 million in 2012.

With an increasingly higher overall GDP per capita in Indonesia (Figure 11) and a standard of living which continues to improve for the people in the middle income class, they would demand higher quality healthcare services, including access to preventive medicines and food/dietary supplements.

Fast Growing Private Hospital Industry

Private hospitals outgrow the public ones
As we mentioned, Indonesia is a seriously underserved market with only 0.6 hospital beds per 1,000 population ratio and 0.2 doctors per 1,000 population ratio, occurring in an overall environment of a growing middle income class who has become more health conscious. During the past two years, vigilant private healthcare players have taken advantage of this opportunity and built private hospitals faster than the government did. As of FY14, private hospitals constitute 33.5% of total hospitals in Indonesia

Indonesian listed hospital operators landscape
As evidenced in Figure 14 below, both MIKA and SAME have been experiencing EBIT margin expansions while SILO’s EBIT margin had only a relatively small improvement in FY14. The cash balance on MIKA’s balanced sheet has resulted in lower asset turnover in FY13. As MIKA’s excellent operating cash flow generation can cover it capex needs, MIKA has the capacity to pay higher dividends in the future.

Also shows that SILO has a lower EBIT margin when compared to its listed peers in Indonesia. Its low EBIT margin is a result of SILO opening roughly four new hospitals per year since FY11. And, since it takes approximately three years for a new SILO hospital to breakeven at net income level, currently five of the newer hospitals are still operating at a loss, thus its lower overall EBIT margin.

Based on our own survey of select hospitals from the three listed hospitals, we found that, on average, MIKA’s hospital room prices are higher than those of SAME and SILO as shown in

Based on a research done this year by the SWA Magazine, across Indonesia’s vast geography there are still no truly dominant private hospital groups. We think it is not easy for a hospital group to enter and dominate right away a new region as the local regional players have been entrenched in their respective strong areas due to their brand equity, customer service and loyalty from their customers.

The need to grow more specialists
Indonesia still lacks qualified specialists, which is a key pull factor for private hospitals to attract patients. The issue is that developing and retaining qualified doctors can take years and high investment costs. On average, it takes 4-6 years to get a medical degree and another 2-4 years to become a qualified doctor in Indonesia.

Afterwards, it takes 4-5 years to become a specialist. Thus, one might need 10-15 years in total to become a specialist doctor in Indonesia. On Figure 17 next page we show that the growth in hospital beds is higher that the growth of both specialist and general practitioners.

Most specialists work as partners and not as hospital employees. Under their license for medical practice, a specialist can work at a maximum of 3 hospitals. This shortage has created an intense competition in retaining and recruiting specialists. For SILO and MIKA hospitals, they both have similar strategies in developing and retaining good doctors, such as: a) cooperate with universities and take on doctors before graduation, b) provide access to quality training and medical equipment, c) provide support for specialists to continue working in other research centers or universities.

Medical tourism
Patients Beyond Borders estimated the medical tourism industry to be worth up to USD55bn with over 11 million travelers worldwide seeking medical treatment. They also estimated, using US medical costs as a benchmark, medical tourists on average can save 65%-80% for similar medical treatments in Malaysia, 50%-75% in Thailand, and 25%-40% in Singapore.

In the annual 2014 Medical Travel Quality Alliance’s ranking of top hospital for medical tourists, Prince Court Medical Center in Malaysia, Gleneagles Hospital in Singapore, and Bumrungrad International (BH TB, SELL, TP: THB143) in Thailand ranked first, seventh, and ninth respectively.

With a growing population of approximately 258 million by FY18, scarcity of qualified specialists, and only 20 Joint Commission International (JCI) accredited hospitals throughout Indonesia, some members of the Indonesian middle class and upper class segments opt to fly to neighboring ASEAN countries for medical treatment.

It is estimated that the affluent Indonesians spent a total of USD1bn per year on medical treatments in Singapore and Malaysia. As Indonesian healthcare sector grows in the future and with more JCI accredited hospitals, we believe Indonesia can attract inbound medical tourists and reduce outbound medical tourists.

Jaminan Kesehatan National – Indonesia’s Universal Healthcare Program

JKN’s five year goal
In FY14, Indonesia launched its universal healthcare program, called Jaminan Kesehatan Nasional (JKN), which is administered by the National Social Security Agency (BPJS). The program has comprehensive benefits, from influenza to critical medical intervention such as cancer therapies and open-heart surgeries. The goal of JKN is to provide 100% health insurance coverage for all the 258 million Indonesians by Jan 2019.

Hospitals participating in the JKN must follow a government formulary, which consists of 2.5% innovator and 92% generic medicines. The remaining is accounted for by dental materials and diagnostics. Thus, JKN can potentially put pressure on working capital requirements and profitability of smaller private hospital operators.

Larger private hospitals, such as SILO, can handle the cost pressure as business from JKN patients represents a small 5% of its FY14 total revenues; furthermore, it benefits from economies of scale by reducing the number of drug formulary from over 8,000 to 2,500 items, entitling volume discounts from its suppliers.

In the near term, we expect JKN might have adverse effects on some private hospitals as patients, especially in the low-end segment, prefer to use the JKN scheme rather than going to private hospitals. In FY14, MIKA witnessed a decline in its FY14 outpatient and inpatient numbers due to its patients taking advantage of JKN. At the same time, public hospitals witnessed overcapacity following the introduction of the JKN.

We believe last year’s negative trend for MIKA will reverse once its patients see that public hospitals are becoming overcrowded (as it will take longer time for the government to build more public hospitals).

Premium structure for JKN
Part of the JKN funding comes from premiums paid by its participants. Fee paying participants, who pay 4%-5% percent of their monthly wages are limited to 1st or 2nd-class hospital beds. The poor and the near poor needing hospitalization, covered by the government subsidy, are entitled to 3rd-class hospital beds.

Deficit by BPJS health
BPJS has been experiencing a budget deficit since its initiation in FY14 because the claim ratio has been greater than 100% as high risk participants joined JKN and needed immediate medical treatments, resulting in a higher than expected budget cost. To overcome the deficit, BPJS will increase the premium for the poor, paid by the government, to IDR27,000/person in FY16F as, on average, it costs IDR21,977 for each medical service that the poor receive.

Coordination of benefit scheme
Under the JKN, the provider-payer mechanisms follow a) case-mix system (INA-CBG) for hospitals, and b) a capitation model for primary care providers to promote preventive services. BPJS also has a Coordination of Benefit (CoB) scheme with private insurers such that BPJS is to pay its standard rates and private insurance companies paying the reminder of the services provided by private hospitals participating in the COB scheme. The COB scheme also allows JKN patients to choose non-registered BPJS hospitals for advanced inpatient care as long as those non-registered BPJS hospitals are approved by BPJS.

Public healthcare spending to rise
In Indonesia, public spending lags behind the average public spending of other ASEAN countries. Despite a decade of rapid economic growth, Indonesia spends relatively little on public healthcare, especially outside the main cities. Key issues to tackle by the Indonesian Government are building more primary care clinics and providing more doctors and nurses to remote areas.

Furthermore, out-of-pocket spending will still remain an integral source of health financing. The high out-of-pocket expenses, along with outbound medical tourism, explain the low Indonesian hospital bed to population ratio and bed occupancy rates of 55%-60% in both private and government hospitals.

Regulatory Environment
There are three primary laws regulating the hospital industry in Indonesia: a) Law No 44/ 2009, b) Ministry of Health Regulation No 56/2014, and c) Presidential Regulation No 38/2014.