The active acquisitions over the past several years are dragging down company’s margins, while both doctor compensation and employee benefit grew faster than revenue. Since HK economy is facing a downturn with an uncertain timeline to reopen the border, the fundamentals of both medical and aesthetical medical are likely to remain stable through organic growths. Further acquisitions are unlikely and not favourable. 1HFY23E earnings significantly missed expectation, with sales up by 31% YoY and net profit down by 50% YoY since it takes time to consolidate the acquired clinics. We downgrade EC Healthcare (ECH) from BUY rating to HOLD. We also cut earnings estimates. TP is adjusted to HK$5.46 by applying the unchanged 40x FY23E P/E, which represents the company’s high growth potential as the leading aesthetic medical group after the reopening of border.
　　Key Factors for Rating
　　ECH reported disappointing interim results, with sales and net profit moving by +31% and -50% YoY in 1HFY23E. The high growth of sales can be attributed to 8.3% YoY increase in external acquisition and 22.7% YoY organic growth.
　　Despite the high top-line growth, margins all dropped. COGS to sales ratio rose by 64.8% YoY, doctor compensation increased by 67.4% YoY, employee benefit also expanded by 38.9% YoY, depreciation and amortisation hiked by 52% YoY, all higher than the YoY sales growth of 31%. The dip in margins led to net margin contraction from 11.1% in 1HFY22 to only 4.2% in 1HFY23E, and the decline in net profit.
　　ECH has been aggressively acquiring clinics in HK over the past years. Starting as the largest aesthetic medical group in HK, the sales mix has shifted with medical being the major segment. In 1HFY23E, medical service accounted for 62% of total revenue and aesthetic medical service contributed 32% of total sales. In HK market, the medical service is growing slower than the aesthetic medical segment. With the sluggish demand and high doctor compensation growth, the margins deteriorate. Obviously ECH ceases further acquisition.
　　Whether and when the border reopens really matters for ECH. With diversified allocation of medical and aesthetic medical clinics, ECH is ready to provide services to Chinese clients. Without Chinese tourist consumers from the Mainland, the growth and expansion potential in HK market is very limited.
　　Key Risks for Rating
　　The time to reopen the border is uncertain.
　　Valuation
　　We cut earnings estimates for the next three years. The revised earnings estimate would decline by 18% in FY23, but grow by 56% and 24% YoY in FY24-25E, respectively. New TP is derived by applying the unchanged target multiple of 40x FY23E P/E, implying a 7% upside. Downgrade to HOLD.