Investment positives
　　We initiate coverage on Arrail Group with an OUTPERFORM rating and a target price of HK$15.44.
　　Why an OUTPERFORM rating?
　　We expect penetration rate of dental care and medical services in China to rise. Frost & Sullivan expects China's dental medical service market will reach Rmb299.8bn in 2025, driven by increasing health awareness and consumption upgrading. In addition, Frost & Sullivan data showed the top-5 companies account for only 8.5% of China's private dental care market by 2020 revenue. We believe growing brand power and a rising number of skilled dentists will combine with digital expertise in the dental industry to boost sales of leading companies.
　　Pioneer with footprint in multiple cities in China. According to Frost & Sullivan, Arrail Group was the largest dental services provider in China’s premium private dental service market by revenue in 2020, and the third-largest dental services provider in the overall private dental services market. The firm operates the Arrail Dental and Rytime Dental brands, spanning 111 hospitals and 1,204 chairs across China as of September 30, 2021.
　　We think the company will continue to be a market leader in the future, mainly due to: 1) its highly-trained team of 882 dentists as of September 30, 2021; 2) a loyal patient base with a total of approximately 7.4mn visits in the past 10 years; 3) its standardized services with a successful expansion model; and 4) its experienced management team.
　　How do we differ from the market? We believe the company’s track record with acquisitions in the cities of Chengdu and Chongqing reflect its integration ability. We are confident in the Rytime Dental brand’s ability to attract middle-class consumers and strengthen customer coverage.
　　Potential catalysts: New stores turn profit faster than we expected; same-store growth faster than we expected.
　　Financials and valuation
　　Our EPS forecast is Rmb0.03, Rmb0.09, and Rmb0.20 in FY22-24, a CAGR of 91.5%. We adopt discounted cash flow (DCF) as our primary valuation methodology. Assuming a WACC of 8.8% and a perpetual growth rate of 1.0%, we derive a fair value of HK$9.0bn for Arrail Group, indicating the target price of HK$15.44, offering 29.7% upside.
　　Risks
　　Future pandemics; regulatory issues; newly opened hospitals and clinics may underperform; outflow of dentists to other firms; negative media coverage related to customer complaints.