Capitol Health On A Strong Growth Path

This story features CAPITOL HEALTH LIMITED, and other companies. For more info SHARE ANALYSIS: CAJ

-Consolidation opportunities
-Stronger than system growth
-Favourable funding backdrop

By Eva Brocklehurst

Capitol Health ((CAJ)) is on a firm growth path, with its industry fundamentals supported by a favourable funding environment, ageing population and an increasingly preventative approach to medicine.

The company is Australia’s fourth largest diagnostic imaging operator and has managed a number of acquisitions recently to consolidate its position. Its closest benchmarks among the listed stocks are Primary Health Care ((PRY)) and Sonic Healthcare ((SHL)). Credit Suisse notes both listed operators have large and reasonably mature diagnostic imaging businesses that face the growth challenges that come with scale.

In contrast, Capitol Health is in a high-growth phase. Its Victorian businesses are reasonably mature, although still likely to grow at system rates, but in NSW the company is less represented and these businesses should offer the opportunity to grow more substantially. Moreover, the government’s existing funding structure is tilted towards scale players who can minimise unit costs. This could lead to a reduction in participants and Capitol Health is at the forefront of the consolidation process.

In this aspect, Credit Suisse observes a lack of ambition to significantly grow diagnostic imaging business via acquisition among the listed competitors. Hence, Capitol Health appears the prime aggregator of size and this is an important factor in ensuring acquisition multiples remain reasonable. The business model is also highly scalable with an increased proportion of revenue generated from high priced, higher margin Magnetic Resonance Imaging.

The industry is seen growing at a 4-year compound rate of 7.8% and, while the stock trades on a seemingly high price earnings ratio of 21.5x, Credit Suisse expects Capitol Health’s four-year earnings growth rate will be more like 12.8% to FY20 with more acquisition opportunities, neither of which is factored into forecasts. Credit Suisse’s models suggest the stock is trading at a 25% discount to peers, when factoring in a conservative acquisition scenario.

Guidance for FY15 signals revenues of $111.2m and underlying profit, pre-tax, of $16.1m. Bell Potter implies earnings of $20m from these figures, which suggests a margin of 18%, comparable with, or better than, larger listed peers. The broker, after stripping out acquisitions, estimates underlying revenue growth of 9.0%, higher than estimated system growth.

The risks to the stock are changes to the Medical Benefits Scheme, which captures 86% of industry revenue, as well as ability to source and integrate acquisitions and retain key radiology personnel. Still, Credit Suisse believes these risks are more than captured in the price and initiates coverage with an Outperform rating and 95c target.

All up, Bell Potter is content to maintain a Buy rating but reduces its target to 98c from $1.05, given some dilution from acquisition-driven growth which utilises, in part, the company’s highly rated scrip. Morgans has a Hold rating and 94c target, preferring to await more certainty on both the Medicare schedule review and the integration of recent acquisitions.

Credit Suisse does observe that some small cap aggregators are out of favour at present. Elevated gearing and restricted access to capital has limited child care operator G8 Education ((GEM)), causing the stock to de-rate. Veterinary services operator Greencross ((GXL)) has also received similar treatment. However, those aggregators which have access to capital markets and are benefiting from structural tailwinds continue to enjoy premium ratings. Credit Suisse cites the aged care industry as a prime example.
 

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