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Uncertainties Prevail For Primary Health Care

Australia | Jul 12 2016

-Management review continues
-Bulk billing still seen under pressure
-Lack of clarity on specific weakness


By Eva Brocklehurst

Primary Health Care ((PRY)) has cleaned up its balance sheet, signalling a more conservative approach to provisioning. Write downs in FY16, worth around $98m, will address the carrying values of a number of items.

The company expects to meet the lower end of its $110-115m profit guidance on an underlying basis. Further charges totalling $6m will be made and brokers calculate the net result is a downgrade in profit guidance to $104m. While the company suggests its revised guidance is entirely driven by non-operational matters, brokers are not so sure and remain cautious about the company's operating performance.

Citi suspects half the headline downgrade to guidance stems from slower trading conditions, which translates into an effective 5-6% downgrade to underlying profit. Given the government has been returned after the election with the slimmest of majorities the broker envisages little likelihood of a reduction to pathology funding in the short term, while industry volumes appear firm.

The presence of Jangho on the company's share register supports the stock, given the elevated risk of a takeover. This is countered, in the broker's view, by the high level of flux in the business, as a new management team with limited experience in health care continues to review and make changes.

Macquarie also believes the relatively minor reaction to the earnings announcement indicates the stock continues to trade largely on takeover speculation rather than fundamentals. Jangho's stake is around 16%.

The re-vamped balance sheet is welcome but Morgans notes FY16 has been marked down for a third time in 12 months while trading conditions have been in line. The broker suspects that while the divestment of a number of non-core assets will help to reduce the cost base, the fact that bulk billing is under pressure cannot be denied.

Funding changes remain on the horizon and there is uncertainty regarding the impact of profit improvements already underway or planned, such as increased private billing, selective co-payments, new medical centres and cost savings.

Morgans revises FY16 estimates down 8% but raises its price target by 20% to roll forward and increase depressed valuation multiples. This reflects progress on the company's plans amid uncertainty regarding how strategic initiatives will actually play out.

UBS suggests the update represents a modest 3.6% underperformance against its estimates and the net effect of the trading update is not material to valuation. On the issue of the implementation of Medicare reform, the broker suspects the election outcome could bring about a weakening of the government's resolve, citing media speculation the coalition government will consider undoing the freeze on the Medicare rebate and overturn the cuts to bulk billing.

The broker's forecasts incorporate the unwinding of the bulk billing incentive reductions via top-up deals for pathology and diagnostic imaging, but for FY17 only. Further changes could be of benefit in FY18, as could any change in the stance on the freeze to the Medicare rebate indexation.

Addressing legacy issues on the balance sheet is a good sign but Morgan Stanley expects more might be needed before the company arrives at a structure which can support its future strategy and improve capital recycling. While an improvement in cash flow and returns is expected, the broker considers FY16 in the near term looks a little light versus expectations, with a lack of clarity regarding specific areas of weakness.

The issues at the start of 2016 are becoming a little clearer with the results of the election, with the possibility the funding cuts in the government's MYEFO announcement may not happen, although these are incorporated into the broker's forecasts. Meanwhile, the company's issues with GP remuneration still need to be cycled through and the impact on the financials remains to be seen.

The broker maintains the story is about creating confidence in management's strategies and more certainty is required as to whether Primary Health Care has reached an inflection point on earnings. Until this is achieved, Morgan Stanley remains on the sidelines.

There is one Buy rating on FNArena's database – UBS. Besides this, there are seven Hold ratings. The consensus target is $3.47, suggesting 8.2% downside to the last share price. Targets range from $2.80 (Macquarie) to $4.11 (UBS).

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