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CORR: Healthscope Rattles Market But Brokers Less Anxious

Australia | Oct 24 2016


This story has been re-published to correct broker info at the bottom of the story.

Healthscope has rattled the market, announcing a very weak September quarter and flagging the prospect of a flat revenue outcome in FY17 if the trend continues.

-Main culprit cited is negative publicity regarding private health care affordability and prostheses pricing
-Industry drivers are intact, such as demographics and under-invested public hospital sector
-Ambitious expansion program raises debt levels but considered manageable


By Eva Brocklehurst

Healthscope ((HSO)) rattled the market with the announcement its September quarter hospital cases were very weak. If the trend continues through the rest of FY17 the company has flagged the prospect of a flat revenue outcome for its private hospitals. Management contends that the main cause was negative publicity about private health care affordability and speculation regarding pricing and government rebates on items such as prostheses. This led to a fall in high-end surgical procedures such as orthopaedics and ophthalmology. October is reportedly tracking better.

Morgans asserts that as September is historically a weak month, flagging the potential for an extended period of weakness seems premature. The broker accepts there may be need for further case/mix optimisation, and this makes the near-term outlook uncertain, but continues to view core industry drivers as intact. Hospital re-developments are on track, the company's capital structure is secure and contract pricing is stable. Nevertheless, the broker expects the shares will take some time to recover from the jolt.

Credit Suisse reduces hospital division EBITDA (earnings before interest, tax, depreciation and amortisation) forecasts by 8% and suspects a volume recovery may take time. Long-term growth in private hospital volumes, an ageing population, increase in chronic disease and an under-invested public hospital sector are considered to be supportive features of the industry.

The broker also cites the need for a positive re-balance of the mix of cases in the company's portfolio and suspects this adverse shift in cases may be amplified in the second half with the scheduled opening of Holmesglen in Melbourne amid potential for a higher medical patient case mix.

The wider issues are not easily discernible from the the announcement and, while downgrading the rating to Neutral from Buy, Citi defers its full assessment of the implications affecting the hospital sector until industry data for the September quarter is published in November. Nevertheless, earnings estimates are re-based for Healthscope.

Morgan Stanley has been questioning the affordability issues affecting over-earning by private hospitals for some time and believes this latest development could be a sign that private hospital earnings are not as durable as suggested by their expensive price/earnings multiples. The broker cannot discount the prospect of further negative revisions to earnings per share.

While Healthscope has a large brownfield development program, which should drive higher earnings growth, the broker considers it largely offset by the ongoing requisite capital expenditure. Morgan Stanley prefers to sit on the sidelines at present and retains an Equal-weight rating.

Ord Minnett suspects the weaker results were also exacerbated by aggressive operational management undertaken over recent years, which have left little room for error and make for a difficult comparable number. Solid private health insurance membership and a supportive regulatory environment are expected to underpin the business, as is the investment in brownfield capacity expansion which should ensure a return to strong growth from FY18.

The ambitious expansion program will mean Healthscope's net debt reaches nearly $2bn at its peak, by the broker's estimates, or over four times EBITDA. Still, Ord Minnett believes this is manageable, noting it includes project finance associated with the Northern Beaches hospital, much of which will be refunded by the government upon completion.

UBS, too, does not envisage any fundamental risk to longer term drivers for hospitals and believes the execution of a strategy that expands non-organic growth opportunities is a precursor to higher valuation multiples. Furthermore, given FY16 also started off quite softly and there was a rebound, there is opportunity for a recovery in FY17.

Macquarie is disappointed in the downgrade and lists a number of processes under way which have potential to curb the robust growth of private hospitals. These include the review into the Medicare Benefits Schedule, associated scrutiny of doctor activity, better reporting of intervention rates from government health agencies, an ongoing focus on private health affordability, as well as insurer auditing. The broker moderates its earnings forecasts, reducing expectations for hospital revenue growth and margin expansion in FY17.

Most brokers do not believe the other major listed private hospital operator, Ramsay Health Care ((RHC)), will experience the same level of revenue pressures, given its more varied geographic exposures. Macquarie also notes Ramsay is less leveraged to a potentially over-supplied Victorian market.

There are four Buy and four Hold ratings for Healthscope on FNArena's database. The consensus target is $2.69, suggesting 18.6% upside to the last share price. This compares with $3.15 ahead of the announcement. Targets range from $2.40 (Macquarie) to $3.00 (UBS and Deutsche Bank).

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