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Treasure Chest: Market Undervaluing Ramsay

Treasure Chest | Jun 20 2018

Perceived headwinds have led the market to downgrade Ramsay Health Care to five-year low multiples. Wilsons believes this is too low.

-Market sentiment weighing
-Challenges in domestic healthcare
-New project openings under-appreciated

By Greg Peel

Private hospital operator Ramsay Health Care ((RHC)) was once a can-do-no-wrong company in the eyes of investors, yet since peaking in August 2016, Ramsay’s share price has fallen -25%.

Aside from a flat outlook for the company’s European operations, perceived structural headwinds for the Australian healthcare industry has been weighing on investor sentiment. The environment is more challenging than it was two years ago, stockbroker Wilsons concedes, given greater restrictions on health insurance premium increases and efforts to push more care into community settings.

This has led the market to downgrade Ramsay to an FY19 forecast price/earnings multiple of 18.9x and an enterprise value multiple of 10.0x, representing five-year lows.

Which, Wilsons believes, is too low. What the market is ignoring, the broker suggests, is the boost to core earnings growth of 8% over the years ahead as brownfield assets (development projects) opened over FY16-18 reach peak utilisation and profitability, contributing some $57m in incremental earnings in FY19.

FY20 will see a smaller contribution given a slowdown in investment in FY17, but further brownfield project at the approved and planned stage, including flagship sites such as Greenslopes, Hollywood, Peninsula, Sunshine Coast, St George and Joondalup, should sustain earnings growth well into the FY20s.

Despite weak market sentiment, Ramsay continues to extract real price growth in excess of real operating expense growth, underpinning margin expansion, Wilsons notes. New global procurement arrangements with Ascension can cut another -$30m in costs and extend margin benefits to the European business.

Longer term, the company is set to respond to the changing domestic structure by investing in non-hospital adjacencies such as community pharmacy, outpatient rehabilitation, allied health and chronic disease coordination.

The de-rating of Ramsay’s valuation means it is now trading in line with listed international private hospital peers, having lost the traditional valuation premium the stock long enjoyed. Wilsons believes the stock can trade at an FY19 enterprise multiple of 10.9x, which implies, on a discounted cash flow basis, a target price of $65.00. At the time of writing this story the shares are trading near $61.87.

To that end, Wilsons has upgraded Ramsay to Buy.

Macquarie has also reviewed the investment case for Ramsay and last week maintained an Outperform rating and $74.50 target on the stock, drawing on a similar argument to that of Wilsons. Macquarie suggests brownfield developments should support earnings growth over FY19-20, and procurement savings should also support margin expansion, making the stock appealing at current valuation.

Within the FNArena broker database, in which Wilson is not included, Citi also rates Ramsay a Buy. Five brokers retain Hold or equivalent ratings.

The contrarian is Credit Suisse, who earlier this month downgraded the stock to Underperform. The broker concedes Ramsay’s is a different proposition to other private hospital operators but does not believe the company will be immune to a structural slowdown.

On that basis, Credit Suisse considers the stock overvalued and has set a $56.50 target, to be the low marker on the FNArena database. Macquarie is the high marker, and the consensus of the eight brokers is $68.24.

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