Weak Hospital Admissions Plague Ramsay

This story features RAMSAY HEALTH CARE LIMITED. For more info SHARE ANALYSIS: RHC

Ramsay Health Care has downgraded FY18 growth estimates amid weak conditions in both Australian and UK private hospital markets.

-Lower volume environment makes margin expansion more difficult
-Volume recovery in the UK considered a medium-term proposition
-Subdued outlook likely to handicap the stock's performance
 

By Eva Brocklehurst

A downturn in UK National Health Service volumes and weaker rates of procedural work and inpatient admissions in Australian private hospitals have caused Ramsay Health Care ((RHC)) to cut growth estimates.

The company has downgraded FY18 estimates for earnings growth to 7% from prior guidance of 8-10%. Ramsay also points to delays in the rolling out of its pharmacy acquisitions in Australia.

Morgan Stanley suggests a poor value proposition for private hospitals will lead to declines in episode growth across most age cohorts, as consumers opt for the public system. A lower volume environment also makes margin expansion more difficult.

The FY18 downgrade is a sign to the broker that the company's domestic hospital portfolio is not as immune to headwinds as previously supposed.

Ord Minnett also envisages the risk of further slowing, as commentary and criticism of the private health system mounts ahead of the next federal election. The broker remains wary that the earnings risk is to the downside, with little improvement in offshore operations limiting any apparent valuation appeal.

While the downgrade disturbed some market operators, CLSA remains unperturbed, although acknowledges near-term headwinds and potential negatives from cost efficiency programs in the near term.

The opportunities, nonetheless, offset this and plans to open more operating theatres will positively affect Ramsay earnings from FY23 . Competitors are not planning to open theatres at the same rate and this means oversupply is unlikely.

Moreover, issues in France, while still difficult, may be resolved under President Macron, who is looking to stabilise reimbursements.

CLSA also estimates a recent joint venture with Ascension could provide additional savings worth $55m. The broker, not one of the eight monitored daily on the FNArena database, retains a Buy rating with a $72.35 target.

Challenges are likely over the next two years, yet Deutsche Bank likes the industry-leading operations, high returns on equity and the appealing valuation metrics versus its offshore peers. Hence, the broker upgrades to Buy from Hold.

UK Headwinds

Initiatives aimed at managing elective surgery have resulted in a significant negative impact on the company's UK hospital volumes. Private UK hospital volume growth has been reduced to 1% from 3-4% historically, prompting the company to take a GBP70m ($125m) impairment across six UK sites.

This mainly relates to onerous lease provisions in FY19 and not the fixed assets. Management expects the trends to continue in the near term and there is no assumed benefit from the recent announcements of NHS funding increases.

Morgan Stanley agrees a short-term rebound in referrals in the UK is unlikely to materialise. NHS regulatory changes have sought to reduce primary referrals into secondary care in the past two years.

While Ramsay has been less affected, as only 5% of UK volumes come via direct contracting from NHS trusts, demand management strategies that have been implemented are expected to affect volumes over the medium term.

UBS suggests NHS funding constraints may ease post the next election but it will take some time for clinical commissioning groups to re-engage private hospitals via the e-referral system.

Australia

Obstetric volumes, rehabilitation and other inpatient medical treatments were weaker than expected in Australia in May and June while elective surgery growth is further reduced. Case mix also appears to be an issue, Morgans suggests, with growth skewed towards day and outpatients, versus overnight and inpatients, and to lower acuity procedures.

Management also indicated that visibility regarding theatre bookings is becoming less clear. UBS suspects there may be some rebound as postponed procedures return but remains concerned about rising out-of-pocket charges that could cause demand from older patients to slow and further weaken activity levels.

Affordability remains a clear concern and there is low government appetite to drive reforms, in Credit Suisse's view. The broker believes the market is underestimating the long-term structural deterioration, and public hospital capacity is sufficient to meet increased demand in the medium term.

Credit Suisse expects a deterioration in case mix and, as a high fixed-cost business, estimates around -20 basis points per annum decline in Ramsay's Australian operating earnings margins and this is unlikely to be offset through cost savings and procurement measures.

The broker assesses the stock is overvalued and retains an Underperform rating, also questioning the company's quality of earnings as continued onerous lease provisions are excluded from core earnings.

The Australian growth engine is now affected by the same headwinds that competitor Healthscope ((HSO)) has experienced since 2016 and this undermines the perceived superiority of the Ramsay model, which Morgan Stanley notes once justified a PE of 30x, suggesting recent weakness in the share price is not overdone and a de-rating is justified.

With no apparent resolution to private health affordability issues, UBS agrees there is little likelihood of a material recovery in Australian private hospital volume growth in the near term.

That said, public hospital elective surgery waiting lists are starting to rise and this suggests some reforms are required. Otherwise, the broker believes public hospitals may need to engage with private operators in order to reduce public waiting lists.

Macquarie is more comfortable about regulatory reforms addressing the issue of private patients in public hospitals, while its more positive investment view of the Ramsay business is underpinned by an expectation that brownfield developments and procurement savings will support growth in FY19 and FY20.

Morgans, on the other hand, envisages no quick fix to what is mainly a demand issue. The broker reduces FY18-20 estimates for net profit by up to -3.8%, mainly because of lower revenue and margin assumptions across the UK and Australia. While value is envisaged over this time horizon the near-term outlook is unclear and considered likely to handicap the stock's performance.

Wilsons remains a buyer of the stock, while acknowledging that the market has consistently expected Europe to be weak and management has now called out weaker conditions in Australia.

The broker, also not one of the eight monitored daily on the database, still expects there are enough new assets to support domestic growth and the valuation has become compelling. Target is set at $65.

The database shows three Buy ratings, four Hold and one Sell (Credit Suisse). The consensus target is $63.90, suggesting 12.1% upside to the last share price, and compares with $68.24 ahead of the update.

See also, Treasure Chest: Market Undervaluing Ramsay on June 20, 2018.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms