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Is Ramsay Health Care’s Valuation Justified?

Australia | Mar 04 2019

While conditions for Ramsay Health Care in Australia are subdued, European operations are expected to provide the main boost to earnings in FY19.

-Australian healthcare industry faces headwinds, amid pressure on private health insurance
-Benefits from Capio, increased tariffs in France and the UK as well as Australian revenue growth should be forthcoming in FY20
-Is the rally in the share price justified?

 

By Eva Brocklehurst

The outlook for Ramsay Health Care ((RHC)) has a number of moving parts and brokers seek to order a degree of importance, in order to obtain clarity on the stock. The company has reaffirmed FY19 guidance for growth in earnings per share of up to 2% and provided guidance for operating earnings (EBITDA) growth of 10-12% including newly-acquired Capio, or 4-6% ex Capio.

The Capio business is now expected to be slightly dilutive to earnings per share (EPS) FY19 versus the neutral impact that was forecast at the AGM last November. The downturn in UK NHS volumes now appears to be correcting and there is a 2019 tariff increase in train in France.

Meanwhile, the Australian business faces headwinds. Credit Suisse calculates the offshore regions account for around 30% of earnings and, therefore, these businesses should trade at lower multiples versus Australia.

Hence, the broker is one that believes the recent rally in the share price is not justified, maintaining an Underperform rating. Credit Suisse envisages downside risk to earnings in Australia, amid the upcoming federal election and the renegotiation of key health insurance contracts.

Morgan Stanley does not find the valuation compelling either. There is support from offshore through the increase in French tariffs and UK NHS volumes, but the major investment debate centres on Australia. Private health insurance is not growing and that should likely result in tougher contracting terms with health insurers, and the increasing evolution of alternative care models.

In contrast, CLSA, not one of the eight brokers monitored daily on the FNArena database, has a positive medium-term investment view, maintaining an Outperform rating and $71.40 target.

Australia

CLSA agrees the Australian business must turn around the recent declines in earnings that have been a feature over the past few years. However, the broker suspects there may be difficulty sustaining cost reductions in Australia without repercussions from the associated doctors.

The broker also notes one of the issues includes the supply of private hospital operating theatres in Australia. The company plans to open more operating theatres in FY19, which should positively affect FY20 earnings growth.

Macquarie retains a positive view on the stock, underpinned by contributions from brownfield developments, although agrees potential risks primarily relate to the Australian business.

Management has indicated that its returns criteria for developments of 15% over a three-year period is unchanged although there is flexibility to extend time horizons to four years, based on the strategic merit of the project. Negotiations relating to consumables contracting (the Ascension JV) have commenced an initial benefits are expected in the second half of FY20.

Citi considers Australian revenue growth of around 5% in the first half was confirmation the company is taking market share. Ramsay Health Care appears to be attracting doctors and driving market share gains.

The broker believes the key to the business over the next few years centres on two aspects, higher synergies, eventually, from the Capio assets, and continued growth in the Australian business. The broker acknowledges diminished consumer confidence as well as decreased affordability of private health are key risks and downgrades to Neutral following the recent rise in the share price.

Morgans observes the company's domestic admissions growth is above the market, although still below trend, and operating efficiencies are allowing for margin expansion.

The broker agrees there are challenges which limit revenue growth and keep profit reliant on cost reductions although, in the longer term, assesses the fundamentals are sound and the valuation of the stock not a problem. With recent gains in the share price at risk of reverting a Hold rating is considered appropriate.

The performance of Australian hospitals reflects an industry that is under pressure from health insurance issues and UBS suspects this will intensify with a 2% cap to health insurance premiums, likely to be introduced if the Australian Labor Party wins government.

In the event of increased pressure on Australian insurer contract rates, UBS believes future cost savings, Capio synergies and ongoing improvements in processes will be required to sustain hospital margins.

Ord Minnett agrees the domestic private hospital sector may come under material pressure if the capped premium policy for health insurers is enacted. Looking at FY20, the broker takes a positive view on top-line growth from the Capio acquisition as well as higher tariffs in both the UK and France.

Europe

France is likely is to sustain fairly flat revenue outcomes, Morgans believes, while Capio margins are contracting and the integration risk remains large. Capio may have contributed to gains above the line in the half-year but management disruptions, softness in Germany and a weak December remain of concern. On the other hand, there are signs of improvement in the UK, although the broker considers there is little visibility around the potential impact of Brexit.

Deutsche Bank agrees benefits should accrue from increased tariffs in France and the UK, amid synergies from the Capio acquisition. Moreover, the company can achieve revenue growth and margin expansion in the Australian business. This broker, citing minimal returns implied by its target, also downgrades to Hold.

FNArena's database shows one Buy rating (Macquarie), six Hold and one Sell (Credit Suisse). The consensus target is $63.02, signalling -1.0% downside to the last share price targets range from $54.80 (Credit Suisse) to $72.00 (Macquarie).

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