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Funding Overhang Weighs On Ramsay’s Rebound

Australia | Jun 10 2021


With earnings momentum coming out of covid, Ramsay Health Care looks set to rebound from the pandemic downturn in surgeries, but the Spire acquisition raises questions over the company's balance sheet and funding options

-Acquisition of UK-based Spire Healthcare threatens investment grade credit rating for Ramsay Health Care
-Company may be in need of up to $1.5bn in additional capital
-Sale and leaseback of Australian assets a likely option

By Mark Story

Despite some encouraging green shoots emerging for a primary casualty of the coronavirus pandemic, Ramsay Health Care ((RHC)), brokers are waiting for valuable insights into how its latest UK-based acquisition will be funded.

The decision to acquire Spire Healthcare in the UK, which will require $1bn to 1.5bn in capital, has also raised concerns over Ramsay’s capital position, and what it could do to the company’s investment grade credit rating.

News of Ramsay’s offer to acquire 100% of Spire Healthcare, one of the UK’s leading operators with a network of 73 hospitals, comes on the heels of a tumultuous 12 months for Australia's number one operator of private hospitals.

Due to elective surgery shutdowns and having to open up its resources to public health systems in Australia, the UK and France to help combat covid, Ramsay experienced a profit fall of -12.5% in the first half of FY21.

But despite the pandemic, Ramsay always had one eye on future growth opportunities which in the last 12 months also saw the company complete a whopping $1.4bn equity raising.

While the Spire acquisition is the first of those growth opportunities, Ramsay CEO Craig McNally recently told investors and analysts the company is likely to be pursing further acquisitions within the UK’s healthcare system.

The company clearly sees a blow out in already lengthy surgery and appointment wait times following the pandemic as a golden opportunity. Ramsay is also expected to continue to expand via other European acquisitions, most recently in France and the Nordics.

Closer to home, pressure on public health systems generally bodes well for private sector operators like Ramsay. The company is currently witnessing a strong resumption of surgeries in Australia.

However, due to uncertainty around future restrictions or lockdowns, Ramsay has not provided specific guidance on the magnitude of the bounce-back in surgeries that analysts are clearly looking for.

Despite limited guidance from management on the speed at which surgeries will bounce back in Australia, Citi expects earnings to normalise as the pandemic ends. The broker assumes Australian volumes will normalise in the first half FY22, and normalise in the UK/France in calendar year 2022.

Citi also views FY23 as a normal earnings year for the company.

All eyes are on Spire

Meantime, Ramsay Health Care’s bid for Spire Healthcare in the UK is commanding all the brokers’ attention.

In late May, Ramsay announced it had bid 240p per share for Spire, at a 24% premium to the last close in an agreed deal. This values the equity of Spire at circa GBP1bn.

Citi remains somewhat confused about what the combined strategy for the UK will be post transaction. Ramsay UK is a day patient business with 84% of its revenue generated from these patients. While Spire is also mostly a day patient business at 62% of revenue, it generates a significant portion of its revenue from inpatient activities.

On the strength of the Spire bid, the broker has upgraded the stock to Buy from Neutral and has increased its target price to $76.00 from $67.00, which implies a FY23 Price-Earnings multiple of around 23x. Citi believes Ramsay shares currently represent good value based on a FY23 Price-Earnings multiple of 19x.

Citi concludes the Spire acquisition, which will give Ramsay 25% of the UK private hospital market, will be earnings per share (EPS) neutral at first. The transaction is anticipated to generate high single-digit EPS accretion in FY24.

Much of Citi’s estimate is based on expected synergy benefits being achieved. Ramsay is forecasting “at least” GBP26m in synergies for the combined group, which Citi regards as reasonable on a combined revenue of around GBP1.5bn.

Funding issues

Ramsay Health Care disclosed that the company may face a negative rating action if it is not able to maintain leverage within specified limits, and this has given brokers cause for concern. Adding to that concern, ratings agency Fitch is concerned funds from operations (FFO) adjusted leverage may rise above 4x on a sustained basis, and has thus placed the company on a Rating Watch Negative.

It is possible, adds Citi, that by maintaining the credit rating, the company could ultimately reduce its overall cost of debt.

For Ramsay to maintain the current investment grade rating, Citi estimates the company will need to raise around $850m in capital. The broker assumes a hybrid security will be issued.

Post the transaction, based on Citi’s forecasts, the company’s FY22 FFO adjusted leverage would be closer to 4.5x, while net Debt/EBITDA would increase to 2.6x, which is higher than June-19 levels. The broker notes a capital raising of $850m would reduce the company’s FFO adjusted leverage to circa 3.9x.

Credit Suisse shares concerns the Spire acquisition will stretch Ramsay’s leverage above 4.0x FFO adjusted leverage, and outside investment grade range. The broker forecasts FFO adjusted leverage increasing to 4.9x in FY22 from 2.6x in FY21, and remaining above the 4.0x limit in FY23, even after factoring in potential synergies.

Even in a bull case scenario, Credit Suisse still obtains a 4.5x FFO adjusted leverage ratio in FY22.

Group covenants to be unaffected

But while Credit Suisse is concerned about the FFO adjusted debt ratio for the investment grade rating, the broker doesn’t see risk to the funding group’s debt covenants. To retain some flexibility for future investments, Credit Suisse expects Ramsay to lower its FFO adjusted leverage ratio to at least 3.5x.

Credit Suisse notes it is likely to take months before Ramsay completes its internal strategic/capital management review, which may include sale and leaseback of Australian assets, divestment of UK assets, along with possibly another equity raising.

It will then take at least 12 months before the UK Competition and Market’s Authority completes its competition review of the proposed Spire acquisition.

Ramsay has stated the Spire acquisition would be funded from existing debt facilities. But until the market gains clarity on future capital management, Credit Suisse deems it likely the share price will be pricing in the potential for an equity raising. Credit Suisse thus retains its Neutral rating with a target price of $70.00.

The broker expects Ramsay to remain on a Rating Watch Negative by Fitch until it comes to the market and outlines the outcome of the capital structure review and its capital management plans.

Having witnessed a number of issuances in 2021, Macquarie suspects a convertible note is another potential capital management initiative Ramsay may consider.

Also, Macquarie agrees a sale and leaseback of Australian property assets would be more favourably received relative to a capital raising. It may also highlight the value of the property portfolio, which the broker believes isn’t reflected in the current share price.

Based on Macquarie’s assumptions, a sale and leaseback of around $1.5bn would reduce leverage to under 4x in FY22, and FY23.

Overall, Macquarie continues to remain positive on the medium-longer term outlook for Ramsay, and retains an Outperform rating, with a target price of $74.75.

The broker expects uncertainty in relation to the capital position to weigh on the share price in the near-term.

Following Citi's upgrade to Buy, Ramsay Health Care now enjoys three Buy (or equivalent) ratings among the seven stockbrokers monitored daily by FNArena. Three others are on Neutral/Hold and Morgan Stanley is currently prevented from rating the company.

The consensus target combining all six ex-Morgan Stanley currently stands at $71.61, but not all brokers have as yet updated post announced acquisition.

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