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Ramsay’s Domestic Outlook Still Healthy

Australia | Sep 06 2017

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

Ramsay Health Care's domestic business is expected to provide the growth story in FY18 as Europe remains a drag.

-Australian growth to be boosted by new beds, pharmacy and procurement savings
-Industry dynamics unlikely to improve until sector reforms enacted
-Can earnings quality continue to be delivered?

 

By Eva Brocklehurst

Brokers are awaiting the outcomes of several reviews into Australia's private health industry as consumers vote with their feet, increasingly opting out of insurance and resorting to the public system. Is Ramsay Health Care ((RHC)) better placed than peers, given its geographic diversity?

On the contrary, Australia could still be expected to provide the growth in FY18 while Europe remain a drag on the business. The company relied on Australian trading to deliver revenue growth in FY17 as the EU was confronted with tariff cuts and currency headwinds.

For FY18, Ramsay expects tariff cuts to lead to an earnings decline in the EU, offset by 10%-plus growth in Australia, which should be boosted by higher new bed openings, pharmacy acquisitions and procurement savings.

The company expects to acquire more hospitals but concedes it is difficult to find EU candidates at low value. Ramsay has identified the US health sector as presenting opportunities that could meet its return on invested capital hurdle of over 15%.

Domestic Support

The company's FY17 results were solid and underpinned by strength in its domestic business that offset well-flagged challenges in the rest of the world. This resilience, Morgans observes, comes despite volatility in the industry, although second half sales slowed and margins contracted more than expected from historical seasonality.

The broker remains confident that management can deliver on its guidance and that gains from procurement and retail pharmacy expansions will remain supportive. There is no change to the core fundamentals that underpin demand such as the ageing and growing population, chronic disease and innovative treatments.

Wilsons observes some systemic malaise creeping into the domestic private hospital industry but believes that scale and operating models matter, and in this respect Ramsay is better placed in the sector.

The company's Australian hospitals remain in a strong position to deliver above system growth based on size, scale, location and case mix but Credit Suisse does not expect an improvement in the industry's dynamics, at least until meaningful sector reforms are introduced.

The length of time it will take for recommendations to be delivered to government from the several reviews in train, and whether the government will enact significant reforms, remains unclear.

The broker estimates Australian hospital revenue growth was 6.0% in FY17 with a 1.1% contribution from the pharmacy function. This compares with Healthscope ((HSO)), which recorded 3.4% Australian hospital revenue growth. Despite the hospital growth remaining above the industry average the broker points out Ramsay did slow, particularly in the second half.

Wilsons suspects the expansion campaign in Australia may have reached a natural limit and, while there are plenty of opportunities in the health setting from adjacent, community-based business, most are still cottage industries which will take decades to become material.

The broker concedes that there is ample such work in France the funding a political environment is not conducive to large-scale investment at the present time. Wilsons, not one of the eight stockbrokers monitored daily on the FNArena database, maintains a Hold rating and a $72.25 target.
 

EU Challenges

Given increasing challenges in the rest of the world going into FY18 Morgans no longer believes the shares should trade at a significant premium to their long-term average. As such, the broker lowers forward estimates and reduces its target to $74.51 from $85.81. The broker recently downgraded to Hold from Add.

Ord Minnett remains more positive, with an Accumulate rating. FY18 guidance equates to earnings per share growth of 12% and this should require another double-digit lift in domestic earnings.

The broker is comfortable this can be achieved, supported by capacity expansion, cost efficiencies and procurement savings. Capital expenditure is expected to step up in FY18 and the broker expects Ramsay's hospital revenue growth will track above industry and peers.

Morgan Stanley observes the slowdown in private health insurance growth has led to low single-digit growth in private hospital industry volumes. Nevertheless, the ageing population should keep volumes among the over 65's growing at around 4% per annum. Offsetting the drag from lapsed policy holders, total system growth should be around 1%, down from 3.5% in prior years.

Ramsay should be less exposed to this downturn than rival Healthscope ((HSO)), in the broker's view, given its geographic diversity. Still, acknowledging headwinds elsewhere, Morgan Stanley questions whether earnings quality can continue to be delivered. There was essentially no growth in the offshore business.

Morgan Stanley expects a poorer value proposition for private hospitals will lead to declines in episode growth across all age cohorts, as consumers opt for the public system, and make margin expansion more difficult.

Citi observes both France and the UK are declining and dragging on the business. For France a one-off tax benefit in FY17 will produce a relative headwind in FY18.

The broker also suspects a full effect of the underlying drag from the French business will not be felt of the group level until after procurement synergies have been fully captured in FY19. The move into pharmacy in Australia is accretive to earnings in the short term but Citi believes this lowers the quality of future growth.

There are five Hold ratings on FNArena's database and one Buy (Ord Minnett). The consensus target is $73.05, suggesting 10.9% upside to the last share price. Targets range from $67.70 (Morgan Stanley) to $80.00 (Ord Minnett).
 

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