The long term prospects for Ramsay Health Care (ASX:RHC) look attractive. However there are reasons to believe we can get it cheaper. We look at both the fundamentals and technicals of RHC.
Overview of Ramsay Health Care
Ramsay Health Care (RHC) is the largest provider of private hospital services in Australia. They have around 66 facilities that include a mixture of large metropolitan acute surgical/medical facilities, smaller regional facilities and a number of speciality psychiatric and rehabilitation hospitals. The Company also owns a 51% majority interest in Ramsay Generale de Santé (RGdS). This is a JV that owns and operates ~110 hospital facilities in France. It now includes the recently acquired Capio business. In the UK, RHC is the largest independent provider of National Health Service (NHS) elective services. Operating segments are classified according to geography. The main earnings and value driver being the Australian Hospitals segment. Offshore regions accounting for ~30% of group earnings.
Australian Hospitals Segment Performing Strongly Despite Challenging Industry Conditions
The performance of the Australian Hospitals segment was the highlight of the recently-released interim results. Earnings were up 5.8% on the back of above-market revenue growth and margin expansion from further efficiency gains and restructuring benefits.
Challenging industry conditions are underpinned by ongoing structural difficulties in the Private Health Insurance (PHI) sector. These include a decrease in participation in PHI and patient sensitivity in regards to out-of-pocket expenses. These are resulting in private health patients downgrading their cover.
The rate of revenue growth (+3.7% in 1H19) reflects a sector under pressure. However, RHC remains well positioned to continue generating above-market revenue growth. They are also positioned for further market share gains. This is particularly in light of the scale and location of its hospitals. A key part of this strategy is ongoing brownfield investment in hospitals. Ramsay’s balance sheet is considered to have enough flexibility to fund the pipeline in brownfield activity expansion as well as future acquisitions.
Can the Private Health Insurance Sector Overcome Its Challenges?
These challenges have the potential to be alleviated over the longer term. This is given that ~55% of all procedures in Australia are conducted in the private health system. Because of this, Federal and State governments cannot afford for this portion to be materially lower. In addition, the health insurance sector is also trying to improve the transparency for patients. The result of this is that out of pocket expenses can be compared more easily.
For RHC, there is downside risk from the potential introduction of the Federal Labor Party’s plans to cap private health insurance rate increases to 2% for two years. While this cap, if enacted, would lead to higher volume growth, it would be more negative for private health insurers. This in turn is expected to put pressure on domestic private hospital providers. Commensurately, price rises for private hospital would be lower – in a domestic PHI industry where the average price increase has diminished each year since 2017 (on an industry weighted average basis). So, the next round of PHI contract renewals is likely to be more challenging. RHC faces contract renewals with the two major insurers this calendar year. (Medibank negotiations are due to commence in August 2019)
Rising Tariffs Improve Outlook for Offshore Operations
The recent performance of the UK and France operations (which constitute the majority of the Company’s offshore operations) has been challenging. However, rising tariffs for both France and UK (in response to the respective governments recognise the need to lift funding) is clearly a positive for RHC. It sets the backdrop for an improvement in the operating environment for private hospital operators. This comes after a long period of downward pressure.
UK earnings have been under pressure over the last few years. This is as a result of tariff reductions, the on-going use of agency staff (which involved a higher cost relative to registered nurses), higher rent costs (as per rent review clauses), as well as a shift towards NHS work (which accounts for 79% of total volumes in the UK). All of which is typically lower-priced than Private Medical Insurance/self-pay.
The recent performance of the French operations has been challenging. There has been flat hospital revenue growth as a result of tariff cuts and underperforming hospitals within the overall portfolio.
Overall, we consider that the uplift to RHC’s offshore earnings from rising tariffs is likely to be more long-dated than initially expected. Further, RHC expects Capio to be accretive to core EPS within 2-3 years. However, “given the timing of acquisition and delays to processes related to completion” expect it to be slightly EPS dilutive in FY19.
Fundamental View of Ramsay
At current levels, we take a cautious view on RHC. The Australian Hospitals division is generating above-market revenue growth in hospitals. However, we are not convinced that initiatives in the Australian Hospitals division, namely cost saving measures and continued brownfields expansion, will be enough to offset continued short-term earnings pressure. This pressure is from the offshore operations (in particular UK and France). This is evidenced by the Australian Hospitals division generating a mild improvement in EBITDA margin in 1H19. With EBITDA margin for Australia remaining at the upper end of the recent range, we question whether further material margin expansion is achievable.
The outlook for earnings growth over the medium-to-longer-term is more attractive. However, we consider that further clarity is need on a number of shorter-term challenges. This is in particular lower growth rates in Hospitals, the potential for capped premium rate increases in Australia and challenging operating conditions in France likely to continue.
Charting View of Ramsay
RHC hit resistance several weeks back before stalling around $64 – $65. If it is able to push past current levels, then we have major resistance near $68, which isn’t that much higher. However, price action at the moment looks indecisive. Without a short term catalyst, we might see it fall back to lower levels. Given the near-term uncertainty over earnings, conservative investors may wish to exit RHC at current resistance levels. This would be with a view to get back in cheaper, or when the outlook becomes clearer. In terms of where it can get to on any pullback, there should be a good amount of support just under $60.
Michael Gable is managing director of Fairmont Equities.
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