HSO takeover offer will be huge for Ramsay, page-52

"I'm wondering if it isn't too early to declare a 'buy' on this stock. There was an article from Motley Fool suggesting that HSO's Geelong hospital closed due to the new Epworth Geelong Hospital (Victoria’s largest not-for-profit healthcare group with 12 locations). What's your take on the growth of not-for-profit healthcare group?
Also, wouldn't it be more prudent to wait until the full-year result, since HSO just downgraded their earning guidance? There's a real chance that Ramsay's local operations might have similar issues.

On the other hand, $61 is 52 week low, so it certainly looks attractive to me."


@supercendol,

I wouldn't put any store of value in the fact the fact that the stock price is at a 52-week low; that is merely one of many statistical metrics, which might psychologically sound somehow meaningful, but which is really arbitrary and totally irrelevant when the stock is viewed though a valuation lens. (For, if the stock overvalued today, then being at 52-week low will not somehow make it a better investment.).

As for waiting before buying it in order to obtain clarity on some of the issues you mentioned (i.e., whether or not it is having Healthscope-like operational issues and the possible competitive impact of the not-for-profit sector); sure, one can do so if one wishes to have a greater degree of "comfort" before buying.


But in my experience, any such perceived comfort is more psychological, than real, for a number of reasons:

1. The issues you have listed are not unknown to the market. To that end, they should already be largely factored into the RHC share price. Besides, in the case of Healthscope's operational under-performance, I suspect that there is a good chance that is more a company-specific issue, than an industry-wide phenomenon (many of Healthscope's hospitals are lacking in scale, and some of them are somewhat dated).

2. With particular reference to the not-for-profit hospital operators, it must be remembered that, by their very nature, hospitals have major geographical moats due to: firstly, the scarcity of land on which to build new hospitals that are able to compete with incumbents and, secondly, due to the disinclination for people to drive anywhere further than their closest hospital. So, for a newcomer to compete in any meaningful way with major established hospitals located in metropolitan areas is nigh on impossible, I believe.

3. These sorts of issues will never go away; they are part and parcel of investing in publicly listed companies. And if they were to go away, they will be replaced by other, new concerns. Indeed, these sorts of perceived concerns have existed all the time, and yet Ramsay has been able to flourish and prosper despite them.

I don't think there is a single publicly-listed company for which one - at any given point in time - cannot draw up a list of at least 10 things about which to worry.


So what I try to do is blank out all the noise, and focus just on valuation.


On that note, in RHC's case, the stock is trading on a prospective (FY2019) EV/EBITDA multiple of 10.0x. This is probably in line with the average EV/EBITDA multiple of the broader market, on average.

Yet RHC is a business which is far superior to the "average" ASX-listed company.


Viewed another way:

Given that I invest for long-term outcomes (i.e., >3 years), the way I look at a company like RHC is I say, if the company continues to grow its earnings by, say, 10% pa [*], what will its prospective valuation multiples look like?

Due to inherent operating leverage, some very rudimentary modelling shows that 10%pa bottom-line (i.e., EPS) growth corresponds to growth of around 5%pa to 6%pa at the Revenue line, 6%pa to 7% pa for EBITDA, and 7% to 8%pa at the EBIT line.

Which means that, by FY2021, RHC's Revenue, EBITDA, EBIT and NPAT will have increased by, respectively, 17%, 23%, 24% and 30%.

Also, given the strong Free Cash Flow generation of the business, Net Debt will have fallen to around $1.8bn by that stage, from the current ~$3.3bn level.

Importantly, based on this scenario, the prospective EV/EBITDA multiple will have compressed to around 8.0X to 8.5X.

Now, I don't know much, but - unless there has been some major calamity befall capital markets (in which case, we'd probably have far greater things to worry about than RHC's seemingly-discounted valuation) - I cannot see the market ever valuing a business like RHC at just 8.5x EV/EBITDA.

Even if there is no re-rating from the current 10x EV/EBITDA multiple (recall that the historical multiple has averaged closer to 12x-13x), that implies a share price of around $75 in two years' time (24% upside, or a 12%pa compound annual investment return... ~15%pa, including dividends).

Now, that might not seem all that spectacular to some, but on a risk-adjusted basis, I think it is a very attractive BaseCase investment proposition.

Of course, when dealing with these sorts of long-duration growth companies, it is prudent to consider a Worst-Case Scenario: say, where the earnings growth is not 10%pa, but an almost unthinkable 5%pa, and where the prospective EV/EBITDA multiple de-rates even further from the current 10.0x, to a discount-to-market 8.0x to 8.5x. This sort of multiple would reflect a market view of the Ramsay model being almost broken, I think. Those input assumptions would equate to a share price between $52 and $56, so between 8% and 15% further downside.

Contrasting this, an Optimistic Scenario, one in which growth is unchanged from the 10%pa used for the Base Case, but where the stock recovers some of its lost rating, back to its longer-term EV/EBITDA multiple of 12x. That implies a two year prospective stock price of around $93, which is >50% upside.

So, to summarise the potential scenario outcomes for a two-year investment time horizon:


WORST CASE: 15% downside (10% downside, after dividends)

BASE CASE: 25% upside (~30% total investment return, including dividends)

OPTIMISTIC CASE: ~55% (~60% total investment return, including dividends)


For me, an investment proposition that - over my investment time horizon - offers 60% potential upside, against 10% potential downside, is one that I find particularly attractive.


Of course, one can always try to finesse the act of investing, by waiting for any potential negative "news flow"to emerge before buying, and one could end up being fortunate enough to purchase the stock a few percent cheaper on such a day.

But in the context of several tens of percent of potential upside, the chance of a few percent cheaper entry point - if that is indeed what transpires - is not at all meaningful; certainly not meaningful enough for me to spend my time worrying about, I don't think... especially since I have no way of knowing whether or not I will be proven correct.



[*] Recall that this is materially lower than RHC's longer-term compound average annual growth rate in excess of 15%pa, but it is probably appropriate given the larger base effect.

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