DCA won't take setbacks lying downAuthor: Fiona TyndallDate:...

DCA won't take setbacks lying down
Author: Fiona Tyndall
Date: 19/05/2006
Words: 1008
Source: AFR
Publication: The Financial Review
Section: Corporate Focus
Page: 67


DCA operates in one of Australia's most highly regulated industries, but it's not letting that stop it from achieving market growth, writes Fiona Tyndall.
Aged-care and diagnostics company DCA Group has a captive audience. The number of people aged over 65 - a group that consumes five times the amount of health services that younger people use - is set to double during the next five to 10 years.

But DCA is captive, too.

The listed group works in a closely regulated sector and sources 60 per cent of its diagnostic imaging revenue and nearly 75 per cent of its aged-care revenue from governments.

The fortunes of operators in the sector shadow government policy, and margins are notoriously tight.

Now DCA, widely considered the most efficient and best-performing company in the sector, is feeling the squeeze.

Last week the group said tougher than expected competition among hospitals for radiology business had hit its profit. After-tax earnings for the second half would be at the low end of the $40 million to $50 million forecast provided in February.

Full-year profit would total about $75 million, compared with previous guidance of $82 million to $92 million.

The earlier forecast had already disappointed analysts, most of whom had expected that profit would reach $93 million.

DCA managing director David Vaux said profits had been hit because public hospitals were chasing private patients, traditionally DCA's clients, to offset funding shortfalls.

Shares in DCA fell 24.22 per cent in the three trading days after the profit downgrade announcement and broker Merrill Lynch dropped its rating to "neutral" from "buy", trimming its estimated revenue growth to 4 per cent from 6 per cent. Yesterday, the share price closed at $2.85, down 3.39 per cent or 10?, on Wednesday's close.

Merrill Lynch analyst Michael Carmody says the competitive pressure on the company will not lighten in the short-term.

But Vaux isn't worried.

The $1.7 billion group reported a 60 per cent increase in revenue in the first half of the financial year.

It has been shortlisted by the UK's National Health Service for three diagnostic contracts worth #535 million ($1.3 billion) and Vaux says the opportunity for growth in the sector is "enormous".

"We are hopeful of winning one and we may get a second," Vaux says.

It has also attracted the attention of the Capital Group Companies, one of the world's largest investment managers, which said this week that it owned 5.2 per cent of the stock.

"We are in an excellent position to take advantage of that growth in demand," Vaux says of the ageing population.

"Yes, we are certainly sensitive to government policy but as everyone knows and understands, government policy towards health care is very supportive."

Supportive only to an extent, say analysts.

It was government underfunding of public hospitals that led the hospitals to chase business from private patients, eroding DCA's business.

"Every public hospital in Sydney has a radiology service that the state government pays for," Merrill Lynch's Carmody says.

"One way to supplement that is to take in private patients and bill Medicare for it."

At the same time, DCA has faced wages pressure.

Public-sector diagnostic imaging technicians in NSW were recently awarded a wage increase of more than 20 per cent.

DCA says it does not need to match the increase immediately, but Carmody expects incremental increases over the next 18 months.

DCA has also shifted its radiologists from fixed-rate and term contracts to long-term remuneration plans tied to profitability, meaning DCA is taking some "short-term margin pain to provide long-term certainty", Carmody says.

In aged care, DCA's other business area, the government gives with one hand and takes with the other.

Earlier this month, the Minister for Ageing, Santo Santoro, announced that the government would allocate 28,500 new aged-care places over three years, increasing the number by 15 per cent nationally.

DCA will apply to be a provider of between 200 and 300 of the 4500 residential aged-care places to be offered this year.

But not all the places will be built by the care providers that take up the licences.

Many will fail to hurdle the sector's high margins, tripped up by the high cost of operating the facilities and the government-imposed cap on what care providers can charge residents.

Vaux, who operates more than 6000 beds in Australia and New Zealand, estimates the squeeze will lead to a shortfall of about 25,000 new beds over the next five to seven years.

Research analysts are scathing about the cap on charges to residents.

They say it has eroded margins in the sector and encouraged inefficiencies and poor standards of care by paying equal subsidies to all aged-care providers, regardless of their performance.

Analysts hope margins have dipped so low that reform of the system is inevitable.

"General market consensus is it is inevitable that the market has to be opened up with more subsidies or greater user-pays systems and that will reverse the margin erosion," Macquarie Research's Marcus Wilson says.

"Otherwise the government is going to continue to encourage inefficiency."

They hope the safety net that covers patients who cannot afford the care will stay, but that the cap on charges in the standard high-care accommodation market (where DCA operates) will be removed or altered so patients who can afford it can pay extra for the kind of care they want.

It would be a boon to DCA's aged-care business.

"As DCA is one of the most efficient operators in the sector, we expect the company will stand to benefit the most from any funding reform," JPMorgan health-care analysts Alexander Smith and Kylie Reynolds say.

In a speech in April, Santoro said he was working on longer-term reforms to the industry, indicating that the need for funding reform was on the government's radar.

Wilson says: "While it doesn't seem as though it's going to happen tomorrow, aged-care reform does seem a little closer than it did three to four months ago."

Until that happens, DCA will look for growth through acquisitions and efficiency improvements.

The company is negotiating to buy the Regis Group, an aged-care operator in Victoria and Queensland with 1575 beds in 18 facilities.

It will be the key to the company's plan to increase market share.