Ramsay Health Care shares were battered to 52-week lows recently by capitulation selling in response to a negative broker report. It’s been a tough two years for shareholders in the former market darling, whose shares have trended lower from a peak over $84 in September 2016 to below $60 today.
The resignation of the former popular and highly regarded CEO Chris Rex (replaced by Craig McNally) was followed by two lower-quality earnings results, vocal short-selling and calls by analysts for the premium earnings multiple to de-rate.
In other words, this one-time favourite defensive stock for retail investors is now well and truly out of favour.
Given Ramsay’s earlier record of growth and investment quality, value investors will be asking if this is an opportunity. I think it is, but only on a three-year view and there could be more downside yet. Weighing growth, capital management and risk Ramsay is currently worth around $60 — not much more than current prices of $59.45.
Near-term, the stock could drift lower if the market decides the 19 times multiple on forward consensus earnings is too high for a stock with single-digit growth. The central problem for shareholders today, however, is the growth curve from ageing is two years away and meanwhile Ramsay is caught in a marked cyclical and structural slowdown in private hospital admissions. Meanwhile the French and British operations, which together contribute some 20 per cent of operating earnings, are ex-growth.
Ramsay attracts a more profitable case mix than peers and has taken market share over time. It can probably continue to do so, but even Ramsay can’t fight the slowdown in private hospital industry volume growth from 7 per cent per annum 10 years ago to 2.8 per cent this year. Australians are turning their backs on private health insurance and private healthcare, due mainly to declining affordability.
Hospital private health insurance coverage is down to 45.5 per cent from a recent peak of 47.4 per cent in the March quarter of 2015. Exclusions within policies are more popular, causing some insureds not to be covered for all surgeries. The resulting increase in high-end surgeries in the public sector is one main reason for the deterioration in case mix for private hospitals. What’s more, I don’t expect the federal government’s October 2017 reforms to private health insurance (gold, silver, bronze and basic policies from April 2019) will materially reduce the trends away from membership and towards more exclusionary policies. There is also no broad acceleration in wages under way to restore the affordability of membership.
Consumers who kept their private health policies are increasingly using them for admission to public hospitals, which cover more costs than private hospitals including policy excesses. Public hospitals have incentives to pursue private business because it shifts costs from the states/territories back to the commonwealth, which so far has not introduced policies to limit the shift of private patients into public hospitals.
Healthcare services stocks always carry elevated political/legislative risk given intensive regulation. While we do not expect the federal opposition, if elected, would remove or further dilute the private health insurance rebate, its policy to cap growth in premiums at 2 per cent per annum for two years would almost certainly damage private hospital profitability. The sharemarket is already starting to price in this risk.
Meanwhile, Ramsay’s acquisitions in Britain and France remain unproven. Tariff cuts and disappointing volume growth have forced the company to bolster earnings by cutting costs. Having considered this gloomy bear case, investors now need to ask if it is fully priced in by the fall in the share price. As long as the government is returned at the next election, on an intrinsic value basis Ramsay is worth $60 per share and would be oversold at $54, where the forward earnings multiple would be too low at 17 times.
It is also important to stand aside from the gloom and ask if the consensus earnings downgrades have now ended. Large-cap stocks like Ramsay are intensively researched and react quickly to changing perceptions of earnings fundamentals.
While the stock is not about to return to its glory days of double-digit earnings growth, and profitability will fall due to less operating leverage from slower growth in Australia, while tariffs in France and Britain have bottomed. There was a 0.75 per cent average tariff increase in Britain in April and French President Macron has said he will not seek further cost savings from the healthcare sector over the next four years. The British National Health Service’s demand management strategies, which inflate surgery waiting lists, are also unsustainable.
All this means probably no further downgrades to earnings forecasts for Ramsay’s European operations and adds to the case the share price is within a few dollars of bottoming. Any further share price weakness from downgrades to forecasts for Ramsay’s Australian business can be seen as an opportunity.
David Walker is the ASX
large-caps portfolio manager at Clime Asset Management.
RHC Price at posting:
$60.23 Sentiment: Hold Disclosure: Held
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