It was telling that Medibank Private (MPL) and NIB Holdings (NHF) leapt by more than 10% after the Coalition’s shock election win. A Labor government proposed capping health premium price increases at 2% for two years, hurting insurer margins and earnings.
The cap would have crunched private-hospital operators because insurers would have pressured them to find more cost savings. Ramsay Health Care, (RHC) my preferred healthcare stock, rallied 7.3% on Monday and has scope for further price gains in the next two years.
Healthcare was not the only winner from the election. Bank shares took off because the Federal Government is seen as less hostile to the sector from a regulatory perspective. And because retail investors, who seek fully franked yield, might start buying the banks again.
Property developers bounced because the Coalition has no plans to change negative gearing and because it pledged extra support for first-home buyers. Retailers such as JB-Hi (my preferred retail stock) also rallied as the market priced in the impact of tax rebates in FY20 and consumers having a few more dollars in their pockets.
This was arguably the most significant election for the share market in many years given the scope of Labor’s proposed reforms and the likelihood of its victory, using opinion polls. But it’s always dangerous buying stocks based on stories about election “winners and losers”.
The election result looks fully priced into retail and property stocks after the Monday bounce. Banks look a lot more interesting, but it’s the healthcare sector that is the biggest winner. The health sector’s star performance on ASX on Monday said as much.
Which brings me to Ramsay Health Care, operator of more than 220 private hospitals in Australia, the United Kingdom, Europe and Asia; 14 day-surgery centres and a range of hospital-related services. Ramsay’s Australian operations account for just over half its revenue.
To recap, I wrote favourably on Ramsay for The Switzer Super Report in June 2018 when the stock traded near its year low of $56.66. The day after that column, Ramsay downgraded its earnings guidance and the stock traded near $52 a few months later. Ouch.
It’s a sickening experience writing favourably on a stock, only for the company to downgrade its earnings 24 hours later, but such are the risks of public commentary on companies. Some readers emailed to question my view on Ramsay and whether I got it wrong. Fair enough.
Readers were worried about greater competition from public hospitals for patients and ever-escalating health-insurance premiums. As health-insurance premiums rose, more people, especially younger ones, would ditch cover and stick with the public-hospital system.
These were valid concerns, but I held my nerve on Ramsay, despite a chorus of commentators arguing the company’s best days were behind it.
I felt Ramsay’s share price had too much bad news priced in. The Price Earnings (PE) ratio in June 2018 was a touch over 18 times; it peaked above 30 in 2015 and 2016. The PE looked too low for one of the market’s great companies.
Ramsay has since rallied to a 52-week high of almost $69 – a 23% gain in less than 12 months for those who bought in June 2018. The company’s first-half result for FY19 slightly beat market expectation and full-year guidance was reaffirmed. Revenue growth from the Australian hospital operations – the key to Ramsay – was better than hospital system growth.
Is the good news fully priced in?
A consensus share-price target of $59 for Ramsay, based on the view of 11 broking firms, suggests the stock is overvalued. The consensus is too bearish; broker price targets of $75 look more realistic, although Ramsay, after rallying this year, is near fair value.
Still, there is much to like about Ramsay over the next few years. The Federal election result does more than potentially lessen pressure from health insurers to cut hospital costs; right or wrong, the government is less likely to pour money into public hospitals compared to Labor.
Opposition Leader Bill Shorten said Labor would spend another $2.6 billion in funding for public hospitals from 2019 to 2025, in his Budget reply speech in May. That and other Labor healthcare initiatives, such as better access to MRI scans and cancer-patient financial assistance, could have increased the perceived value of public hospitals over private ones.
An improving tariff outlook in the UK and France (for government-funded healthcare services) is another tailwind. Ramsay earns lower margins on its global operations compared to Australia because of low growth in offshore government health-service funding with years of low or no tariff growth. Improving patient volumes offshore also bode well for Ramsay.
The completion of medium-term projects is another growth driver. As more people opt out of private health insurance, Ramsay has increased its delivery of “brownfield” expansions where it adds services to boost earnings. For example, higher-margin specialist centres, consulting suites and expansion in retail pharmacy.
This year’s takeover bid for hospital rival Healthscope could benefit Ramsay in the near-term. Under private-equity ownership, Healthscope may have to contend with greater capital rationing and internal change – short-term pain for long-term gain. Nobody knows for sure how Healthscope will change, but any disruption could be a small benefit to Ramsay.
Longer term, Ramsay is leveraged to an ageing population that will need extra health services. It will also benefit from East Coast population growth and, inevitably, continued pressure on the public-hospital system and demand for private hospitals.
The strategic goal is clear: more private hospitals offering more services in more locations in Australia and overseas. And greater economies of scale as the hospital network expands.
Ramsay could create value by spinning off its overseas operations into a separate vehicle, or selling them. It would retain the Australian operations, which provide the bulk of earnings and benefit from a more favourable regulatory environment and higher profit margins.
Ramsay’s local hospitals are hard to replicate and provide some sustainable competitive advantage or “economic moat”. In contrast, the offshore operations depend more on lower-margin, public-tender contracts in markets that have less favourable regulatory settings.
An Australian-only operation with a strong position in an attractive industry would reduce some risk in Ramsay (that comes from its overseas operations) and help it pay a higher dividend. Ramsay doesn’t see it that way and is ploughing more capital into its European expansion strategy. Given Ramsay’s long-term performance, one has to back management on that view.
What can go wrong?
The two main risks are unfavourable regulatory changes and a faster-than-expected decline in private health insurance and thus lower demand for private hospitals.
As mentioned, the Coalition’s return to power reduces some regulatory risk for Ramsay; there’s always potential for policy change in the healthcare sector but I’d rather own a private hospital operator with the Coalition in charge than Labor.
On health-insurance demand, it is inevitable that more Australians dump cover or downgrade to cheaper policies. Rising insurance premiums and growing gap payments, where patients have out-of-pocket expenses, are encouraging younger people to ditch health insurance.
Federal Government reforms to make private health insurance more attractive might help private-hospital operators at the margin, but it’s hard to see the trend of people dropping out of health insurance abating. The decline could accelerate in the next few years if low wages growth persists and more people struggle to keep up with rising living costs.
The upside is that people under 35 who are likelier to drop out of insurance are not big users of private hospitals. People over 65 who use more health services as they age tend to hold on to their health insurance for longer and pay for cover extras, where possible.
Risks aside, investors might watch and wait for better value in Ramsay, and for the election euphoria in the stock and market to subside a little. There’s no obvious catalyst to re-rate Ramsay from the current price between now and the full-year result that is due in late August.
That said, some headwinds for Ramsay are easing: notably low tariff increases in its offshore operations and domestic regulatory risks.
For all its gains this year, the well-managed and governed Ramsay is still trading below its peak price in 2016 (above $81). If conditions continue to improve for the company – and the share market holds up – Ramsay could test its all-time high within 2-3 years.
Chart 1: Ramsay Health Care: short-term performance
Chart 1: Ramsay Health Care: long-term performance
Source: ASX
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article, do further research of your own and/or seek personal financial advice from a licensed adviser. All prices and analysis at 22 May 2019.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.
