As you know, one of my core views is that many perceived ‘defensive’ stocks will not prove defensive in share price terms, as the interest rate cycle turns up. I am most cautious on the Healthcare and Infrastructure sectors and that’s where my AIM Global High Conviction Fund has the majority of its short positions.
Regular readers would know I have been bearish on market darling Ramsay Healthcare for the last 18 months. That caution is proving warranted, with RHC’s interim earnings missing at every level and leading to consensus downgrades of 3-5%. RHC shares fell another -6% yesterday after reporting. That is not “defensive” and I continue to target a $54.00 share price for RHC, a further -15% decline from here.
Despite RHC’s share price weakness and earnings downgrade cycle, the analysts still look at this stock historically. There are currently 5 buys, 6 holds and 0 sell recommendations and the consensus share price target is $77.00.
However, the brokers at big investment houses are starting to join the cautious view, overriding their analysts’ optimism. The following was written by the desk of a big investment bank summarising the RHC result.
Ramsay Health (RHC) – No good. SELL
– Missed at Revenue, EBIT and NPAT.
– EBIT $470m (vs. us $492m = 4.5% miss).
– Managed to deliver “Core NPAT” exactly in-line with consensus, thanks to even more abnormals than usual (16.8% of NPAT).
– Abnormals reflect all sorts of things but primarily restructuring charges in France (taken through Employee, Occupancy and Service cost lines).
– Gross cash flow (Receipts less Expenses) went DOWN 1% on pcp.
– Europe remains weak on tariff cuts + staff cost inflation.
– Aus Rev +4% (vs. US +6%)…better EBIT performance on cost-out + Pharmacy contribution.
– Spent $165m on Pharmacy aqns in the period…assuming they paid ~9x EBIT (I have no idea and maybe that’s too aggressive), implies that ~25-30% of Aus EBIT growth came from Pharmacy aqns.
– Tax rate gone down again, despite weak European performance…need to ask on call…recall last year they took a DTL (deferred tax liability) writeback through the tax line (they’ve probably done it again).
– Reiterated guidance for “Core EPS” growth of 6-8%. I don’t think that means very much given will mostly be Pharmacy + Abnormals.
– Wrong multiple. SELL
Sales growth in RHC’s Australian operations moderated to 4.3% year-on-year, whilst the French and UK operations went backwards. At the same time, the quality of RHC’s earnings have deteriorated sharply on a number of measures. To achieve NPAT guidance, RHC is booking high levels of abnormals. This means it is relying heavily on taking costs below the line to meet expectations. “Non-core” expenses grew to 17% of H1 statutory NPAT from 11% in FY17 and 7% in FY16. The only major significant cost to be singled out by RHC management is a restructuring charge taken at its French operations to centralise non-core functions. A pre-tax charge of €44m was taken (“below the line”) for a program which is targeted at producing €5m of annual (“above the line”) cost savings, once the program is fully implemented in three years. By most metrics, a program that has implementation costs nine times the targeted annual cost saving is marginal. However, it does serve to help preserve “normalised earnings”.
Operating cash flows also show a diverging trend from reported profit growth. Gross cash receipts for the business (cash from customers minus payments to suppliers and employees) went backwards in FY17 and again went backwards in 1H FY18.
The market is starting to see through this and that is one reason the share price reaction was negative yesterday. When you are trading on a premium P/E rating, you simply can’t consistently book high percentages of abnormals. High P/E’s need clean earnings streams, not messy ones. It’s as simple as that. That is why the broker above writes “wrong multiple, sell”. They are correct.
I thought it would be useful now to revisit our short RHC thesis from six months ago after the FY17 results – Ramsay Health Care (RHC): why I remain short [1].
This is still our core short RHC thesis and the interim FY18 results simply give us more conviction in this short thesis.
https://switzersuperreport.com.au/ramsay-health-care-rhc-why-i-remain-short/
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