Valuation The Issue For Ramsay Health Care

This story features RAMSAY HEALTH CARE LIMITED. For more info SHARE ANALYSIS: RHC

The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

– Ramsay expands in Qld and France
– Little immediate earnings impact
– Consensus view is Ramsay shares are fully priced

By Chris Shaw

Ramsay Health Care ((RHC)) had two items of news for shareholders yesterday, announcing the Queensland government had selected the company as preferred bidder to build and operate a private hospital on the Sunshine Coast and advising of a hospital acquisition in France.

With respect to the Queensland hospital, Citi notes the facility will have 200 beds, six operating theatres, a day surgery centre and medical consulting suites. As part of the deal, Ramsay will need make some beds available for public patients until a public hospital also being built is completed.

In exchange Ramsay will receive an availability fee from the government, helping offset part of the forecast capital cost of about $150 million for construction of the hospital. The hospital is expected to open late in 2013.

While adding one hospital won't have a major impact on earnings for Ramsay, the key point according to BA Merrill Lynch is the deal shows private/public partnerships will continue to offer scope for growth in Australia. This reflects an ongoing overflow of public patients into private facilities.

What this means, according to BA-ML, is Ramsay should enjoy a much faster occupancy ramp up in its private hospitals in the future. This implies a better return on invested capital for the company.

The other point made by Credit Suisse is the agreement with the government effectively de-risks what is a greenfield development for Ramsay, as it implies higher occupancy rates at the new hospital. This means there is less risk to earnings, Goldman Sachs noting the agreement means typical issues of an untested location and a slow build-up to critical mass with respect to doctor and patient mass are significantly reduced.

Turning to the acquisition in France, Ramsay, via a joint venture where it holds a 57% stake, has bought a 178-bed private hospital in the Rhone-Alps region. Credit Suisse suggests deal metrics look reasonable given an implied margin of around 10.5%. There is some potential margin upside from operational efficiencies and procurement benefits.

BA-ML suggests the deal is only the first step in what should be an ongoing consolidation strategy in the French market. The broker estimates Ramsay has around $600 million in remaining headroom to make further acquisitions in what continues to be a highly fragmented market. Such expansion is likely to be a slow process in BA-ML's view.

According to RBS Australia, the fact the French purchase was at an attractive price likely reflects some challenges in the business. While expansion such as the deal announced yesterday offers potential long-term benefits, RBS's view is the additional operating risk from such moves also needs to be considered.

On the back of the two announcements yesterday there were few changes to market forecasts for Ramsay. One reason is the Queensland hospital will only really become a contributor to earnings from FY15 onwards, notes Goldman Sachs.

RBS actually trimmed its earnings per share (EPS) forecasts slightly to reflect higher capex assumptions, while Citi and Credit Suisse both went the other way and made minor increases to numbers. Consensus EPS forecasts for Ramsay according to the FNArena database stand at 102.1c in FY11 and 115.7c in FY12.

Based on EPS forecasts of 102.7c this year and 115.9c in FY12, Citi estimates Ramsay is trading on a 12-month forward earnings multiple of around 17 times. This is viewed as expensive, which sees Citi downgrade to a Sell rating.

This is the most negative view in the FNArena database, which shows a total of two Buy ratings, five Holds and the Sell by Citi. Those rating Ramsay as a Hold offer a valuation argument, RBS for example suggesting at current share price levels there is little scope for outperformance.

At the same time, the market is not pricing in much caution for execution of the offshore expansion strategy, adds RBS. A similar argument is offered by UBS, which also sees the stock as fully priced at current levels.

A dissenting view comes from JP Morgan, the broker arguing a 12-month forward multiple of around 16.6 times remains attractive given Ramsay is a quality defensive story and offers expected earnings growth of 20% in FY11, 16% in FY12 and 13% in FY13.

Goldman Sachs is not in the FNArena database but sides with the JP Morgan view there is still value in Ramsay at current levels, while Morgan Stanley sides with the majority and rates Ramsay as Equal-Weight within a cautious outlook for the Australian healthcare services sector.

Price targets for Ramsay according to the FNArena database range from $17.78 for RBS Australia to $20.40 for Credit Suisse, the consensus target being $18.71. Morgan Stanley has a target of just $16.29, while Goldman Sachs has set a target of $20.50.

The consensus target implies upside of just 2.4% from current share price levels, which supports the RBS view there is little scope for share price outperformance at current levels.

Shares in Ramsay today are weaker and as at 1.15pm the stock was down 54c or 2.9% at $18.31. Over the past year Ramsay has traded in a range of $13.01 to $19.22.

The chart below shows how Ramsay shares have continuously struggled with the consensus price target over the past six months.

(If you are reading this story through a third party source and you cannot see the chart included, we apologise but technical limitations are to blame).

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