Health Care Stable But Needs Monitoring

This story features COCHLEAR LIMITED, and other companies. For more info SHARE ANALYSIS: COH

-Least funding risk, best premium
-Handling of US cost cutting critical
-FX movements matter
 

By Eva Brocklehurst

How healthy is the health care sector?

Funding is the main risk for for nearly all stocks in the health care sector but robust demand, underpinned by an aging population, should ensure most report solid earnings growth in FY13. Deutsche Bank has observed companies with the least apparent funding risk continue to attract the richest premium, given the low risk to earnings, especially with the weakening Australian dollar. However companies currently grappling with reimbursement pressure emanating from the US offer the potential for greater outperformance, if the funding cuts can be managed.

Of those stocks that are reporting with a June year-end, Citi is seeing tough industry conditions in the offshore businesses to be the largest drag. Maybe more so than consensus estimates are factoring in. Currency considerations are also a major variable as most have offshore exposure. Here, any rally in the Australian dollar against the US dollar or euro is seen having a negative impact. Credit Suisse expects no surprises and less volatility in the June half than has been previously seen.

Cochlear ((COH)) is facing the risk of a multiple de-rating as its growth slows, in Deutsche Bank's view. The question is whether the company can turn around a sceptical broking community with unit sales growth and market share gains. Citi suspects consensus views are underestimating the negative impact of the continued roll of hedging gains, or overestimating the offset from cost improvement. Growth is developing regions also seems to be slowing, with a competitor now emerged in China. Cochlear's FY13 result posted yesterday was in line with consensus but only after June's profit warning. The company is reliant on the new Nucleas 6 device gaining traction and leading to upgrade sales, but US hold-ups may delay the release and cut into the window has for COH to move before peers.

No ratings changes flowed from database brokers post result, leaving five Sell and three Hold (or equivalent) ratings. Cochlear is expensive, most brokers believe, and could be ex-growth.

Citi retains a conservative view on CSL ((CSL)), due to report August 14, and is 2% below the market consensus for profits in FY14. The broker thinks market share gains from Baxter are likely to diminish, given Baxter's supply situation is improving. The stock boasts a 15% premium to Deutsche Bank's US dollar Discounted Cash Flow valuation and the broker thinks this is justified for the upside that's on offer from the company's target markets, robust earnings profile and potential for further capital management. Downside risks stem from pricing pressure in European markets and adverse FX movements. Credit Suisse also thinks the stock is undervalued and the current and potential markets under-appreciated. Moreover, the track record of being the best plasma fractionation company should be confirmed in the upcoming results.

Citi thinks consensus estimates for Ramsay Health Care ((RHC)), due to report August 29,  are overly optimistic for FY14. Citi is 8% below consensus. Consensus expectations for FY14 appear to entirely discount any negative impact from means testing of the PHI rebate in Australia, any continued drag from the offshore businesses, and/or any slowdown in the incremental earnings contribution from brownfield investments in Australia. If company guidance is more conservative at the results briefing, this may result in some modest negative consensus earnings revisions, in Citi's view.

Deutsche Bank names Ramsay as a stock where the least apparent funding risk deserves the richest premium. The broker has applied a 10% premium to DCF valuation to arrive at a price target and thinks upside risks are for higher-than-expected returns form brownfield expansion, private health insurance premium increases and potential acquisitions. Credit Suisse believes, despite headwinds from private health means testing legislation and the risk of consolidation in the industry, Ramsay should benefit from underlying demand for high quality private health care and this should drive volume growth.

Sonic Healthcare ((SHL)), due to report August 20, offers potential for outperformance, in Deutsche Bank's view, if those US funding cuts can be managed. Acquisitions in the second half may also have assisted the company to reach its target of 5% earnings growth. Citi also thinks the main source of surprise will likely be the performance of the US business and whether cost cutting initiatives have been, or are likely to be, sufficient to offset this. The performance of Germany may also be important, given funding reductions in that market.

Credit Suisse will scrutinise Primary Health Care ((PRY)), due to report August 14, for the operating metrics at the core medical centre division. GP attendance, revenue and head office costs should all influence Primary's earnings margin.

Further comments on new product performance in FY13 will have a bearing on Credit Suisse's valuation of Ansell ((ANN)), due to report August 20. The competitive advantage is in the company's R&D and intellectual property but if new products are not gaining traction this may be a sign that this advantage is waning. Citi surmises that strong sales momentum from new product launches will likely be required to achieve FY14 expectations, as end-market conditions remain subdued.

ResMed ((RMD)) having already reported, remains Citi's only Buy rated stock in the group. The broker's preference is for Primary Health Care over Sonic Healthcare given less downside earnings risk. Sell ratings are applied to Ansell, CSL and Cochlear because of excessive valuations. Deutsche Bank rates Sonic Healthcare as a Buy, because of the potential for outperformance if the funding cuts can be managed. The rest of the stocks referred to above rate a Hold in Deutsche Bank's view. Credit Suisse rates CSL as Outperform and Cochlear as Underperform. The remainder of those reviewed take a Neutral rating.

ResMed's fourth quarter revenue was up 11% on the prior corresponding quarter and US machine sales were again strong, while masks were weak. Revenue growth was enhanced by margin growth, and solid cash conversion has led the company to increase its dividend by 47%. Brokers such as UBS, Citi and JP Morgan have retained Buy ratings for the stock. Deutsche Bank has upgraded ResMed to Buy.
 

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