Healthscope Comfortably Set For Growth

This story features RAMSAY HEALTH CARE LIMITED, and other companies. For more info SHARE ANALYSIS: RHC

-High growth in top hospitals
-Pathology more subdued
-Key catalyst late Sept
 

By Eva Brocklehurst

Healthscope ((HSO)) is in a comfortable place, provided by a rosy outlook for the private hospital business given Australia's demographic trends. Healthcare represents 9.5% of Australia's GDP and 47% of the population has private health insurance. Moreover, 20% of the population is over 60 and the rate of aging is rising.

Australia's second largest private hospital operator appears eminently capable of replicating the growth strategy of Australian peer, Ramsay Health Care ((RHC)), in BA-Merrill Lynch's view. Healthscope has 12 large hospitals which, on a bed basis, represent 45% of the portfolio. Over 80% of $600m in planned capex over the next three years will be spent on the more profitable tier one hospitals, which underscores the broker's expectations for margin expansion of 100 basis points in FY15/16.

Earnings are driven by patient volumes, private health insurer contract pricing and cost inflation. Volumes are resilient and insurer contract pricing is secured for two years. This significantly de-risks earnings variance, in the broker's opinion. Wage inflation is lower than usual and procurement savings have been targeted. Merrills believes the government-run hospital sector will start to run out of public beds by FY17 and this should lead to outsourcing of patients to the private sector. This underpins the broker's forecasts for high single digit earnings growth from FY17.

Merrills initiates coverage with a Buy rating and $2.60 target. There is one obvious catalyst in the near term that the broker expects will provide upside potential to the target. Healthscope is short-listed to operate the planned Northern Beaches hospital. A partnership with the NSW government could add 3% upside to FY18 earnings estimates. Healthscope is one of two final bidders to develop and operate the new 423 bed public/private hospital and the successful applicant will be decided later this month.

Goldman Sachs has also initiated coverage, with a Buy rating and $2.40 target. Healthscope is expected to deliver strong earnings growth over the next three years driven by capacity expansion, agreed price growth and efficiencies, Goldman suggests. The broker expects the share price to be well supported in the medium term by expanding existing hospitals and opening new ones, such as on the Gold Coast. This should underpin both scale and margin.

Goldman expects revenue growth of 7% over FY14-16, based on admission volumes and pricing in the hospital division. Deutsche Bank also believes share price performance will be contingent on the execution of aggressive investment in its existing hospitals. While execution risk is low, a significant portion of the opportunity is already reflected in the price. Hence the broker has a Hold rating and $2.30 target.

Risks? Broker concerns centre on any further deterioration in pathology through market share losses, collection centre rent increases or reimbursement cuts, or reduced volumes if co-payments were to be legislated. From the hospital perspective, any reduction in affordability of health insurance premiums could result in lower admissions to private hospitals.

In terms of pathology operations, the economics are largely based on scale. Goldman estimates Healthscope has 12% of the revenue share in the market in FY14 compared with the top two controlling 70% combined – that is Sonic Healthcare ((SHL)) and Primary Health Care ((PRY)). Healthscope lacks scale in some states and, partly for this reason, its margins have been under pressure in recent years. Goldman notes the company has restructured and scaled back in NSW. Its market share in Victoria and South Australia is on a more equal footing to its peers and the broker acknowledges Healthscope is a much stronger competitor in these two markets.

Domestic pathology operations have struggled since the collection centre deregulation in 2010 and, while the business has been pared back to sustainable levels, with further funding pressure it likely offers only modest earnings growth potential, in Deutsche Bank's view. Goldman Sachs concurs. Australian pathology is expected to be the more difficult environment, suffering rising collection centre rents and potential further losses in market share. As a result, Goldman maintains relatively flat earnings forecasts

International pathology is expected to deliver mid single digit growth in revenue and earnings. Healthscope operates laboratories in New Zealand, Malaysia, Singapore and Vietnam. The large majority of offshore revenue comes from New Zealand, with most of its business under long-term contract with district health boards.

Merrills notes Healthscope was historically valued at a multiple discount to Ramsay because of several issues with operating performance and perceptions. On the acquisition of Affinity Health by Ramsay and subsequent divestment of hospitals to Healthscope, as required by Australia's Competition and Consumer Commission, the broker observed a shift in the rate of development and level of investment, prior to the private equity acquisition. This prior investment is likely to be supportive of the forward growth strategy now the stock is newly listed on ASX.
 

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