Healthscope Best Placed For Insurer Negotiations

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

-Among the highest margin earners
-Continued margin deterioration a risk
-Can fund hospital expansion from sale
 

By Eva Brocklehurst

Australian private hospitals are under the spotlight at present as health insurers battle to sustain margins. Insurers are feeling the chill wind of churn, as customers look for better value premiums and downgrade their cover as costs escalate. How does this translate to the hospital sector?

Morgan Stanley has initiated coverage of Healthscope ((HSO)), citing a mix of influences on the private hospital sector. Healthscope is Australia's second largest provider of private hospital beds, with Ramsay Health Care ((RHC)) the largest and twice its size. Hospital industry margins have risen over the past seven years but insurer margins are flat to lower. Insurers are intent on paying lower rates to hospitals as rising lapse rates signal ongoing premium increases will not assuage their margin downtrend.

In this aspect, Healthscope has signalled more openness and a willingness to accommodate insurer concerns, based on industry feedback, but then then the broker observes Helthscope also has more potential for cost reductions in Australia relative to Ramsay. In the main, the margins hospitals enjoy imply rate reductions from insurers can be withstood without materially affecting capital expenditure. Morgan Stanley estimates Healthscope has a relatively underdeveloped hospital portfolio compared with Ramsay Health Care and this means a larger capacity to bring more brownfield beds on line, which in turn implies better medium-term organic growth.

Morgan Stanley's calculations signal around 2.0% growth in hospital beds over the next 10 years would be required to maintain occupancy at or below 85%, at a total cost of $10bn, funded by the hospitals. Healthscope is well placed as it enjoys some of the highest earnings margins among Australian private hospitals. Moreover, management has signalled potential for more upside if it realises the benefits of centralising newly launched procurement and staff management systems.

Morgan Stanley models for 4.0% volume growth and rate increases of 1.5% per annum. That said, the broker considers continued insurer rate increases are unsustainable and industry challenges will limit margin expansion. Downside risks for the hospital sector include further deterioration in average margins and government intervention on prothestics pricing. The broker understands surgically implanted prostheses are at a significant premium to cost but remain the industry standard and, therefore, are at risk of regulatory intervention. Prosthetics, on the broker's estimates, contribute around 3.8% to Healthscope earnings and any intervention could mean 5.0% earnings downside for its hospitals.

The broker kicks off with an Equal-weight rating for Healthscope on a $2.59 target as the shares are trading near the fair value estimate. In contrast Morgan Stanley has an Underweight rating for Ramsay Health Care and a $61.58 target.

UBS recently upgraded to Buy from Neutral when Healthscope announced the sale of its Australian pathology business to private equity. That business was lacking in sufficient scale to make it workable, UBS maintains. Funds are expected to be used to finance hospital expansion, which this broker also envisages offers potential to turn earnings around. The company sold the local pathology operations for $105m but retained its overseas business and Australian medical centres, apart from six skin clinics which were included in the sale.

There are three Buy ratings, three Hold and one Sell on FNArena's database. The consensus target is $2.84, suggesting 2.6% upside to the last share price.
 

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