Reform Risk Overhangs Life Healthcare

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The healthcare industry faces several developments which could influence stock performances in the next few months. A key item is reform to the Australian government's Prostheses List.

-Life Healthcare revenue highly exposed to reforms of Prostheses List
-Life Healthcare likely to mitigate cuts by renegotiating with suppliers
-Several AGMs expected to reveal key developments in outlook
 

By Eva Brocklehurst

The threat of regulatory reform overhangs the healthcare industry on several fronts, given numerous reviews for both providers and the health insurance industry underway. One that looms currently is the review of the Prostheses List. The Australian government has made its intentions plain that it will pursue savings in this area, as it is a major funder of the $2bn expenditure annually on such items by the private health insurers.

Life Healthcare ((LHC)) calculates its exposure to items on the Prostheses List amounts to around 40% of revenue, of which brokers estimate the majority comes from spinal prostheses.

UBS downgrades Life Healthcare to Neutral from Buy, reducing the target to $2.30 from $2.75, believing the stock has not priced in the risk of regulatory change. At this stage the broker does not adjust its earnings outlook, as there is a lack of clarity regarding the magnitude and timing of the reductions, together with any potential offsets.

Bell Potter also downgrades Life Healthcare to Hold from Buy, believing there are few reasons to purchase the stock during the current period of regulatory reform. This is despite the fact the stock appears cheap on the current enterprise value/operating earnings (EBITDA) ratio. Target is reduced to $2.14 from $2.97.

Bell Potter agrees the issue of the Prostheses List adjustment is likely to remain in overhang for the stock a least until the cuts are announced. The broker observes it will be some years before the company can make inroads into debt repayments and this leaves little headroom under its stated maximum leverage.

Prostheses List

Where prostheses are provided to private patients the price paid for the prostheses by the private health insurers is set by the Prostheses List. This list is regulated by the Australian government and requires private patients have no out-of-pocket expenses for prostheses.

For the quarter ended June 2017, benefits paid for private health insurers for prostheses accounted to $531m. The main group in this benefit was cardiac. Spinal implants were 8% of the total or around $42m.

The government has outlined plans to secure an agreement with private health insurers whereby they would be asked to commit to below-trend premium increases in private health insurance. To secure this agreement the minister has targeted hospital cost savings, including material reductions to prostheses prices.

UBS expects the reductions will be confirmed this month and allow the industry to set lower premium increases in submissions that are due early in November. The government is also likely to examine other savings potential including the elimination of items not deemed to be prostheses from the list, as well as the list's anti-competitive features.

UBS is unsure whether the company will be able to convince the government to set aside items for some level of local exemption given the breadth of the savings that are being targeted. Instead, the broker considers it more likely the company will mitigate the impact of the cuts by renegotiating the price with suppliers.

Longer term, addressing the anti-competitive nature of the list may allow Life Healthcare to enter major areas such as hips and knees, although the broker does not model this beyond an upside case scenario at this stage.

Bell Potter concludes that current public hospital prices for prostheses will not become a floor price for items on the prostheses list. By implication, reductions to the Prostheses List may have a wider in impact on group revenues, as prostheses sales to public hospitals may also be subject to a price adjustment.

Morgan Stanley also suggests feedback regarding changes to the Prostheses List and submissions to address privately insured patients in public hospitals may be forthcoming at the AGM of hospital operator Healthscope ((HSO)), to be held on October 19.

Operating earnings guidance is expected to be similar to FY17. Nevertheless, there is no patient volume growth that will dissuade Morgan Stanley from expecting a decline in Healthscope's first half earnings.

Recent US observations suggest double-digit unit growth for Cochlear ((COH)) is likely as it gains market share. Moreover, the N7 compatibility with the iPhone is driving strong growth of new patients as well as upgrades sales. The company will hold its AGM on October 17.

CSL ((CSL)), meanwhile, should benefit from a strong upcoming US flu season and there is upside risks to break-even expectations. A smaller competitor in immunoglobulin is constrained and this means market tightness in the product is being sustained.

However, Morgan Stanley believes the upside risks are balanced out for CSL in the context of rising plasma costs and capital expenditure. The broker is also looking further FX guidance at the October 18 AGM, which was absent at the FY17 result.

Ansell ((ANN)), whose AGM is on October 20, has upside risk for organic growth, given improving emerging market trends. Recent US hurricane-related shutdowns at plants have put pressure on butadiene prices which the broker expects could reduce the rubber input cost tailwinds expected in the second half.
 

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