Australia | Jun 25 2012
– Ramsay Health Care shares now fully valued in view of Morgan Stanley
– Means testing of private health insurance rebate offers downside risk to earnings
– This is not priced in, broker downgrades to Underweight
By Chris Shaw
A combination of secure growth and defensive status courtesy of exposure to the healthcare sector has helped Ramsay Health Care ((RHU)) outperform the ASX200 index by 23% since March.
But in the view of Morgan Stanley this outperformance may be set to end, as the growth profile for Ramsay is now at risk. This suggests the shares are expensive at current levels and sees Morgan Stanley downgrade to an Underweight rating within a cautious Industry view.
The issue for Morgan Stanley is the current Ramsay share price ignores the negative impact from means testing of the private health insurance rebate that starts from July 1. Means testing should save the government close to $750 million in FY13, with the earnings impact for Ramsay likely to become evident from FY14.
Morgan Stanley expects FY13 earnings guidance will be strong given bank bill swap rates are down by around one percentage point relative to average rates through FY12. This should boost earnings for FY13 to the extent Morgan Stanley sees scope for double digit earnings per share (EPS) growth. This appears priced in given Ramsay is trading on 16.1 times Morgan Stanley's FY13 earnings forecasts.
These forecasts in EPS terms stand at 116c this year and 135c in FY13, the latter up from 133c previously. By way of comparison, consensus EPS forecasts according to the FNArena database stand at 116.6c for FY12 and 129.9c for FY13.
Given Morgan Stanley expects the means testing earnings impact will become apparent from FY14, the broker has cut its numbers for that year. The expectation now is for earnings growth of around 7%, while under a bear case scenario EPS could actually decline by a little more than 2%.
The changes to its numbers leave Morgan Stanley 7% below consensus with respect to EBIT (earnings before interest and tax) in FY14 and 5% below on an EPS basis. As noted by Morgan Stanley, the impact of means testing will be felt over a number of years, which adds to downward pressure on earnings growth for the medium-term.
Based on its new earnings estimates, Morgan Stanley has a price target for Ramsay of $18.27. This compares to a consensus price target for the stock according to the FNArena database of $20.35. Targets in the database range from Citi at $17.50 to Macquarie at $24.00.
Given the range of price targets for Ramsay it is no surprise there is a spread in broker ratings, the database showing two Buy recommendations, four Hold ratings and two Sell ratings. Citi and UBS agree with Morgan Stanley's view Ramsay is a Sell, this given a significant valuation premium relative to peers in the sector.
Macquarie argues the Buy case in taking the view Ramsay is likely to achieve ongoing revenue growth and margin expansion, which would more than justify the current valuation on the stock. JP Morgan is similarly positive.
Those with Hold ratings include Deutsche Bank, who suggests while private hospital operators are set to win more public sector work, which is a positive for Ramsay, the stock appears fully valued around current levels given the share price is above Deutsche's target.
Shares in Ramsay today are weaker in a down market and as at 11.35am the stock was 50c lower at $21.60. This compares to a range over the past 12 months of $16.00 to $22.75 and implies downside of around 6% relative to the consensus price target in the FNArena database.
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