Oz Health Sector Finds Favourable FX Tailwinds

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

-Meaningful FX benefit
-Attractive valuations
-Still need to consider individual stocks
 

By Eva Brocklehurst

Brokers rate the probability of both surprises and disappointments in the Australian health care sector as low during the upcoming reporting season. Those receiving a tail wind from the fall in the Australian dollar in the first half look set to continue to enjoy that benefit. It's this currency variable that has potential to make the greatest difference to the earnings outcomes, in Citi's view, and most of the major stocks in the sector have meaningful offshore exposure.

While there are likely to be few catalysts for a re-rating, brokers note the sector is attractively valued. UBS believes the sector is priced at its most attractive levels in four years. With the exception of Ramsay Health Care ((RHC)), all major stocks are trading well below 10-year averages. The subdued valuations are driven by concerns over changes to government expenditure, both abroad and locally, and until these are resolved any re-rating is considered unlikely. In this respect, UBS believes the Australian federal budget on May 13 should be closely watched.

Credit Suisse also expects the first half of FY14 to have been benign. The risks that may emerge for the full year include potential upside to guidance from Ramsay and Sonic Healthcare ((SHL)), because of the more favourable currency rates, lower interest expenses as well as potential upside in UK margins. UBS thinks Sonic, specifically, has upside earnings risk based on solid growth in domestic services, but this is also reliant on there being no material cut to fees in the second half.

In this respect, Credit Suisse expects Sonic to report ahead of expectations for the first half, largely because of a delay in Australian fee cuts, but be unlikely to upgrade guidance. The company's goals are sound, in the broker's view, but volumes in the US may be soft this year if the roll-out of the health care reforms continues to suffer from implementation difficulties. Citi expects any surprise with Sonic will come from the US business and relate to whether cost cutting initiatives have been enough to offset the tough conditions there.

The greatest risk for a downgrade to the full year is with Cochlear ((COH)), in the opinion of both UBS and Credit Suisse, as the company's guidance signals a heavy weighting to the second half. UBS notes market feedback suggests the release of the N6 processor has only slowed the decline in market share, at best. Credit Suisse expects expects US operating conditions will make it difficult for ResMed ((RMD)) over the rest of the financial year. 

Citi takes a different tack, seeing some upside risk to consensus forecasts for ResMed and Cochlear, with the positive impact of a lower AUD perhaps understated. ResMed is Citi's only Buy-rated stock. The broker suspects the market is not only under-estimating the positive impact of the lower AUD but over-estimating the impact of Round 2 competitive bidding in the US. The broker's least preferred stock is Ramsay. Citi considers there's no room for disappointment in a PE multiple of 27 times and where consensus forecasts are suggesting 22% earnings growth.

Despite the large increases in Australian health insurance premiums, Credit Suisse is more optimistic about the demand for Australian private hospital services. The broker expects Ramsay will deliver a robust result. A key risk in the longer term is the sustainability of price increase from insurers to hospitals, but the broker notes Ramsay has 70% of its insurance pricing contracted over the next three years, so near-term share price risks appear to be on the upside.

UBS sees scope for a guidance upgrade from CSL ((CSL)) on the back of product launches while Citi thinks such scope is limited, acknowledging that commentary on the medium-term competitive threats will be important in assessing any upside.

While investors may be asking whether the sector has become overvalued, having recently outperformed the ASX200, most brokers believe the sector is relatively inexpensive. Credit Suisse cautions that scrutiny must be applied to individual stocks as the models and geography do vary. CSL has the most valuation support for an Outperform rating in the broker's view, Cochlear appears the key undervalued stock relative to the ASX 200, while Primary Health Care ((PRY)) and Ramsay seem to be the most overvalued. Citi thinks there is potential for upside surprise at Primary, given the strength of demand in end markets but believes expectations for the dividend may be overly optimistic. 

 With Ansell ((ANN)) Citi thinks the area of sales growth, or lack thereof, will contain any surprises. End markets appear subdued but declining latex prices should add an important ingredient to the mix. Credit Suisse expects that macro-focused investors will hold Ansell as a reasonably-priced exposure to recovery in industrial economies, as this should drive glove use.
 

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