Primary And Sonic Oversold?

This story features SONIC HEALTHCARE LIMITED. For more info SHARE ANALYSIS: SHL

-Current proposal looking less likely
-Sell off in PRY, SHL seems overdone
-Impact complex and difficult to assess
-Potentially negative for earnings from FY16

By Eva Brocklehurst

A co-payment of $7, to be made when visiting a general medical practitioner, was a feature of the latest Australian government budget, creating a good deal of publicity and angst among lower income earners and pensioners. The mooted changes to the medical system put the focus squarely on those companies sourcing earnings from private practice such as Sonic Healthcare ((SHL)) and Primary Health Care ((PRY)). Primary derives around 64% of revenue from GP services while Sonic derives around 70%.

Implementation of the proposal is some way off, if it proceeds at all. Increasingly, it looks like the government will have trouble passing the bill through the parliament, particularly with a newly configured, and likely hostile, Senate taking up residence from July 1.

CIMB finds the impact difficult to assess for healthcare providers, but believes the post-budget sell-off in the two noted stocks at more than 5% was excessive. The broker's analysis suggests, if the reforms were implemented as proposed, that GP visits may decline 3-9%, with a 5-14% decline in pathology volumes and a 4-12% decline in diagnostic imaging. This would equate to modest FY16 earnings declines of 0-5-3.0% for Primary Health Care and 0.2-2.2% for Sonic Healthcare. The reasons the calculation remain rough is there are numerous aspects to the legislation that are difficult to gauge, such as the varying proportion and different pricing of the Medical Benefits Scheme (MBS), the mix of concession card holders and non-concession visits to the GP, and physician discretion to waive or increase the co-payment.

Adding to the confusion, in CIMB's opinion, is a prior bad experience of providers introducing co-payments in pathology in 2009, as an offset to government price cuts, that were quickly and subsequently withdrawn. The broker hastens to remind the market this experience does not reflect the current situation.

Another layer of complexity comes from differences across these companies in terms of their relative exposure to Medicare-derived revenues and the proportions of both bulk-billed services and concessionary attendances. Credit Suisse is mindful of these differences in attempting to model the possible scenarios. In the broker's bear case – with a $2 net price increase on bulk-billed services based on a $7 co-payment, offset by a $5 reduction in the scheduled fee, a reduction in bulk billing incentive items and a 10% reduction in bulk billed concessionary volumes, as well as no change to the current percentage that are bulk billed – this would deliver revenue reductions of 4% for Primary Health Care and 3% for Sonic Healthcare.

Based on the high proportion of fixed operating costs the broker assumes there is no offset to lost revenue at the earnings line. Moreover, any cost cutting would be negated by increased administrative expenses associated with the collection of co-payments. Therefore, if such measures play out – and there are a lot of assumptions – there could be a group net profit reduction of 22% for Primary Health Care and 9% for Sonic Healthcare.

At the other end of the scale Credit Suisse models a scenario where the co-payment is $15 for ordinary patients and zero for concession holders with no volume loss. In this instance, FY16 profit forecasts for both Primary Health Care and Sonic Healthcare would actually increase by 7% and 3% respectively. As there is such uncertainty over whether the measures will pass the Senate the broker makes no changes to earnings, target prices or ratings on the two stocks.

For UBS there are three likely outcomes. Either the proposals are passed in their current form, in which case the range of impact is a 1.0-2.3% reduction in FY16 earnings for the two companies at a 5% reduction in volumes, or the Senate blocks the reforms and that's the end of the story. The third outcome is that some variation is requested by the Senate in order to ensure passage of the bill, such as a more moderate co-payment or no co-payment on pathology and diagnostic imaging. The worst case scenario is the current proposal, which UBS notes has been captured in the selling down of the stocks, and the broker thinks the outlook can only improve from here.

The uncertainty makes it difficult for both these companies to respond to the measures. The co-payments would not be due until FY16 but confusion abounds and UBS believes this is a risk to near-term patient volumes. The broker applies an immediate 2% hit to GP volumes for both stocks which affects FY15 earnings estimates. These are reduced by 1.1% for Primary Health Care and 2.5% for Sonic Healthcare.

On FNArena's database Primary Health Care has three Buy ratings, four Hold and one Sell. The consensus price target is $4.99, suggesting 10.1% upside to the last share price. Sonic Healthcare has three Buy and five Hold ratings. The consensus target is $17.71, suggesting 1.4% upside to the last share price.
 

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