Capitol Health Maintains Robust Outlook

This story features CAPITOL HEALTH LIMITED, and other companies. For more info SHARE ANALYSIS: CAJ

-IT investment a drag on margin
-But should improve synergies
-Growing above system rates
 

By Eva Brocklehurst

Diagnostic imaging operator Capitol Health ((CAJ)) is confident, expecting a strong sustained performance to continue in FY16. Acquisitions are expected to continue apace while the company also lifts investment in its IT infrastructure.

Morgans shares the bullish outlook and upgrades its recommendation to Add from Hold, with a 94c target in place. The share price has fallen significantly in recent months and the stock is now looking more attractive. The broker also observes the underlying margin in FY15, at 14.5%, was up from 11.3%, demonstrating the scalability of the company's business model.

Management has also guided to further acquisitions, with little competitive tension in the market as the larger players are preoccupied elsewhere. Morgans notes the weaker volumes in the final quarter of FY15 but also that July volumes appear to have staged a recovery. The broker cautions about relying on monthly Medicare numbers.

The second half may have been softening in terms of growth but Credit Suisse considers the company's strong track record warrants a measure of confidence, given commentary regarding a weak winter period in the legacy Melbourne business. Further group-wide growth of at least 8.0% is forecast, which suggests to the broker there is upside potential to assumptions surrounding the outlook in Melbourne.

Credit Suisse maintains an Outperform rating with a 95c target and notes an imminent transaction in NSW, albeit small, is more attractively priced than recent additions. The detail on this deal is expected to mitigate concerns regarding the pace and price of acquisitions. Capitol Health completed four acquisitions in FY15 which were funded from equity and an additional $34m in debt.

With the well-documented ageing of the population, and a national policy that is increasingly emphasising the importance of early detection and preventative medicine, Credit Suisse has no doubt these tailwinds will continue for Capitol Health.

Capitol Health's organic growth rate has been above system over FY11-15 at 11% and this reflects management's capability in attracting and motivating employees who drive revenue, the broker observes. Moreover, the industry is fragmented and this will continue to underpin consolidation efforts.

Industry conditions remain favourable for players with scale, given there has been no real increase in Medicare Benefits Schedule funding since 1999. Another supportive aspect, Credit Suisse observes, is that competitors such as I-MED, Sonic Healthcare ((SHL)) and Primary Health Care ((PRY)) do not have a stated ambition to significantly grow diagnostic imaging via acquisition.

The company's IT spending is to accelerate to improve communications and security. This may be a drag on margins in the short term but brokers understand it will accelerate the integration and realisation of synergies from recent deals.

Bell Potter also estimates the company's growth rate to be above the system. Medicare statistics show volume growth for general diagnostic imaging between 2.0% and 3.0% while MRI (magnetic resonance imaging) volumes are growing at an 8.0% rate. The broker estimates, after stripping out the impact of acquisitions, that Capitol Health's growth rate is around 9.0%. Margins are expected to improve with scale in FY16 and Bell Potter retains a Buy rating and 98c target.
 

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