Australia | Nov 23 2015
-Longer-term outlook more stable
-Yet weakness across all divisions
-Opportunity if market overshoots?
By Eva Brocklehurst
Several factors have heightened uncertainty for Primary Health Care ((PRY)), which has guided to FY16 earnings of around 5.0% below FY15.
The company cited the impact on pathology from the cycling of vitamin D cuts, weaker diagnostic imaging and inadequate GP recruitment. Progress is being made on these factors, and asset sales and the refinancing of bonds are expected to help drive debt levels down.
JP Morgan is cautious on the stock, considering regulatory and operational headwinds. Medical Centres are experiencing flat revenues because of the freeze on the indexation of Medicare rebates and lower healthcare practitioner numbers.
Diagnostic imaging has also been subdued, likely as a consequence of the uncertainty surround the Medicare Benefits Schedule review, the broker maintains. There is also a risk to the pathology business as well as imaging, as the Productivity Commission has recommended a review of items to reduce overuse.
JP Morgan believes the company will face challenges in obtaining health practitioners in the wake of the Australian Taxation Office decision on the acquisition of doctor practices. The focus is now on how the company intends to change its recruiting model to meet the challenge. Citi is negative about the trading update and reduces estimates sharply, taking it as a warning and downgrading to Neutral from Buy.
In contrast, UBS suspects new management has obtained control of the direction of earnings and this could be the low point. The broker's view is based on longer-term expectations for improved remuneration for primary health providers, in order to reduce hospitalisation and bring about better health outcomes.
Part of the weakness for Primary Health Care is due to the uncertainty prevailing with the current reviews underway in the health system. Precedent suggests to UBS that the market will try and price the risk but this is difficult to quantify and the market invariably overshoots.
Hence, precedent can also create a value opportunity. The broker's stance on the longer term is not supported by the negative direction of short term trading. Eventually the strategic value of the stock will be acknowledged, UBS asserts.
While disappointed, Morgan Stanley was not surprised at the slightly softer earnings outlook. Fewer GPs working from the beginning of FY16 raises risks around GP retention and the broker assumed this was a given. So the new GP acquisition strategy is considered a positive step.
The broker maintains an Overweight position on the basis that the company’s strategy to reduce debt and improve cash flow will deliver meaningful results. The share price reaction encapsulates the earnings advice and Morgan Stanley now questions whether this reaction is overdone.
Credit Suisse tempers assumptions and envisages the earnings risk is still to the downside. It may be too early to call a structural slowing of diagnostic services but, noting its substantial contribution to overall volume growth in the past decade, the broker believes this area is a key risk to current operating margins.
There is valuation appeal but Deutsche Bank is also cautious, suspecting earnings may deteriorate further before the benefits of the company's new model become apparent. There is added risk from the government funding reviews. All up, the outlook is cloudy.
What is more worrying, in Macquarie's view, is the lack of revenue increases despite expenditure on doctor up-front payments last year. The broker is also concerned about the extent of weakness implied in the guidance, given it extends across all divisions.
The consensus target on FNArena's database is $3.97, suggesting 21.5% upside to the last share price. Targets range from $3.25 (Macquarie) to $4.95 (UBS). The stock has a dividend yield on FY16 estimates of 5.3%. On FY17 it is 5.7%. There are two Buy, four Hold and two Sell ratings.
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