Concerns Grow Over Ramsay’s French Connection

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

-Brake on French earnings
-Further consolidation potential
-Strong Oz growth trajectory
-Headwinds not abating yet

By Eva Brocklehurst

A reduction in tariffs for private hospitals by the French government has put the cat among the pigeons at Ramsay Health Care ((RHC)). The French government has announced a 2.15% tariff reduction, less than the 2.5% announced in 2015 but ahead of what brokers were expecting. Several brokers are concerned about the company's French strategy, as the different settings compared with the Australian business are put into stark relief.

Macquarie calculates that acquisition-related cost synergies mean that the French business earnings were flat in the first half and, if this latest reduction is not offset, it imparts a 5.0% brake on earnings. Tariffs in France will now be 3.5% lower than 2005 while in Australia prices have risen by 33%, the broker observes.

Prior to the latest cuts, Ramsay was generating a return of 8.9% pre-tax on its French investment, which is considered well below both its cost of capital and its internal target of 15%. Macquarie observes this would not be such a problem if France was not a key part of the business. Since the initial acquisition of Generale de Sante, Ramsay has spent $1.85bn on acquisitions in the country and France now contributes 15% to earnings.

Moreover, conditions are unlikely to improve for some time. Macquarie notes the French government's fiscal position is challenged, with debt to GDP at 98%. That said, this is in the context of margins for earnings in France of 19.9% compared with 16.4% in Australia, which suggests to the broker the French government has room to move before imposing financial distress on operators.

So, it is up to the company's Australian business to carry the growth trajectory and, although this segment impressed Macquarie in the first half, there are risks emerging as industry volumes are seen slowing. The broker retains an Underperform rating.

On the Australian front, CLSA is not worried, given the company has a 27% market share and pricing power, able to roll out new theatres in existing hospitals which should lead to longer-term profit expansion.

The analysts calculate 73 private hospital operating theatres will open in Victoria between now and 2020, an increase of 30% over the current stock, compared with a smaller increase in public hospital theatres. While if too many were to open in a given time frame volume growth might be an issue, the fact that Ramsay is instead opening relatively more theatres in NSW, which is not subject to the same volume of openings as Victoria, augurs well in the broker's view.

While this volume issue remains on CLSA's radar (not one of the eight brokers monitored daily on the FNArena database) as a potential pressure point for earnings. a $80 price target and Buy rating are maintained.

Ramsay Health Care has a large skew in its French operations towards psychiatric hospitals and Ord Minnett points out that the extent of tariff reductions in this discipline is unclear. The impact of the tariff change will vary from operator to operator. In 2015 the broker observes the changes were more pronounced in dialysis and less so in obstetrics.

Ord Minnett believe the reduction in tariff has potential to force further consolidation on the industry, particularly as some private equity owners of hospitals have high debt balances. Ramsay is well placed in this regard, the broker observes.

While the question marks over the company's foray into the French market are now more marked, Ord Minnett still believes the tariff reductions need to be read in tandem with synergy and procurement opportunities and retains an Accumulate rating.

Deutsche Bank downgrades to Hold from Buy, disappointed with the news as it highlights the difficult operating conditions under the current French government. The broker remains confident in the medium-term outlook but believes Generale de Sante is becoming an increasing drag on group earnings. Other near-term risks are also heightened locally, with the changes to prostheses funding and the pending negotiation with Medibank Private ((MPL)).

While another reduction in the tariff was probably factored into the company's guidance at the first half results, Morgan Stanley does not believe the upgrade cycle can be maintained. The broker believes a third reduction in 2017 is likely.

No financial detail has been provided on the nine hospitals acquired in the town of Lille in December but, with procurement synergies not expected until FY17, the French division could be challenged, Morgan Stanley adds. The stock appears priced for perfection and the broker reiterates an Underweight rating.

The new measures imply flat organic revenue growth for Ramsay in France over the next 12 months, in Credit Suisse's opinion. Nevertheless, the broker envisages a favourable case mix, with an ongoing transition to day surgeries and a rationalisation of services/assets will support margins. There are also cost reduction opportunities in terms of global procurement initiatives as well as acquisition potential, given the fragmented private hospital market. Outperform retained.

FNArena's database shows three Buy, three Hold and two Sell ratings. The consensus target is $66.14, suggesting 5.2% upside to the last share price.
 

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