Australia | Aug 22 2017
Primary Health Care has completed a year of transition but there is more to come and most brokers are taking a back seat, awaiting further clarity.
-Certain transformation costs may recur in FY18
-Lack of clarity on expenses, retrenchments demonstrates state of flux
-Less experienced GP base may mean lower productivity
By Eva Brocklehurst
Primary Health Care ((PRY)) has completed a year of transition, with further changes to come. Diagnostic imaging and pathology businesses performed well, boosted by structural demand growth, while the transition of the medical centre recruitment model is proving challenging.
FY17 results were pre-released and contained few surprises for brokers, with $587m in impairments, a $38m restructuring charge and a transition of management. Results were affected by a number of non-recurring costs. Free cash flow improved while net debt declined.
Morgans hails the good progress being made and notable improvements in cash generation and debt metrics. There are still many uncertainties and management has acknowledged this by being unable to provide quantitative guidance, flagging a trading update at the AGM in November.
The broker liked the turnaround in imaging while there was good volume growth in pathology, albeit weighed down by higher costs. Medical centres appear to be moving in the right direction, as the company transitions to a new GP model.
Cash flow improved and reflected the benefit of lower up-front payments to GPs but there was a significant increase in trade creditors, which Citi suspects may not be sustainable. The broker is also wary of the cash consumption and the classification as transient certain transformation costs, which may recur in FY18.
Several issues such as a lack of guidance, lack of clarity on expenses, a new CEO arriving and recent retrenchments demonstrate a high level of flux in the business. This is expected to continue in the near future and, given the cloudy outlook, Citi retains a Neutral rating.
GP Changes
The turnaround is taking longer than Morgan Stanley expected although GP churn and cash flow continue to improve. The broker finds evidence of both an increasing mix of part-time and lower contracted hours among GPs, and falling productivity in the existing GP base as legacy contracts roll off.
The mix-shift to higher revenue share for GPs, with no near-term efficiencies, has meant operating earnings (EBIT) continue to fall. In FY17 this was somewhat offset by lower cash recruitment costs, leading to lower capital expenditure requirements.
Credit Suisse makes adjustments to modelling assumptions which results in downgrades to earnings of -7% over the forecast period. The broker notes, despite average GP numbers increasing by 3%, total gross billings were flat. The broker assumes this is because of lower productivity in the less-experienced GP base. Over time this is expected to improve. In the meantime, with the uncertainty prevailing, Credit Suisse retains an Underperform rating.
Ord Minnett observes the incoming CEO, Dr Malcolm Parmenter, will inherit a business that after a problematic two years has emerged with a repaired balance sheet, growing doctor numbers and improving free cash flow. Still, the broker acknowledges the challenges and the fact that earnings are at risk of further erosion as the transition and restructuring costs continue.
As cash flow trends have turned positive, the broker is reasonably confident that the worst has passed. Regardless, there is insufficient upside to warrant changing view on the stock because of the uncertainty and Ord Minnett also sticks with a Hold rating.
UBS is more positive, believing the exit momentum from the second half is suggesting a modest turnaround in FY18. The broker believes Dr Parmenter is a strong clinical leader and his arrival will help the growth outlook after the FY17 re-base.
FNArena's database shows one Buy rating (UBS), four Hold and one Sell (Credit Suisse). The consensus target is $3.65, suggesting 2.6% upside to the last share price.
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