Rumoured Budget Changes Could Hurt Ramsay

Array
(
    [0] => Array
        (
            [0] => ((RHC))
        )

    [1] => Array
        (
            [0] => RHC
        )

)

This story features RAMSAY HEALTH CARE LIMITED.
For more info SHARE ANALYSIS: RHC
The company is included in ASX100, ASX200, ASX300 and ALL-ORDS

By Chris Shaw

With leaks emerging that tonight’s Federal budget will see a shift in the income threshold level for tax penalties for those who don’t take out private health cover, stockbrokers have been quick to make an assessment of what this might mean for private hospital plays such as Ramsay Health Care ((RHC)).

At the start of last week the stock has been one of the more preferred in the sector as the FNArena database showed it scored five Buy ratings, three Holds and a single Sell recommendation but this now stands at four Buys, four Holds and two Sells as ABN Amro has lowered its Buy rating to a Hold and UBS has donethe complete turn and shifted from a Buy to a Sell recommendation.

UBS’s about face is based on the premise hospital profitability follows insurer profitability and the rumoured changes in the tax threshold mean less people, and especially younger workers, are likely to take out private health insurance. Until now the $50,000 threshold meant younger people had little coice but to take the cover or pay a similar amount as a tax penalty but with the threshold expected to move to $100,000 they are less affected by the tax penalty.

With the broker expecting the move will impact on private health insurer profitability at the same time as investment returns are falling it sees a situation where hospitals are less able to provide reasonable growth in annual benefit outlays, meaning margins will be hurt.

This means the long-term earnings outlook for the industry will change for the worse if the tax threshold changes are delivered in the budget, so the broker has reduced its view on the hospital sector as a whole. This impact on Ramsay as a leader and so the broker has downgraded accordingly.

For ABN Amro the argument runs along similar lines, the broker pointing out an increase in the income level at which the tax penalty applies likely means less people will opt for private health cover. As well, most likely to drop cover are the young and given they have less health problems in general for their age mean private insurers are likely to be left with more older, higher risk members.

To counter this premiums may have to rise and as this impacts on the number of people taking out private cover there is scope for private hospital volumes to fall, which would put downward pressure on earnings. While the broker has not adjusted its forecasts at this stage its downgrade to Hold suggests a more conservative view on the stock is the best course of action at present.

But as the broker points out, and Credit Suisse agrees, Ramsay has bargaining power given its size in the private hospital sector and as a result the impact on its operations going forward should be less than for smaller players in the sector.

This leads to Credit Suisse making no changes to its forecasts for the company, which in turn supports its Outperform rating. JP Morgan disagrees though and suggests the potential impact if changes are made in the budget only add weight to its argument the stock is overvalued at current levels.

As the broker points out the shares, even after yesterday’s falls in the initial reaction to rumours of the changes in tax thresholds, are still overvalued compared to historical multiples. On its numbers the stock as at yesterday’s closing price of $11.49 was still at a 6% premium to its historical 5-year average P/E (price to earnings) ratio of 16.5x, which it sees as unsustainable given earnings growth is now forecast to be only around 9% in FY09.

Rather the broker suggests this modest growth outlook and the negative implications of the proposed threshold changes imply the shares should trade at a discount to its historical multiple, so the broker retains its Underweight recommendation.

Given brokers have largely left earnings estimates intact to date the recommendation changes have had only a limited impact in terms of the average price target on the stock, with the FNArena database showing it now stands at $12.36, down from $12.50 last week.

Shares in Ramsay today are weaker again and as at 11.20am the stock was down 6% or 70c to $10.79, which compares to a trading range over the past 12 months of $9.93 to $12.56.

Click to view our Glossary of Financial Terms