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Morningstar | Corporate Action: Primary Meets Guidance and Unveils AUD 250 Million Capital Raising

No-moat Primary Health Care met our expectations following recently issued guidance. However, the firm surprised by announcing a AUD 250 million capital raising to fund the acquisition of a day-hospital network, along with new initiatives aimed at improving operational capacity in existing medical centres and upgrading pathology infrastructure over a five year horizon. The capital raising is a 1-for-5.21 rights issue at AUD 2.50 per share. We assume the hospital purchase component is around AUD 75 million, representing an EBITDA multiple of around 10.7 times. We think the price is reasonable, given the AUD 155 million acquisition of Pulse Health in 2017, reflecting an EBITDA multiple of 12.8 times. Our revised forecasts include the capital raising and incorporate the estimated impact to earnings of the day-hospital group, subject to the planned spend, but does not factor in potential synergies with existing medical centre services such as IVF, radiology, and pathology. As such, we lower our fair value estimate by 9% to AUD 3.50 from AUD 3.85. Although shares are in a trading halt pending the raising, we view the shares as undervalued based on the last closing price of AUD 3.20. As such, we recommend that shareholders participate and take up the offer.

Key metrics of the result included underlying net profit after tax of AUD 92.3 million on group revenue of AUD 1,740 million after adjusting for impairment and restructuring charges, which came in essentially flat and up 4.9%, respectively, year on year.

Performance in medical centres remained soft with an 89-basis-point decline in EBITDA margin to around 30%, reflecting lower operating leverage and lower full-time equivalent general practitioner, or GP, numbers of 945 compared with 959 at the end of fiscal 2017. This was below our forecast EBITDA margin of 36% and highlights the vulnerability of Primary’s profitability to GP numbers. Notably, share of revenue for the year proved lower than our expectations at around 40% of gross billings. Although management cited clinic closures being partly responsible for the GP departures, and flagged a three-year target FTE number of 1,400, up 45% on the present day based on a more regional-level customized approach to attracting new GPs, we remain cautious given the track record of recruitment to date. As such, our current forecasts have FTE GP numbers reaching around 1,043 by 2023, with medical centre revenue growing at a five-year CAGR of 2.6%. However, we do see upside risk associated with funding from the capital raising, providing Primary with some leeway in contract negotiations with new GP recruits.

From a balance sheet perspective, Primary is carrying a relatively high level of debt with net debt/EBITDA of around 4 times. Excluding the capital raising, we see this trending towards 1.56 times by 2021. However, including the raising we see this trending towards 1.37 times over the same period, not including revenue and cost synergies between the day hospitals and existing assets. The company declared a full-year dividend of AUD 0.106, fully franked, representing a payout ratio of about 60%. We remain comfortable with Primary’s ability to maintain its dividend, given the strength of free cash flow generation, up around 4% this fiscal year to AUD 147 million.