EUR 850.00 For Business Accounts Only

Morningstar | Lowered Guidance Suggests Medical Centres Still Bleeding: Lowering FVE for Primary Health Care

We cut our fair value estimate for no-moat Primary Health Care by 4% to AUD 3.85 from AUD 4.00 per share after adjusting for management’s confirmed expectations for fiscal 2018 earnings, now at the lower end of previous guidance of AUD 92 million-AUD 97 million, compared with our previous forecast of AUD 99 million. This assumes slower ramp-up of general practitioners, or GPs, dampening operating leverage, leading to EBITDA margin compression for the medical centre division in conjunction with lower share of revenue flowing back to Primary from contract arrangements, given the higher reliance on bulk-billing rebates. However, our divisional revenue forecasts are unchanged, implying higher volumes processed by fewer doctors. Nonetheless, we see EBITDA margins stabilising in the medical centre division at around 37% over the medium term, while the market appears to be overly negative regarding the achievable segment profitability. At current levels, shares in Primary are screening as undervalued.

GP numbers remain key to operating leverage in medical centres. At first-half 2018, Primary cited 958 full-time equivalent GPs, compared with 959 at the end of fiscal 2017, with the company’s share of revenue ratio declining to 41.3% from 42.9% over the same period. Although incoming CEO Malcolm Parmenter’s credentials in building Sonic’s medical centre business (in terms of increasing GP numbers over nine years) are impressive, we are now more cautious about the much-touted revamp of medical centres and his focus on increasing GP numbers, increasing operating leverage, and improving divisional operating margins. As such, we think the medical centre will remain heavily skewed to bulk billing, which in turn will weigh on fee-sharing ratios for Primary. Previously, we assumed growth of the private billing business would increase GP numbers by 2.2% over five years for a total GP number of 1,068 by 2020, given gap fees paid out of pocket by patients.

Furthermore, this growth in private billing would allow Primary to retain 43% share of patient revenue under individual contracts with GPs. Our revised outlook now reflects lower assumed growth of GP numbers of 1.7% over five years to 1,043 in fiscal 2020, and given the greater reliance on bulk billing, Medicare rebate contracts result in 42% share of revenue per year for Primary.

Although our medical centre division revenue forecasts are unchanged with a five-year CAGR of 2.9%, assuming higher volumes processed by fewer doctors, we have lowered our EBITDA margin assumptions. Our revenue forecasts are based on average four-year pricing and volume growth of 1.9% and 1.6% from fiscal 2019, given Medicare Rebate Indexation and population growth assumptions. Nonetheless, given the slower ramp of GPs, we expect lower operating leverage will result in lower EBITDA margin compression. As such, we are lowering our fiscal 2018 EBITDA margin assumption for the division to 36% from 39% previously, and lowering our EBITDA five-year CAGR outlook to 1% from 5% previously. We now assume margins remain flat over the next five years, versus our previously targeted ramp-up of EBITDA margin to 42% by 2020, which assumed benefit from operating leverage through increasing the number of GPs and increasing component of the private billing fee business defraying the reliance on bulk billing in contract negotiations with GPs.

In the absence of more granular details, which we anticipate will be forthcoming in next week’s full-year result, we believe the lowered guidance points to ongoing challenges in the beleaguered medical centre division, which we assume continues to struggle with issues of recruitment and retention of GPs.