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Morningstar | Ramsay Health Care’s FVE Maintained at AUD 65.00 as 1H Result Meets Expectations

Narrow-moat Ramsay Health Care’s first-half result was in line with both our expectations and management guidance. We maintain our earnings forecasts and AUD 65.00 fair value estimate. The share price has risen 16% over the past four months, and at the current price of AUD 64.64, the stock is now fairly valued. The price and fair value imply a fiscal 2020 P/E ratio of 21 and dividend yield of 2.4%, or 3.5% including franking credits. We consider the dividend sustainable due to the defensive nature of the business. Although Ramsay is expanding its overseas operations, we expect the dividend to remain fully-franked for the foreseeable future due to the magnitude of the franking balance.

Although first-half revenue and EBITDA increased by 15% and 10%, respectively, growth was significantly boosted by the acquisition of Capio. Without Capio, revenue and EBITDA grew by 8% and 7%, respectively, driven by a relatively strong performance from the core Australian business. Management continues to expect recently acquired Swedish hospital operator Capio to be EPS-accretive within two to three years and maintains fiscal 2019 EPS growth guidance of “up to 2%”, and EBITDA growth of between 10% and 12%. All of these expectations are broadly consistent with our forecasts.

Ramsay’s Australian business comprises 68% of first-half group EBITDA and performed relatively well in a tough environment. Revenue growth of 5% was broadly in line with our full-year forecast of 6%, while EBITDA growth of 6% was slightly above our 4% full-year forecast. Despite an uncertain legislative outlook and falling private healthcare affordability, Ramsay grew admissions and market share thanks to the quality of its hospital portfolio. Longer term, we continue to believe the business is well placed to benefit from population growth and an ageing population. We expect the division to fall to about 60% of group EBITDA by fiscal 2021 following the integration of Capio.

The performance of Ramsay’s French business, which comprises 27% of first-half group EBITDA, was skewed by the AUD 1.9 billion acquisition of Capio with revenue and EBITDA growing by 26% and 19%, respectively. But excluding the Capio acquisition, revenue and EBITDA growth were 3% and 5%, respectively. It’s also worth remembering that Ramsay only owns 51% of its French business meaning the "look-through" contribution of the division is less than the headline figures indicate.

Capio appears to be performing broadly in line with our expectations, although the business only contributed earnings for seven weeks in the first half. Management claims December is typically a weak month for Capio and that the business has been disrupted by the acquisition and weakness within its relatively small German business. This means we are reluctant to draw too many conclusions from Capio’s first-half earnings. However, we still think the acquisition makes strategic sense, giving access to new markets while adding modest scale to Ramsay’s existing operations in France. Capio will diversify regulatory and business risk as it operates in the Nordic countries (Sweden, Denmark, Norway, France, and Germany). Aside from Capio, Ramsay’s French business performed satisfactorily, with modest revenue growth and margin expansion in an uncertain regulatory environment.

Ramsay’s U.K. business, which comprises about 6% of group EBITDA, struggled with volumes in the first quarter but recovered in the second. Management expects the recovery to continue in the second half of fiscal 2019. The business also benefited from a change in accounting policy, though on a like-for-like and constant currency basis revenue grew by 1.6%.

From a balance sheet perspective, Ramsay is in reasonable shape, but we caution the company remains vulnerable to a deterioration in earnings given sizable operating lease obligations. Net debt was AUD 5.4 billion as at Dec. 31, 2018 on a fully consolidated basis, which implies a stretched net debt/EBITDA ratio of 3.2, but a manageable EBIT to interest coverage of 7. However, on a "look through" basis, which excludes nonrecourse debt within the 51%-owned French business, the net debt/EBITDA ratio falls to 2.1, which we think is manageable particularly considering the defensive nature of the group. Considering much of the debt does not mature until 2022, we don’t believe the group faces a material near-term refinancing risk at this stage.