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Morningstar | Ramsay Posts In-Line Results but Fiscal 2019 Outlook Guidance Disappoints; Shares Oversold

Narrow-moat Ramsay Health Care posted full-year results in line with recent guidance provided in June but outlined a softer fiscal 2019 than we forecast. Net profit of AUD 579.3 million on revenue of AUD 9.2 billion, up 6.8% and 5.4%, respectively, tracked our expectations. The final fully franked DPS of AUD 86.5 cents took total dividends for the year to AUD 1.44 per share, fully franked, representing an increase of 7% and equating to 51.5% payout of adjusted EPS. The key driver of the result was the Australian division, representing 54% of group revenue, which grew at a more subdued 5.5% on the prior corresponding period compared with historical averages of around 7%-8%. In contrast, the 12.1% improvement in EBITDA to AUD 896 million led to a divisional EBITDA margin of 18%, up 106 basis points, which is evidence of improved operational efficiencies.

Nonetheless, we were disappointed by management’s fiscal 2019 guidance of EPS growth of up to 2% in fiscal 2019, citing slower growth in Australia due to softer volumes, ongoing challenges in the United Kingdom, and a neutral outlook in France. This sharply trails our prior outlook for double-digit earnings gains, and after incorporating management’s guidance, primarily in the Australian division, including revised guidance of the procurement initiative, we reduce our fair value estimate by 7% to AUD 76 per share from AUD 82 previously.

The stock is trading at a significant discount to our valuation and closer to our bear-case fair value estimate of AUD 54. We think this reflects the market’s more bearish view on further declines in private health insurance participation rates, in addition to the risk of premium increases being capped at 2% for the private health insurers in the event of a change of political leadership, given comments by the Labor Party to date. Our bear-case assumptions have volumes and pricing declines of 1% and 2%, respectively, resulting in a 3% decline of growth per year, leading to a five-year revenue CAGR of around 4.5% in the Australian hospital division. But with this risk priced in, we contend that shares have priced in a suitable margin of safety.

With respect to the rollout of the Ramsay Pharmacy franchise network, our assumptions are unchanged. In our base case, we assume 62 total pharmacies for fiscal 2019, growing to around 79 by 2023, generating an average of about AUD 3 million. As such, our five-year revenue CAGR stands at 9%.

We have reduced our growth outlook in the United Kingdom, given challenges to NHS admission created through the implementation of demand management strategies and guidelines around elective-care services on the part of the government. With potential disruption of Brexit adding to the government’s budgetary woes, we now expect growth to remain flat over the next five years, versus our previous five-year revenue CAGR of 1%.
Operations in France, accounting for 38% of group revenue in the period, delivered a flat performance in both revenue and EBITDAR levels, in line with expectations, given a negative tariff environment that the company expects to continue to fiscal 2019. As such, we still forecast modest top-line growth of around 1% beyond fiscal 2019, reflecting underlying volume growth broadly in line with the general population. We remain positive on management’s plan to centralise noncore hospital functions, such as finance, administration, and HR, into a national service centre outside of Paris over the next three years, and we expect this (along with significant reduction in headcount over three years, commencing this half) to generate annual savings of EUR 5 million once fully implemented and expand EBITDA margins in France to around 12.2% ongoing from 12% currently.

Ramsay's balance sheet remains robust, with AUD 770.6 million in cash on hand as at June 30, 2018. Cash flow from operations was a solid AUD 995 million, compared with AUD 882 million in the prior corresponding period. Net debt/EBITDA edged up to 2.3 times from 2.2 previously but remains at healthy gearing levels. We forecast net debt/EBITDA for fiscal 2019 at 2.00 times, trending down to 1.60 by fiscal 2021, given solid cash from operations. As such, we remain comfortable with Ramsay’s capacity to fund its development pipeline of brownfield capacity expansion projects and dividends at the current payout rate.