The 3.5 per cent relief rally in Ramsay Health Care shares on the day of the AGM, Thursday last week, will and should reassure shareholders. Preceding days had seen a selloff to as low as $64.39 as the market priced in a downgrade to Ramsay’s 2018 earnings guidance after the insurance regulator APRA reported the number of people with private health insurance fell 17,000 in the September quarter following a decline of 10,000 in the June quarter. Growth in private hospital admissions had already slowed to low single-digit. Ramsay’s guidance, issued with the 2017 result in August, was for 8-10 per cent earnings per share growth in 2018 but some investors must have expected a downgrade to the lower end of this range as the lower number of insureds pressures admissions and surgery volumes. The stock was already out of favour after the guidance issued with the result fell short of the 11 per cent growth the market forecast for 2018. Short selling interest in the stock has risen.
The reiteration of the guidance at the AGM means it was appropriately conservative in the current soft environment for admissions, which is a product of minimal wages growth, household indebtedness, pressure on household disposable income – and our dysfunctional federation. Where possible cash-strapped Australians are deferring elective surgery in private hospitals to avoid the expensive and sometimes unpredictable gap between the total cost and the health fund benefit, while public hospitals are competing for private patients to shift costs from state governments and their underfunded public health systems to private health funds and the Commonwealth.
The 2018 outlook is also difficult in the UK and France, which contributed around a third of 2017 earnings. The public health systems in these countries have progressively cut the ‘tariffs’, or rates paid to private hospitals for particular procedures, in return for greater volumes of outsourced work. An undersupply of nurses in the UK is inflating Ramsay’s costs there while uncertainty remains in France about the new Macron Administration’s policy towards public funding of private healthcare. Ramsay’s European earnings will only be flat in 2017-18 before resuming incremental growth in 2018-19 after the UK’s National Health Service increases tariffs in April 2018.
But we think the market – as it tends to – is focusing on short-term problems at the expense of longer-term accelerating growth. The timing of the wave of greater demand for hospital care from the ageing of the baby boomer cohort remains 2020 onwards but forecasts for the increase in demand continue to be upgraded.
In expecting a guidance downgrade the market also possibly missed the significance of the procurement cost savings Ramsay is extracting from suppliers as it grows. The group is already one of the world’s five largest operators of private hospitals. These savings, operating leverage and new revenue from brownfields expansion (capacity additions to existing hospitals) are why Ramsay is able to grow at high-single digit in 2018 when industry volume growth in Australia is low single-digit and European earnings are flat.
There is another reason to like Ramsay – a very sad one but one the market possibly does not yet appreciate, as we have seen no sell-side research on the matter. Ramsay is Australia’s largest private provider of mental health services, with 25 facilities and 900 beds. Every Australian family would know someone who has suffered mental illness and the matter has become more prominent in the public health debate over the last 10 years. The need for more mental health services is further underlined by a disturbing statistic we heard last week: amongst Australian women under 30 accessing private healthcare, there are now more annual admissions to mental hospitals than to wards for pregnancy and childbirth. This partly reflects the increasing average age at which women give birth but is mainly due to the incidence of mental illness in young people and better diagnosis and referrals.
Ramsay likes the mental health sector and wants to do more. This year it opened a new facility on the Gold Coast to address the shortfall of services there. Under the government’s reforms to private health insurance last month, patients with limited mental health cover will be able to upgrade their cover to access in-hospital mental health services without serving a waiting period. All the trends point to increasing demand for mental health services – where Ramsay is positioning itself.
The simplification of private health policies under the reforms, and the discounts for insureds under the age of 30, should restore some coverage. The surge in private patients in public hospitals is unsustainable because it inflates public waiting lists and private premiums. It will be addressed in the next National Health Agreement.
We think the disappointments and share price volatility of recent months will turn out to be a long-term buying opportunity. Our model portfolio trimmed its position in Ramsay in June after the stock ran up to $75, above our estimate of value around $72. In September, after the result and guidance disappointed, we rebuilt the position as low as $61.20. We still think the stock is worth $72 in 2018 rising to $82 in 2019.
Originally published in The Australian, Tuesday 21st November 2017.