A strong performing resident of our model portfolio, Ramsay Health Care (RHC) is one of the world’s leading private hospital operators, with operations across six countries and over 3 million admissions annually. Founded in Australia, management have their eyes set on continuing an overseas expansion, to replicate its successful local model to other countries where private health care is prominent. In our view, such traits make RHC one of the ASX’s highest quality and most consistent value generators.

Figure 1. RHC v S&P ASX200
Source: Company data, Credit Suisse estimates
Under the Valuation tab on the StocksInValue Dashboard as pictured below, is a chart exhibiting RHC’s historic and future normalised return on equity (NROE), comprising both distributed and reinvested earnings. Here you can see the NROE for RHC has consistently been above 30% in years past, with forecasts pointing to a sustained rate over 35% for FY17 and FY18.

Figure 2. RHC Historic and Future Performance (click image to enlarge)
Source: StocksInValue
Its current share price is between our FY17 and FY18 valuations of $63.62 and $72.94 respectively. As a result we believe that while RHC is not cheap based on most traditional metrics or relative measures, it is fair value intrinsically.
Because of the business’s great reputation and robust corporate governance policies, a low required return of 10.3% has been assigned to reflect our minimum return that would justify investing in the business. Though RHC’s RR is low, it would be lower still if not for the risk factor associated with its high net debt to equity ratio of ~160%. Though we prefer more conservative gearing, it should be noted that RHC’s low equity base inflates this number.

Figure 3. Business Risk & Financial Health
Source: StocksInValue

The risks for RHC are apparent across all operators in the sector. Most prominent is the possibility that negotiated increases in funding from health funds are insufficient for meeting the growing operating costs such as nursing – in wake of wage growth. Furthermore, the industry is very susceptible to shifts in government policy. In Australia, despite campaigns for affordability reform, the recent federal budget had a largely neutral effect.
Also pleasing is RHC’s strong cash flow conversion rates as indicated when looking at operating cash flows compared with net profit in the financial summary below. This indicates that RHC is able to generate good cash returns from its investments. It also shows that RHC’s accounting policies are not overly aggressive in terms of revenue recognition, depreciation and leasing agreements. We always look for good cash flow conversion because it gives us confidence that the ROE we are adopting is supported by cash earnings.

Figure 4. RHC Financial Summary
Source: StocksInValue
Going forward, there are a broad range of supportive macro tailwinds positioning RHC well for the future. The strongest of which is the favourable demographic shift of the growing and ageing population. This is in conjunction with the burgeoning expectation for public hospitals to meet rising demand, which will see a requirement to outsource beds.

Clime Asset Management owns shares in RHC.