Primary Health Care provides services to medical and health professionals through its medical centres, as well as pathology and diagnostic imaging services.
The medical centre division receives most investor attention, but accounts for only about 17% of group earnings before interest and tax and its anticipated recovery is likely still a year or so away. Meanwhile, diagnostic imaging has become an increasingly attractive segment with robust demand growth, stable funding and moderating costs, and now accounts for about 18% of earnings.
We expect double-digit earnings growth for Primary in FY19 and FY20, supported mainly by solid growth from the diagnostics division and operating leverage as group debt stabilises. This has led us to upgrade our recommendation on Primary to Accumulate from Hold and raise our target price to $4.30 from $3.50, based on our discounted cash flow valuation, allowing for the $100m of strategic initiatives the company will book below the line.
- Pathology – Primary’s pathology business now accounts for two-thirds of earnings, up from 50% in FY14 when medical centres accounted for a much larger share. Solid growth, moderating collection centre costs and stable funding should support industry-wide margin expansion. Primary’s operations will be affected by the loss of the National Bowel Cancer screening contract and potentially higher wages following the Dorevitch Pathology industrial action in August 2017, but we are confident it will report solid mid- to single-digit growth.
- Diagnostic imaging – Primary’s imaging division accounts for 15% of earnings, up from 13% in FY14. Newly opened centres will be a drag, but the strong Medicare data and the recent acquisition of Brisbane Private Imaging should ensure earnings continue to expand.
- Medical centre rebuild – In the medical centre business, we expect the appointment of a respected and experienced management team will allow a rapid improvement in GP recruitment. However, realisation of the $1m of earnings per centre goal is likely some years off.
- Strategic initiative – We remain cautious of Primary’s treatment of its multi-year $100m-plus ‘strategic initiative’ expenditure, but we are comfortable the investment can be accommodated without causing a material lift in net debt.
- Funding risk – At this stage, we have made no explicit allowance for future government funding cuts, given their inherent uncertainty. However, moderating top-line growth forecasts and minimal margin expansion in our outer-year estimates reflect our expectation that funding reforms are highly likely, especially for pathology.