Valuation Appeal

Despite widespread reporting of pressures on the private health system over the past couple of years, volume and funding growth have been resilient. The negative trends in health fund participation appear set to continue, but Ord Minnett believes robust membership levels of older members (aged 65-plus years) will ensure volume growth remains stable, in the 2-4% per annum range. Equally, we expect rates from insurers to broadly keep pace with health cost inflation.

 

The new health minister seems keen to pursue policy initiatives to support the sector, which, while unlikely to dramatically alter industry trends, should at least be helpful.

 

Against this backdrop, we have undertaken a detailed review of the issues faced by Healthscope and the industry in an effort to delineate the improvements and milestones required to see the group’s $1 billion-plus investment program deliver its promised earnings boost.

 

Healthscope faces another challenging year, with earnings set to contract as a number of Victorian hospitals track below plan and the new chief executive officer undertakes a portfolio review. We believe value has emerged, however, with the stock trading well below its 2014 initial public offering price despite adding more than $0.5 billion of new capacity.

 

We have upgraded our recommendation on Healthscope to Buy from Hold, with our target price unchanged at $2.00.

  • Operating environment – Consistent with the experience in FY17, our forecasts assume continued growth in private hospital activity despite the drop in fund membership, supported by the ageing insured population. We also foresee policy support from Canberra.
  • Project risk – We believe Healthscope’s higher-risk projects limit near-term earnings potential. A significant portion of the company’s large expansionary capital expansion program has been directed to projects that require a solid uplift in volumes and/or patient acuity to be viable – such as Holmesglen, Frankston and Northern Beaches. These projects diverge from the well-tested brownfield strategy, adding uncertainty to the earnings outlook in FY18 and FY19.
  • Balance sheet risk – We see balance sheet risk as manageable given solid underlying growth. Healthscope’s hospitals outside Victoria and Tasmania delivered about 7% operating earnings (EBITDA) growth in FY17, a clear indicator of the underlying strength of the division. Considering the reliability of hospital earnings, we do not believe the debt covenants are at risk unless there is an abrupt change in conditions.
  • $1.3bn investment in new capacity – Even allowing for some catch-up capital expenditure and the timing risk from quasi-greenfield projects, we are comfortable that Healthscope’s large investment will, in time, deliver on its modest return assumptions. This should support at least mid- to high-single-digit earnings growth.

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