Primary Health Care (PRY)
THE much-maligned medical centre and pathology group Primary Health Care has seen its shares fall 15 per cent since November last year. In the same period the Australian Health Care Index has been a star performer, notching up a gain of 15 per cent.
This 30 per cent underperformance can be sheeted back to a number of factors including low earnings growth, a lack of overseas exposure and a discount for management.
In recent weeks, though, sentiment towards the stock has started to turn. The share price has climbed 5 per cent, breaking a long downward trend. In recent years Primary has spent heavily on acquisitions and expanding its medical centre business. As a result, return on equity has plummeted to around 5 per cent, meaning the company does not earn its cost of capital. Not a great result for shareholders.
Now the company is reducing its capital expenditure program, returns could improve. Additionally, the medical centre business, the main driver of profits, seems to be enjoying better trading conditions.
If the company can produce cash, pay down debt and extract some earnings growth, its price to earnings ratio could expand two points from the current level of around 11 times. This would lift the share price to around $3.40.
Gold
I AM not a gold bug. Buying gold stocks is difficult because the underlying asset price does not depend on supply and demand. This does not mean you can't make money out of the precious metal, as evidenced by the 12-year bull run that has increased the price of bullion by about 500 per cent.
However, since August 2011 the bullion price has struggled, falling from a high of $US1900 an ounce to the current level of just over $US1600 an ounce. Interestingly, this has been an orderly decline and a highly unusual way to end a multi-year boom. Most bull-market tops are characterised by volatility and then a share decline. This alone suggests there may still be life in gold in a mature market.
On May 15 this year the price of bullion sunk to a low of $US1526 an ounce but has flicked up by about $US100 an ounce. Could this be the beginning of the next big leg-up in gold? This is difficult to work out at this stage, because if central banks around the world decide to get everyone a shot of extra liquidity then gold may just work its way higher, towards the inevitable end of a giant bull market.
What is even more intriguing is the fact that gold stocks peaked well ahead of the share price. In fact, gold company shares around the world are trading at their cheapest level, compared with the bullion price, in decades. Ideally, investors interested in gold should look back at gold stocks rather than bullion itself.
Furthermore, if the Australian dollar falls against the US dollar then the attractiveness of local gold stocks rise. However, the scenario of gold moving up and the Australian dollar moving down is rare and you should not hold your breath.
The Reject Shop (TRS)
IT IS hardly news that traditional shop-front retail businesses are struggling at the moment. The shy consumer and the onslaught of the internet has crippled top-line growth.
The discount variety chain, The Reject Shop, should be resilient in the face of these trends. The company concentrates on low-priced goods that are not easy targets for online retailers. However, these defensive qualities have not stopped the group's share price falling 28 per cent since mid-March compared with a 4 per cent fall in the benchmark All Ordinaries Index.
Analysts covering the stock have been winding back their earnings-per-share forecasts on the back of a deteriorating environment and a sagging Australian dollar. Adding to the company's woes is the stellar performance in recent times of Wesfarmers' Kmart, which competes with The Reject Shop in many areas.
The company is yet to comment, but at the current levels its shares are trading on a price-to-earnings ratio of 11 times 2013 financial year earnings. It is never wise to buy a company's shares if analysts are downgrading earnings, because no one is sure when that trend will end. However, The Reject Shop, with its defensive qualities, has a lot to offer prospective shareholders.
The company still has a major store rollout program to undertake over the next five years that should drive earnings. A retailer in this position can trade on a much higher PE ratio. The store rollout should be supportive as long as the management is able to buy quality stock and drive inventory turns.
It is worth watching this for the commentary at the next result and gauging if the outlook is healthy despite soft current earnings.
Frequently Asked Questions about this Article…
Why have Primary Health Care (PRY) shares underperformed the Australian Health Care Index?
Primary Health Care has underperformed because of a mix of factors highlighted in the article: low earnings growth, limited overseas exposure and a valuation discount related to management. Heavy spending on acquisitions and expanding its medical centre business has pushed return on equity down to about 5%, meaning the company hasn’t been earning its cost of capital. These issues help explain the roughly 30 percentage-point gap versus the Australian Health Care Index.
What does a return on equity (ROE) of around 5% mean for Primary Health Care investors?
An ROE near 5% suggests the company is generating low returns on shareholders’ funds and, as the article notes, is not earning its cost of capital. For investors that typically signals weak value creation. The article points out that Primary’s heavy spending on acquisitions drove this decline, and management’s plan to reduce capital expenditure could help lift returns if it leads to stronger cash generation and earnings.
Could Primary Health Care’s share price rise to about $3.40 as the article suggests?
The article presents a conditional scenario: if Primary Health Care can produce cash, pay down debt and generate earnings growth, its price-to-earnings (P/E) ratio might expand by two points from the current level of around 11 times. Under that assumption the share price could reach roughly $3.40. This is contingent on improved trading, debt reduction and visible earnings recovery—not a guarantee.
What recent signs of improvement are there for Primary Health Care?
Reportedly sentiment has started to turn: the share price climbed about 5%, breaking a long downward trend. Management is cutting back its capital expenditure program and the medical centre business—the main profit driver—appears to be enjoying better trading conditions. Those factors could help cash flow, reduce debt and potentially boost returns if sustained.
What is the article’s view on gold and gold stocks for investors?
The article is cautious about bullion but notes interesting dynamics: after a long bull run bullion fell from about US$1,900/oz to near US$1,600/oz, briefly dipping to US$1,526 before rebounding about US$100. Importantly, gold company shares peaked ahead of bullion and are trading cheaply relative to the bullion price compared with decades past. The article suggests investors interested in gold might look at gold stocks rather than bullion, while also noting currency moves (a weaker Australian dollar versus the US dollar) could make local gold stocks more attractive—although that scenario is described as rare.
Why has The Reject Shop (TRS) share price fallen and what are the main risks?
The Reject Shop’s share price has fallen about 28% since mid‑March as traditional shop‑front retail faces a shy consumer and online competition. Analysts have been cutting earnings‑per‑share forecasts because of the deteriorating retail environment and a sagging Australian dollar. Strong competition from Wesfarmers’ Kmart in overlapping categories also adds pressure. Those factors explain the share weakness despite TRS’s defensive low‑price positioning.
Does The Reject Shop have upside potential despite recent downgrades?
Yes, the article argues there’s potential: TRS still has a major store rollout program planned over the next five years that should drive earnings growth, and retailers in expansion phases can trade on higher P/E ratios. That upside depends on management’s ability to source quality stock and improve inventory turns. However, because analysts are downgrading earnings, investors should be cautious until the company demonstrates a healthier outlook.
What should everyday investors watch in upcoming results for Primary Health Care and The Reject Shop?
For Primary Health Care, watch commentary on capital expenditure cuts, cash generation, debt reduction and trading conditions in the medical centre business—these signal whether returns and earnings can improve. For The Reject Shop, look for management’s update on the store rollout, sales and margin trends, inventory turns and any guidance that addresses recent analyst downgrades. In both cases the companies’ outlook commentary on the next results will be key to assessing if the recovery case is real.
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