Ramsay & Healthscope: Interim results 2016

Australia's largest private hospital operator, Ramsay Health Care, just got a whole lot larger. The company has reported a 25% increase in revenue to $4.2bn for the six months to December, mainly due to strong admission growth in Australia, the lower Aussie dollar and acquisitions in France.

After excluding non-cash rent on its UK hospitals, the company's underlying earnings before interest, tax, depreciation and amortisation (EBITDA) increased 19% to $607m, while earnings per share rose 18% to $1.08.

The Australian business, in particular, had a strong half with revenue up 7.4% at $2.2bn (52% of the total), mainly due to strong admissions growth as an ageing population boosts hospital occupancy rates, as well as some recent expansion projects.

'We are continuing to expand our facilities to meet demand and, to this end, we have completed $126 million worth of new developments so far this financial year,' said Ramsay's chief executive Christopher Rex.

Ramsay's strong revenue growth is significant as it was ahead of overall industry growth of 4.5% as well as Ramsay's largest competitor, Healthscope, which increased revenue at its hospitals by 4.5% to $981m. Healthscope said that capacity constraints at key hospitals put a cap on admission growth.

While Ramsay is increasing its market share relative to Healthscope – and is already nearly twice its size – we don't expect that trend to continue for much longer. Healthscope has some $600m worth of 'brownfield' projects in the pipeline to increase capacity at existing hospitals. These are expected to add 980 new beds and 50 theatres to Healthscope's 4,400 bed network between now and 2018.

This compares favourably with Ramsay's smaller pipeline of developments so we expect Healthscope to have increased its market share at Ramsay's expense by completion (see Will the aging population rejuvenate Healthscope?).

Overseas operations

Healthscope's New Zealand pathology business had a good half with revenue increasing 21% to $106m and EBIT up 23% to $18m. The company has recently built a new laboratory in Wellington and began servicing the region in July.

Turning to Ramsay, the company's UK and French operations performed well, with operating earnings increasing 9% to £17m and 17% to €53m respectively.

In December, Ramsay's French business – Ramsay Générale de Santé – acquired the HPM group of nine hospitals, bringing the total number of Ramsay facilities in France to 124. France now accounts for more than a third of Ramsay's total revenue.

However, 'we maintain our interest in Asia and the opportunities that this region presents, and are continuing to progress several prospects there,' said management.

In November, the company's Malaysian business –  Ramsay Sime Darby – penned a new agreement for a joint venture with Jinan University Hospital in China. The company intends to 'establish a number of high quality international hospitals in China's Pearl River Delta,' which has a population of more than 100 million.

Financial details of the deal weren't given, but the Chinese Government wants to expand the private hospital sector significantly in coming years and the recent China-Australia free trade agreement means Ramsay now has to ability to own hospitals outright in the country. We won't be surprised if China shows up more and more in Ramsay's presentations. 

Regulatory reviews

Several Government reviews of the public and private health system are currently underway due to growing concerns around affordability and efficiency. These include the Medicare Benefits Schedule Review, Primary Health Care Review, Private Health Insurance Consultation and Reform of the Federation. Findings will be released at various points during the year.

'Rising demand for health care is a key issue for all the markets in which we operate and so government reviews and investigating new modes of health care delivery will be part of the vernacular for the foreseeable future. However, whatever measures are put in place, demand for health care will continue to rise due in most part to unchangeable demographic factors,' said Christopher Rex.

That may be true, but the reviews still pose a risk in the medium term. As we explained in health insurer NIB's recent result, virtually all of a hospital's services are charged on an 'activity' basis – that is, they're paid for the number of surgeries and tests performed, days admitted etc. This acts as a subtle financial incentive to increase volumes, even where the patient derives little benefit.

We won't dive into the murky waters of trying to pin down exactly what proportion of Ramsay and Healthscope's earnings are derived from 'unnecessary' care. But, in any case, these regulatory reviews aim to remove it, possibly by shifting to a 'value-based' payment model focused on patient outcomes.

This could ultimately lead to reduced utilisation rates at the hospitals, which would act as an anchor on revenue growth in the immediate future, before growth eventually stabilises and the aging population tailwind kicks in again.  

We aren't overly concerned by the reveiws. Above all, the Government wants – needs – more people to use the private health system, and that will favour Ramsay and Healthscope more than almost any other companies. But the reviews could cause some hiccups over the next few years, and the companies' current share prices leave little room for error. 

Ramsay's management expects underlying earnings per share to grow 15–17% in 2016. With economies of scale, strong management and a well-executed growth strategy, Ramsay is a high-quality company. We're increasing the price guide slightly to reflect the growing business but with a fully franked dividend yield of just 1.7%, there's no margin of safety. SELL

Healthscope has many of Ramsay's attributes, though is arguably slightly more risky due to most of its earnings being exposed to the Government healthcare reviews. Still, with decent growth prospects and a yield of 3.1% we're happy to HOLD.