Ramsay Health Care: Result 2014

Its hospitals glisten. Waiting lists are almost non-existent. You’re entitled to complimentary massages and mud-baths – even the taxi ride to the clinic is free. With so many benefits, the French medical system has long been the envy of the world. But it’s going broke.

And that matters because Australia’s largest private hospital operator, Ramsay Health Care, is just weeks away from becoming the largest operator in France too.

The company’s French outfit, Ramsay Santé, acquired a controlling interest in Générale de Santé in June (see Ramsay to triple French presence … again from 13 May 14 (Sell – $46.59)). Générale de Santé operates 75 hospitals, employs 19,000 people, and the company has revenue of around €1.7bn. It's a big fish, even for Ramsay: the fifth largest hospital operator in the world.

This is Ramsay’s fifth major French acquisition since 2010 and, following the merger, Ramsay Santé will operate 15% of France’s commercial hospitals. However, the deal will only be finalised in late September so it won’t show up in Ramsay’s financial results until 2015. When it does, the French division will contribute more than a third of total revenue.

Even without Générale de Santé, Ramsay released an impressive result for its 50th year in operation. After excluding acquisition costs and other one-off expenses, underlying earnings before interest and tax (EBIT) increased 20% to $580m on revenue that rose 18% to $4.9bn, mainly due to strong admission growth in Australia and smaller French acquisitions (see Ramsay doubles French presence from 2 Dec 13 (Sell – $38.80)). The company made an underlying net profit of $346m, up 19%, while earnings per share rose 21% to $1.64.

Vive la France

France has the largest commercial hospital sector in Europe – and one of the least efficient. Patients pay upfront but France’s universal healthcare coverage ensures virtually all the money is reimbursed. As they’re never out of pocket, they have an incentive to visit the doc for even the slightest bump or tingle. For instance, the French have almost three times as many MRI scans per capita compared to Australia and French mothers stay in hospital for an average of 4.2 days after giving birth; in Australia, the average is just 2.7.

All that extra demand should be a boon for Ramsay, except that the government imposes equal pricing for public and private operators and doesn’t restrict a patient’s choice of provider. Commercial hospitals in France must compete against the private not-for-profit and public hospitals which make up about 60% of local operators.

This puts more pressure on Ramsay to be efficient and prudent in managing costs. Générale de Santé had an operating margin of 12% in 2013, well below the 16% Ramsay makes in Australia. The company has a good history of margin improvement due to its centralised purchasing of medical supplies (putting a little more pressure on suppliers with each acquisition) and operating leverage due to large fixed costs. But we expect it to be more difficult than usual to improve French margins.

Regulatory risk

We also have some concerns with regulation. The private health insurance industry is very small in France, accounting for 13% of healthcare funding compared to 49% in Australia. Overwhelmingly, it’s the government that pays the bills. However, the French healthcare budget ran a $5bn deficit in 2013.

Other countries are facing similar pressure from healthcare spending and are addressing the issue in different ways – we could see downward pressure on regulated price increases, as in Australia; a shift to greater private health insurance coverage, as in America; or higher taxes, as in Russia.

It’s hard to know what the French will do, but it’s clear its current medical system is unsustainable which raises the risk of adverse government reform.

Valuation

The iron law of investing is that every stock is a claim on a future stream of cash flows, and the return an investor gets depends on the value of that stream of cash relative to the price paid for it.

Ramsay is a high-quality company that has grown quickly through acquisitions. However, its share price has risen 47% over the past 12 months and 14% since Ramsay to triple French presence … again from 13 May 14 (Sell – $46.59). It now has an enterprise value of 21 times EBIT and a price-earnings ratio of 32.

Management expects earnings per share to grow by 14–16% in 2015 and we’re increasing our price guide to reflect the growing business. However, the current share price leaves no margin of safety and we continue to recommend you SELL.