Ramsay Health Care Limited (ASX: RHC) is the largest private hospital operator in Australia and one of the top five hospital companies in the world. It has a presence in the UK, France, Indonesia and Malaysia.
A top company
Ramsay Health Care is an exceptional business for the following reasons
- Aging populations across the world ensure that demand for its hospitals can only grow over the coming decades.
- It has pricing power over its customers, insurers and governments, which often have no alternative but to use Ramsay's services.
- The company is now reaching a scale whereby it can negotiate heavy discounts with suppliers through centralised procurement.
- Demand for its services is strong through all economic cycles.
- Its hospitals enjoy a monopoly, because it makes no sense to build another nearby if the local population is already fully serviced.
- Buying and building hospitals is very expensive and this is a major deterrent to other companies looking to enter the market.
Unfortunately, identifying the best companies is only half of the job of an investor. The other part is buying them at a price which is less than what they are worth.
Is there any value?
I use enterprise value (EV) rather than market capitalisation when valuing companies because it adjusts for debt levels. Assuming that Ramsay records a 20% increase in net profit after tax (NPAT) this year, it is trading on an EV/NPAT of over 40 times. To put this another way, it is trading on an earnings yield of less than 2.5%.
Investors should demand a higher return when buying stocks than what is available in term deposits because unlike term deposits, stocks are not risk free. With the current low interest rate environment, the best term deposits are paying just 4%, but these are unprecedented times and rates will eventually rise. As an investor with a longer term time horizon, I use 6% as my risk free benchmark when valuing stocks and Ramsay Healthcare falls a long way short.
It could be argued that it is safe to buy a growing business like Ramsay Health Care at an earnings yield that is lower than the risk-free rate. This is because if earnings grow as expected, in a couple of years, its earnings yield will be much higher based on today's price. However this is not something I would recommend for the following reasons.
- Nobody can predict a company's future earnings with any precision. This is why management teams only provide guidance for the next year and not for multiple years ahead. Even then they are often wrong, despite the fact that they should know their company better than anyone else.
- In a couple of years, the economy may be booming again with interest rates much higher than they are today.
In other words, there is no margin of safety buying Ramsay Healthcare at current prices. Investors may wish to investigate Healthscope Ltd (ASX: HSO) and Pulse Health Limited (ASX: PSG), as they are also ASX-listed private hospital companies that may be available at more reasonable prices.
Just because Ramsay Healthcare looks fully valued currently, its share price may continue to rise. I would fully expect this if everything goes according to plan, the problem is nobody knows if it will.
