After debuting at $2.10 in August 2014, shares in Healthscope Ltd (ASX: HSO) rose as high as $3 last year before a number of factors outside of shareholder control buffeted confidence in the company.
First were the conspicuous downgrades from Dick Smith Holdings Ltd (ASX: DSH), and Spotless Group Holdings Ltd (ASX: SPO), which were relatively recent private equity companies launched on the ASX. As another recent private equity Initial Public Offering (IPO), Healthscope may have been fairly or unfairly tarred by fears that the same would happen to it.
Something that possibly also weighed on the share price was the government's recently announced cuts to diagnostic imaging services as well as its ongoing review into waste in the healthcare system. Fortunately Healthscope sold its Australian pathology division in June last year and is unlikely to be immediately affected by these cuts.
At its most recent report, the full year results in August 2015, Healthscope posted a 4.8% increase in revenue and an 8.7% increase in Operating Earnings Before Interest, Tax, Depreciation and Amortisation (EBITDA). Healthscope delivered a $140m profit compared to a loss of $183m in 2014.
Margins rose during this time, especially in hospitals and international pathology, while gearing was 29%, excluding the benefit of the Australian Pathology division sale.
The outlook
Healthscope has several expansions and new facilities under construction, and the company is expected to add north of 900 beds and 50 theatres by the end of 2018. Management announced 'further improvement is expected in 2016' without expanding on that statement.
While hospitals and theatres are attractive to investors because of their perceived defensiveness, the cash generation of these facilities depends on their utilisation rates, which in turn partly depends on the level of private health cover. According to the Australian Bureau of Statistics (ABS), private health cover rose from 52.7% of the population to 57.1% between 2007 and 2012 (more recent statistics were not available).
The government is increasingly trying to shift individuals into the private health system to reduce the public healthcare burden. However, anecdotal reports indicate the cost of health insurance is becoming prohibitive recently, which could result in movements in the other direction.
Additionally, recent media reports quoting health insurers have implied that the cost of some procedures in private hospitals is unreasonable, which could result in pressure on margins if these complaints are followed through on.
Well, should I buy it?
Healthscope has an attractive, long term business that has several tailwinds in the form of an ageing population as well as increasing private hospital utilisation. While it carries debt, it remains well funded to carry out its expansion plans, especially after the recent sale of its Australian Pathology division. On the downside, there are regulatory and pricing risks associated with the government investigation into healthcare spending. Healthscope is also vulnerable to pressure from its major customers, health insurers like Medibank Private Ltd (ASX: MPL) and Bupa.
Trading on a Price to Earnings (P/E) ratio of 27 times last year's Net Profit After Tax (or 22 times pro-forma Net Profit After Tax), Healthscope appears to be priced for more growth than the 8.7% increase in EBITDA it reported. The company is expecting to grow its total number of beds by 20% or more by the end of 2018.
Based on these facts, Healthscope appears likely to deliver growing earnings to shareholders over the next few years, although I would not call it a bargain today.
