Ramsay Health Care Limited's (ASX: RHC) yield of 1.5% lacks appeal at face value.
It is lower than the ASX's yield of 4.3%, as well as popular income stocks such as Westpac Banking Corp (ASX: WBC) and Commonwealth Bank of Australia (ASX: CBA). They yield 6% and 5.4% respectively.
However, Ramsay's dividend growth potential is significant for these three reasons. Due to their effect, it could become one of the ASX's best income stocks.
Strategy
Ramsay's strategy is expected to deliver earnings per share (EPS) growth of 21.7% per annum over the next two years. A key part of its growth strategy is international expansion. It sees potential for further acquisitions in France due to the healthcare industry undergoing a period of consolidation. As the biggest private hospital operator in France, Ramsay is in a strong position to make asset purchases. Further, weaker sterling improves the prospects for M&A activity in the UK.
Ramsay's brownfield development programme delivered $126 million worth of new developments in the first half of financial year 2016. This included 186 beds and 8 operating theatres. It expects to open 400 beds and 12 theatres before the end of the first half of FY 2017. Its brownfield development programme also provides the latest technology to existing assets to give Ramsay a competitive edge over its rivals.
Business model
Dividends represented 76% of free cash flow in FY 2015. This is despite an increase in capital expenditure of 98% versus FY 2014. Ramsay's relatively stable and resilient business model means that the dividend payout ratio (as a percentage of free cash flow) could increase without sacrificing Ramsay's sound financial standing.
Its net gearing of 155% is relatively high, but debt interest payments were covered 6.1 times by operating profit in FY 2015. Further, Ramsay's consolidated leverage ratio of 2.7 times is within its internal parameters.
Outlook
Ramsay has benefitted from an ageing population which is living longer. Chronic diseases have risen, while technological improvements and population growth have created growth opportunities within the private hospital sector. Those trends are showing no sign of slowing and Ramsay is well-placed to capitalise on them through its dominant position in multiple developed economies.
Sterling and the Euro are forecast to weaken versus the Aussie dollar due to their looser monetary policies. This could provide a currency translation boost to Ramsay's earnings. This positive short term and long term outlook, as well as its sound strategy and successful business model mean that Ramsay's dividend Is set to rise over the next decade following its 17.3% annualised rise over the last ten years. Therefore, while its yield is low, Ramsay could become a top income stock in the long run.
