The RBA is forecast to cut interest rates by 50 basis points in the next year. This would reduce interest rates to 1% and mean that the return on cash balances will be even lower than it is today. Therefore, dividend-paying shares could become increasingly popular among investors. Although Ramsay Health Care Limited (ASX: RHC) yields 1.6% versus 4.2% for the S&P/ASX 200 (Index: ^AXJO) (ASX:XJO), I believe that it has a bright future as an income stock.
Dividend affordability
Ramsay's current dividend is highly affordable. In financial year 2016 it paid out 54% of earnings as a dividend. Further, free cash flow covered dividend payments 1.7 times. This shows that Ramsay is able to invest in its future growth through high levels of capital expenditure while also increasing dividends.
The stability and consistency of Ramsay's earnings mean that it could afford to pay a higher proportion of profit as a dividend without increasing its risk profile. The private hospital sector enjoys a high level of earnings visibility. It also has high barriers to entry and an oligopolistic market structure. This reduces the level of competition among incumbents and makes a higher dividend payout ratio more sustainable in the long run.
Dividend increases
Ramsay's dividends are set to be positively catalysed by its rising earnings. The healthcare sector is forecast to benefit from increased demand from an ageing population. Over the next 50 years, the number of people in Australia aged 65 or over is expected to increase from 3.4 million to 9.6 million. It's a similar story in other developed nations such as the UK and France, where Ramsay also has operations. This should provide Ramsay with consistently growing demand for its services which could boost dividends.
A brownfield investment programme means that Ramsay's size and scale will increase over the medium term. In the 2016 financial year Ramsay completed over $300 million in brownfield capacity expansions. This should allow Ramsay to strengthen its competitive position within the Australian private hospital market. Its leverage with private insurance companies should improve as a result over the medium term.
Ramsay has also announced plans to establish a network of pharmacies. This provides a new growth space for the company. It should benefit from cross-selling opportunities among existing patients. Due to its sound financial standing, Ramsay should still be able to afford to engage in M&A activity. A weaker Euro and Sterling provide additional opportunities in Europe for Ramsay to consolidate its dominant position.
Outlook
Ramsay has increased dividends per share at an annualised rate of 17% in the last decade. Given the affordability of its dividends and its bright earnings growth prospects, a similar rate of growth is achievable in the long run.
Its dividends are forecast to rise by 15.1% per annum during the next two years. This puts it on a forward yield of 2%. This is lower than the yields of popular income shares such as Telstra Corporation Ltd (ASX: TLS) and Westpac Banking Corp (WBC). They yield 6.2% and 6.1% respectively. However, in my view Ramsay has the potential to become an appealing income stock in the long run due to its dividend coverage and earnings growth potential.
