About: Ramsay Health Care owns, operates, and manages health care facilities throughout Australia, Indonesia, and Europe. It’s the largest private hospital operator in Australia and the fifth in the world. Following the acquisition of Capio, a Swedish/Norwegian/French hospital operator, in October 2018, revenue for the European division (57%) has overtaken the Australian one.

Why it is in the portfolio: Ramsay is the quintessential 'quality' stock in what has been a growth industry for many years. It has managed to grow earnings by more than 20% year in and year out and, with a well diversified and managed global portfolio of hospitals, there is little reason to suggest it can't carry on doing so. Its real estate portfolio of hospital buildings represents a strong competitive advantage. Given their location, construction cost and required permits, these assets are hard to replace. Another trend that favours Ramsay is that the number of public hospitals in Australia has been in decline for over a decade, compensated by a rise in private hospitals, and the public sector increasingly outsources services to private hospitals. . Furthermore, overall growth will most likely still be underpinned by favourable demographics while disruptive technologies could further bolster productivity in the sector. Over the longer term, hospitals should provide a hedge against a structural rise in inflation.

Fundamentals: From a portfolio perspective we have invested in Ramsay Healthcare and Sonic at the expense of some of the more expensive national champions such as Resmed or Cochlear which seem expensive and are potentially more vulnerable to market or product specific setbacks. Ramsay’s multiples have eased in the past few years and are now far from the heights of 27x to 32x forward earnings reached in 2015 and 2016. The market already forecasts somewhat slower earnings growth in the future and any surprise to the upside is likely to be rewarded. The current forward P/E of 23x, is slightly below its long term average of 24x and compares favourably to the 27x multiple at which Healthscope, RHC’s closest local competitor, was acquired in February 2019. Ramsay trades at around 6.6x price-to-book and currently offers around a 3% gross dividend yield with a 52% payout ratio. Ramsay’s debt-to-assets sits at 42%,

What could go wrong: The utility like stability of hospital earnings has attracted yield starved defensive investors and made this stock somewhat interest rate sensitive so it may underperform for a while in a rising interest rate environment. Stocks like Ramsay tend to be quite highly leveraged and this is even more the case following the Capio acquisition, which was funded mostly by debt. Although this company is by no means financially stressed, high levels of debt are worth keeping an eye on. The issue of insurance affordability and declining rates of private health insurance participation may constitute headwinds to earnings growth. This issue will also weigh on another risk: re-negotiation of contracts with large private health insurers, which in this context may limit Ramsay’s ability to raise prices. The government’s promise to invest an additional $1.2 billion in public hospitals over the next four years, although modest, may reduce the quality of service gap with private hospitals, reducing demand for the latter. Looking forward, public sector cost cutting might provide further headwinds and it will probably become more difficult for even the best operators to eke out further gains through operational efficiency and scale alone. The biggest risk though maybe if the stock were to disappoint for a while and lose its quality 'halo', resulting in a likely de-rating.