Netcare in need of stronger domestic economy
FOR MANY years, Netcare was a star performer of the JSE, until April 2015, when it reached a high of just more than R42. From there it was a downward trend, almost halving in mid-December 2017 at R22. It won the prize for the third worst-performing top 40 stock on the JSE last year.
Netcare ranks on the list of South African companies impressing shareholders with foreign deals, but unfortunately ending up as a bust. Like MediClinic and Life Healthcare, Netcare fell victim to the dream of global success.
What else? In South Africa they ran out of runway, plagued by nervousness and lack of confidence in the future.
It was an accepted fact by most South Africans that the rand would continue on its downward path and earnings had to be externalised (as quickly as possible).
Extensive network Netcare operates the most extensive network of private hospitals in South Africa and the UK, comprising 54 facilities in South Africa and 57 in Britain.
The most significant sources of the company’s revenue are its private hospital base, which includes hospitals, day clinics and specialised medical facilities.
Among others, it comprises oncology centres; cardiac units, including cardiac catheterisation laboratories and electrophysiology laboratories; renal dialysis units; organ transplant units; and emergency departments with trauma units.
In South Africa, the company also operates the largest pre-hospital emergency medical services and primary healthcare networks. South Africa contributes 56 percent of revenue and the UK 44 percent.
BMI Healthcare, National Renal Care, Medicross Medical Centre and Prime Health Cure all belong to the Netcare Group.
The company reported dire results for the first half-year in May 2017. Revenue declined 10 percent, and headline earnings per share dropped 12 percent.
The second half and full-year results brought even more disappointments. BMI Healthcare, Netcare’s majority-owned UK business, made an operating loss of £20.6 million (R336.4m) for the year to September, mainly due to “demand management initiatives” by private medical insurers and the cash-strapped National Health Service.
Restructure Netcare announced plans to restructure its UK business after buying out minority shareholders. Management said they want to go through a very comprehensive and well-thought-out restructuring programme and want to be in a position to re-establish the operating base.
They want to be able to implement their own enterprise-wide IT systems that they are accustomed to in South Africa – which will take at least three years. They also plan to move specific back-office functions from the UK to South Africa.
Netcare seems to have bungled its UK foray, and in 2017 was forced to write off close to R6 billion against BMI Healthcare.
For a start, it has rerated considerably since the 2015 high.
After a disappointing year for domestic volumes in the healthcare sector, trading updates indicate a modest recovery in paid patient days (PPD).
A stronger local economy is also likely to be a tailwind for volumes as higher employment should drive the growth in medical aid memberships.
We feel Netcare’s share offers value at R25, trading at a forward price/earnings multiple of below 15 times. This represents a 6 percent discount to its long-term price/ earnings average, and a 9 percent discount to its local peers, while earnings are off a depressed base.
The share price is supported by an attractive historic 3.7 percent dividend yield.
Despite the group’s local operations facing pressure from funders and regulatory risk, it seems as if the worst of these risks are priced into the share price.
Material recovery The group’s UK operations remains a concern. However, our current valuation does not capture much value for the UK operations. A material recovery in this operations will likely provide further upside to our valuation.
Management has indicated that the group will not invest more money in the UK unless a rent reduction transaction – which will be beneficial to all parties – can be reached.
High demand for the group’s healthcare services in both its geographies is expected to increase.
The increase is due to a higher disease burden, particularly in South Africa, combined with an ageing population in the UK.
The group has a well-balanced portfolio of healthcare businesses.
It operates in a defensive industry which traditionally leads to high operating margins and returns on equity.
Morgenrood is PSG Wealth regional director.