A consistent earner with defensive qualities
The JSE has been trading at stubbornly high levels since the start of the year, even amid uncertain economic conditions. This has prompted us to limit our exposure to equities, favouring those shares that predominantly generate their earnings offshore.
Mediclinic is one such a share that is in the top 10 holdings of the Investec Opportunity Fund. The hospital group is a high-quality company that has successfully diversified geographically – it now earns 50% of its prof its in Switzerland, 20% in the United Arab Emirates (UAE), with the rest coming f rom South Africa. In t his way it provides an appropriate rand hedge to a deteriorating local economy.
We particularly like the defensive nature of the business and the fact that it can provide consistent earnings and strong cash f lows. Mediclinic focuses on the upper end of the care spectrum, and derives its earnings from people who are prepared to pay for the best healthcare.
There is strong demand for highquality hospital care, driven in part by ageing populations and an increasing disease burden worldwide. Just in SA, in the past f ive years we have seen a significant increase in the number of cases of chronic conditions in the medical aid population. The prevalence of HIV/ Aids has increased by 164%, while diabetes and arthritis have gone up by 68% and 54% respectively, according to the Council for Medical Schemes.
The c ompany ha s g e ner a t e d exceptional returns over a number of years. In the year before its most recent set of results, it delivered a return of approximately 70%. Its most recent set of results were weaker than the market, resulting in a pullback in the share price. The business suffered from short-term headwinds due to high start-up costs for new hospitals in SA and the UAE, medical practitioner tariff adjustments in Switzerland and higher growth in the lower-margin basic insured patients in Switzerland.
However, we do not believe the recent performance has changed the long-term earnings fundamentals of the business. In SA and Switzerland, hospital occupancy continues to rise, even as more hospital beds are added. Medical cases have been growing faster than surgical cases, which has driven up the length of stay in hospitals.
Notwithstanding the start-up costs of the business in the UAE, margins are still strong and it remains an attractive market. Demand for healthcare is
8 000 running ahead of supply and hospital occupancy rates are now ahead of SA and Switzerland.
There are some risks to the business in that it is exposed to government regulation and nursing shortages. Locally, there is also the risk of a Competition Commission inquiry into hospitals, which may result in lower pricing, but may also have positive outcomes for volume growth.
The business may be trading on a free cash-f low yield of 3%, but this is primarily a result of the recent increase in capital expenditure. Importantly, management has delivered a consistent track record of being able to generate high returns on this expenditure, and has been able to grow cash f low at a compound annual growth rate of 16% for the past decade. We expect cash f low to receive an additional boost from a lower cost of capital in Switzerland off the back of lower interest rates. The priceto-earnings multiple may appear high, but it is trading on a discount to global peers. Importantly, this is a business that provides more downside protection and consistency than the market, with more certainty with regard to its growth.
We believe the most recent share price weakness represents a buying opportunity for investors currently not owning the stock.