A con­sis­tent earner with de­fen­sive qual­i­ties

Finweek English Edition - - PRO PICK - BY SUMESH CHETTY AND CLYDE ROS­SOUW, Port­fo­lio Man­agers, In­vestec As­set Man­age­ment

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


12 000

10 000

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.

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