Invest in health, but don’t overpay

SHARE prices of listed hospital stocks have dropped about 10% on average this month, begging the question whether now is the time to invest in a sector where the big three companies have at least doubled their market value over the past five years.

In the past month, Mediclinic has dropped 15.3%, Life Healthcare is down 10.6% and Netcare has lost 6.7% .

But over five years, Life Healthcare has jumped 170% to a market cap of R38-billion, and Netcare has surged 188% to R58-billion. Mediclinic has been the biggest gainer, more than tripling in value to R92.7-billion, but analysts will point out that it has had a number of rights issues so some of the growth represents additional capital provided by shareholders.

Andre Bekker, an equity analyst at Avior Capital Markets, said as an investment category, one should not look at the priceearnings ratio relative to the South African market, but rather compare the top three with global hospital operators. One should compare Mediclinic with established first-world hospital owners “and then see how expensive those are”.

“The same goes for Life Healthcare. It’s an emerging market player so compare it with Indian hospital operators. That being said, Indian operators are growing much faster.”

He said the local business might not be shooting the lights out, but hospitals were defensive stocks, and South African top-line growth for the stocks was in high single digits.

“Healthcare is a good space to be in, but it depends on which geographies,” Bekker said. “Netcare UK is in a very painful situation with a struggling private insured market. However, Netcare is managing to grow operationally despite weak top-line growth.”

Are these stocks a feasible investment at this price?

“It depends on the investment horizon. If you are looking for a growth story, maybe it’s not the place to be. But if you think about your portfolio as a whole, you need to have exposure to these kind of defensive stocks because in an economic downturn they still tend to make good money.”

For hospital stocks, the key has long been the balance between the fairly inelastic need of South Africans for private hospital cover given the poor delivery on the public side — countered by the constant threat of regulation by the government, which is set to gain momentum with the current Competition Commission inquiry into healthcare costs.

Reuben Beelders, a portfolio manager at Gryphon Asset Management, said of the three, Netcare was the biggest operator in South Africa and most likely to derive efficiencies. But all healthcare stocks, whether pharmaceuticals or hospitals, were subject to regulations and “as an investor I’m always cautious when government has the freedom to impose regulation on a sector, like healthcare and education”.

The problem was overpaying, he said. The price-earnings ratios of the listed hospital stocks had come down, with Life Healthcare and Mediclinic both on ratios of 21 and Netcare on 23, but he cautioned investors against expecting quick returns on businesses that had made big investments recently, such as Life Healthcare’s injection into Max Healthcare in India.

“I do believe these investments in new territories take a lot longer than people realise [to generate returns].”

Offshore expansion has been a priority for the big three for several years, and although Netcare moved offshore first with a 50.1% stake in the UK’s General Healthcare Group, it is Mediclinic that has become more of an overseas play.

In 2006, Mediclinic set up operations in the United Arab Emirates (UAE) and then in Switzerland, where its Hirslanden unit makes it the largest private hospital group.

Mediclinic’s financial results for the year to March, released this month, show that Switzerland provided 53% of revenue, and the UAE 12%. The rest is derived from South Africa. In terms of profitability, exactly half is generated from Switzerland, 13% from the UAE and 37% from South Africa.

While Mediclinic has targeted more developed markets, Life Healthcare has been pursuing emerging markets, where private healthcare is in its infancy. It entered India through a joint venture in 2012, and last year invested in Poland.

When Life Healthcare released its interim results this month, its share price fell 6% on the day — to levels last seen in March last year. It reported a 3% drop in diluted headline earnings a share to 80.1c. The fall in profit was attributed to increased funding costs for international acquisitions.

Netcare, in results also released this month, said it continued to explore further investment opportunities offshore. It expected the weakness in the South African economy to persist, but foresaw the demand for private healthcare locally would remain resilient. Netcare reported that adjusted headline earnings a share jumped 19.6% to 90.8c for the six months to March.

The South African operations remain a cornerstone for all three groups. Growth in the medical aid population is fairly stagnant, but the Government Employees Medical Scheme has brought a larger proportion of users into private hospital cover. With an ageing population, stays are more frequent and longer. The three groups collectively are working on adding close to 1 000 new hospital beds this year.