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The private hospital diagnosis this results season was as unpleasant as this year’s flu season.
Since result day, Healthscope (ASX: HSO) has plummeted 25 per cent down to $1.68 and Ramsay Health Care (ASX: RHC) 19 per cent to $63.84. Roger Montgomery previously discussed some of the risks we had identified into the results in this June blog. Into the results we felt that both hospital operators were trading at stretched valuations and as a result reduced our positions. Following the share-price correction, we remain comfortable with our remaining holdings.
To begin we wish to make clear that we view both Ramsay and Healthscope as strong quality companies with competitive advantages and exposure to well supported growth dynamics. Private hospitals play a critical role in Australia – they make up 33 per cent of Australian hospital care by beds, 40 per cent by number of patients, 59 per cent of surgeries, and 70 per cent of rehab.
The prescription for these services increases with an aging population – and Australia has one heavily supported by the baby boomers. We note the proportion of people aged over 65 years old has increased to 15.3 per cent (from 12 per cent) in the last decade and only the first 5 years of baby boomers have reached this maturity.
It is this 65+ age group that accounts for the lion’s share of medical claims:
It is for this reason that we have seen increased hospital demand which in turn has driven strong top-line growth for both RHC and HSO. In fact – this (together with high healthcare inflation and a positive mix shift) has led to consistent high single digit top-line growth for both RHC and HSO:
But what went wrong? Why was growth stunted this year? What’s changed?
To answer this question we need to consider where the profits come from – ie. Who is actually paying. 70 per cent of private hospital funding comes from health insurers (the remainder includes Government, Department of Veteran Affairs and Medicare payments). This relies on private health insurance take-up, which has experienced consistent decline. Providers find themselves competing more for switching patients than those that are new-to-market:
Whilst on the positive side, hospital treatment coverage appears to have stabilised at around the 47 per cent mark;
This misdiagnoses the truth because more people are moving to policies with higher excess and exclusionary policies. This leads to higher out-of-pockets from using the Private health system – unpleasant on top of your already steepening private health insurance fees.
Now whilst this trend has been going on for a while, in 2017 it began to come through more in the data. We saw more private patients in public hospitals (avoiding gap payments), and this volume leakage was exacerbated with some seasonally lower healthcare volume. A dire prognosis for a highly fixed cost business such as a hospital. Even worse for one which had recently expanded its capacity significantly (HSO has had a more recent pipeline of both greenfield and brownfield projects).
We could see weak volumes from lower usage of private hospitals, and a cyclically lower use of health services this year. This pressured the top-line – particularly for the newer hospitals that HSO had recently opened, and further compressed margins from fixed costs. Whilst we trimmed our position for these risks, the result surprised the market and we saw a significant share-price correction.
Now at less stretched valuations, we see a more favourable diagnosis for the private hospitals. We continue to see strong demographical support for health services. Whilst we continue to see signs of private patients in public hospitals – there is a tipping point at which waiting lists become too long and the government must inevitably intervene to lower pressure on the stretched public system. In terms of lower surgical volumes experienced in 2017, we see this as cyclical and that it is unlikely patients put off procedures ad infinitum. We remain happy long term owners of both companies.
The Montgomery Fund and the Montgomery Private Fund own shares in both Ramsay Healthcare and Healthscope.
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