We cut our fair value estimate for narrow-moat Ramsay Health Care RHC by 9% to $62. Fiscal 2024 revenue from patient activity grew 7% in constant currency to $16.7 billion, in line with our expectations, driven by 3% volume growth, tariff uplifts, and new capacity. However, underlying earnings before interest and taxes (“EBIT”) of $1.034 billion was up a smaller 6%, and 9% below our forecast.

The result was dragged down by underlying EBIT in France falling 21%. The decline largely reflects lower government support that is significantly lagging cost inflation. While future earnings in France are supported by a 3.2% tariff increase from July 2024, indexation will be 0.6% in the UK, and, overall, wage growth is likely to outpace tariff indexation in Europe.

We decrease our midcycle EBIT margin forecast by roughly 50 basis points to 10%, with wage inflation having more of an impact than previously assumed. The UK government for instance has delivered a 10% increase to the minimum wage. We have also cut our revenue forecasts by an average 2% over the next five years. This was largely due to Ramsay returning the Peel Health Campus contract to the government in August 2024, which accounted for roughly 3% of fiscal 2024 Australian activity. In addition, Australia saw a decrease in volumes from public activity in private hospitals due to government budgetary constraints. Cost of living pressures are also resulting in patients avoiding out-of-pocket fees.

Nonetheless, shares are materially undervalued. We think the market has a myopic view of Ramsay’s profitability. Longer term, we expect margin expansion as activity trends in higher-margin work recover and staff availability increases. In addition, while margins are constrained by digital expenses near term, we see this driving cost efficiencies longer-term by optimizing staff levels and reducing administrative paperwork

Business strategy and outlook

Ramsay’s Australian business enabled its global acquisitions, but the market fundamentals offshore are far less attractive. The key differentiator is the proportion of private health insurance, or PHI, coverage of the population.

According to data from the Australian Prudential Regulation Authority, 45% of the Australian population have PHI resulting in roughly 80% of Ramsay’s Australian revenue flowing from PHI versus 20% or less in its other geographies. This has a direct impact on profits earned as providers are price-takers in publicly outsourced work.

Ramsay has been willing to divest, selling the German business in fiscal 2021, and we would support further exits in countries where the firm doesn’t have critical mass. Holding a large market share within regions provides negotiating power with payers and cost advantages from scale, but we think the benefits of being a global operator are limited due to varying regulatory regimes and most costs being staffing.

Despite pandemic pressures weighing on Ramsay, the firm is increasing its capital expenditure to better position itself for long-term growth. The key areas of investment are brownfield and greenfield expansions in Australia, and digital overseas. We are positive about the Australian development pipeline as it strengthens Ramsay’s cost advantages derived from scale, typically pays back in three to four years, and is low risk as demand in the area is already established. Ramsay is focusing on increasing its day surgery capacity as the proportion of day surgeries at Australian private hospitals has increased to roughly 65% from 60% in the last 10 years.

The firm also sees opportunity for integrated care and higher-margin nonsurgical ancillary services such as rehabilitation and mental health. Ramsay is also strategic by adding doctors’ consulting rooms to hospital sites which encourages higher usage of on-site operating theaters. Relationships with referring physicians is key and Ramsay is reliant on maintaining its reputation for quality of care and modern facilities. The focus on digitization in Europe is also strategic given synergies from integrating IT are relatively easy to capture.

Ramsey bulls say:

  • Ramsay is entrenched as the market share leader in Australia, which contributes the bulk of group earnings and remains an attractive market, given relatively stable participation in private health insurance.
  • Coronavirus pressures are largely temporary in nature, and Ramsay is well positioned once volumes and mix normalise.
  • Increased investment in the Australian development pipeline and digital overseas is strategically sound and strengthens Ramsay’s moat.

Ramsey bears say:

  • Elevated safety costs and staffing challenges are lingering with continued coronavirus surges.
  • Recovery in volume, particularly higher-margin nonsurgical services, is likely to be protracted given lower overall urgency and patient hesitancy.
  • Group ROICs including goodwill have significantly declined following European acquisitions and currently sit below the 7% weighted average cost of capital.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn more about how to identify companies with an economic moat, read this article by Mark LaMonica.