Shareholders of Capitol Health Ltd (ASX: CAJ) will hope FY17 can deliver a turnaround of fortunes after experiencing a one-way decline in share price for the best part of 15 months.

However, judging by the company’s latest set of financial results this is likely to be a difficult task for the medical diagnostic imaging company.

The results, which were released after the market close yesterday, revealed a sharp swing from profit the year earlier, to a $4.7 million net loss for FY16. Although it was a disappointing result, it was not entirely unexpected with the company previously announcing it had been suffering from weakening demand as a result of the Medicare Benefits Schedule review. Capitol Health was also smacked down after the Federal government announced budget cuts that would see rebates for the sector scrapped.

Interestingly, management has also blamed the negative ‘Mediscare’ campaign run by the federal Labor party during the extended election campaign as a contributing factor to reduced patient visits to its clinics.

While it could be argued that Capitol Health was hit with the perfect storm over the past 12 months, the result did highlight just how sensitive the company is to any changes in demand. Most of the company’s costs are fixed (such as rent and equipment), which means a reduction in patient visits cannot be offset by a reduction in costs. This is clearly demonstrated by the reduction in underlying EBITDA margins from 20% the year earlier, to 14.5% in FY16.

Capitol Health’s operating margins also came under pressure in FY16 as a result of ‘modality substitution’. This was caused by changes to referral patterns from healthcare professionals that resulted in a drift away from higher margin scans like CT and MRI, to lower margin tests such as ultrasound.

Overall, it was a pretty disappointing result from Capitol Health and one that places further pressure on the company’s already fragile balance sheet with net debt now standing at $88 million.

Outlook

Although the company tried to highlight some potentially positive developments, including a new partnership with Health Engine to boost market share through online bookings, it was overwhelmingly clear that investors should expect another tough year ahead.

Capital Health noted that the demand for diagnostic imaging continues to remain below historical averages and that margins are expected to remain under pressure thanks to ‘modality substitution’.

Is it a buy? 

After witnessing an 80% decline in the share price over the past 12 months, it would be tempting for investors to believe that the worst is over for Capitol Health, but I think the company needs to overcome a number of hurdles before it could be considered investment grade.

Until the company addresses these issues, including the strength of its balance sheet and the deterioration of operating margins, investors may be best served by looking for more attractive opportunities elsewhere.

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Motley Fool contributor Christopher Georges owns shares of Capitol Health Ltd. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.