Healthcare stocks have become increasingly popular in 2016. Over the year Healthscope Ltd (ASX: HSO), Ramsay Health Care Limited (ASX: RHC), and Cochlear Limited (ASX: COH) have outperformed the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO). The ASX has risen by 3%, while Healthscope is up 14%, Ramsay is 17% higher and Cochlear has gained 47% year-to-date. In my view, Healthscope has the potential to record significantly greater returns for these three reasons.

Ageing population

Healthscope’s financial performance is set to be boosted by a demographic tailwind. For example, the proportion of the Australian population aged over the age of 65 is forecast to double to 25% over the next 40 years. Rising life expectancy and a lower birth rate are the main causes of this. A higher number of people aged 65 or over is likely to mean a higher demand for healthcare. That’s because chronic conditions and illnesses are usually more prevalent in that age group than in younger age groups.

This provides Healthscope with a growing market for its services. It is well positioned to capitalise on this since it has substantial scale as one of Australia’s largest private hospital providers. This should allow it to negotiate successfully with private health insurers on areas such as level of claims and the range of services covered for reimbursement. Further, Healthscope has a number of Tier 1 hospital assets in major cities. This should provide high demand for its services as well as greater bargaining power with private health insurers.

Financial standing

In financial year 2016 Healthscope strengthened its balance sheet. This was done through the refinancing of its existing debt facilities. It increased Healthscope’s total debt facilities to $2.2 billion and extended the maturity profile out to 10 years. Its current debt levels indicate that Healthscope’s balance sheet could accommodate more debt to fund growth opportunities. For example, it has a net debt to equity ratio of 54%. Further, Healthscope’s interest payments were covered 6.7 times by operating profit in the 2016 financial year.

Healthscope’s financial strength provides it with the flexibility to invest for growth. For example, it invested $440 million in growth projects in financial year 2016. This included nine major hospital expansion developments. Healthscope has either approved or started constructing projects which are due to deliver 833 beds and 53 theatres by the end of financial year 2019. Its long term pipeline includes the Gold Coast Private and John Fawkner Private. They could positively catalyse Healthscope’s long term earnings growth.

Outlook

Healthscope has a P/E ratio of 26.4. This may seem high while the ASX has a P/E ratio of 17.4. However, healthcare peers Ramsay and CSL Limited (ASX: CSL) have P/E ratios of 34.4 and 31.7 respectively, while Cochlear’s P/E ratio is 40.5. Therefore, Healthscope’s valuation could be viewed as low relative to its sector peers. Alongside its sound finances and the growth potential from an ageing population, Healthscope’s valuation indicates that it could rise in value.

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Motley Fool contributor Robert Stephens has no position in any stocks mentioned. 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.