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Ramsay Health Care forecasts double-digit profit growth – is the stock a buy?

Private hospital operator Ramsay Health Care (ASX: RHC), which owns and manages hospitals and day surgeries across Australia, the UK, France and Indonesia has held its Annual General Meeting today at which it reaffirmed its guidance for double-digit growth in profits.

With 121 hospitals in five countries that in total admit around 1.3 million patients per year, Ramsay is a large player in the private hospital space. The firm recorded revenue growth of 5.5% to $4.2 billion and 15.1% growth in core net profit after tax (NPAT) to $291 million in financial year (FY) 2013.

On a per share basis, core earnings per share increased 17.1% to 135.9 cents per share and the dividend was raised 17.4% to 70.5 cps.

Ramsay’s impressive growth profile has helped its share price rocket nearly 58% higher in the past year; in comparison the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) is up 22% over the same period. This has resulted in the stock currently trading on a trailing price-to-core earnings ratio of 27.7 times. This is a hefty multiple and is only justified if the outlook is for particularly strong earnings growth in future years. As such Ramsay’s earnings guidance needs to be watched closely.

Contained in the company’s outlook statement was confirmation that guidance for core NPAT and core EPS growth of between 12% and 14% in the FY 2014 was still expected to be achieved with “strong industry fundamentals and continuing implementation” of Ramsay’s successful growth strategy continuing into the current year.

The question now for shareholders and investors is whether Ramsay’s share price has run ahead of its valuation. Its outlook statement combined with its current PE multiple would appear to suggest it has.

Compared with its peer group of multinational health sector stocks, Ramsay’s high pricing isn’t alone. Plasma products manufacturer CSL (ASX: CSL) trades on a PE of roughly 28 times and is expecting NPAT to grow at approximately 10% this financial year. Meanwhile Sonic Healthcare (ASX: SHL) which provides medical diagnostic services is currently trading on a PE multiple of 19 times and has provided guidance for growth in earnings before interest, tax, depreciation and amortisation of 5% holding currency constant.

Foolish takeaway

A trap for investors is that with the market having moved to multi-year highs, it can blur what is a reasonable price to pay for an investment. One way for investors to avoid this potential pitfall is to focus on historical long-term averages which can help provide a context in which to compare the current market.

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Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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