Ramsay Health Care Limited (ASX: RHC) is one of the most expensive healthcare stocks on the ASX when measured by price-to-earnings ratio (PER). Ramsay currently trades on a trailing PER of nearly 37, and a forward PER of around 31. This compares with a trailing PER of 26 for CSL Limited (ASX: CSL) and around 19 for ResMed Inc (ASX: RMD), however there are a few very good reasons why Ramsay trades at such as premium.
1. Perfect investment timing during the GFC
In what hindsight will see as perfect timing, Ramsay used the GFC period to invest heavily in growing space and facilities at its many major metropolitan hospitals. Development costs were low, compared to today's standards, and have resulted in Ramsay holding a monopoly of the private hospital market in many metropolitan and regional areas. Ramsay-owned hospitals now have more than 10,000 available beds, which makes Ramsay the largest private hospital owner in Australia.
2. Pricing power over insurance companies
Being the biggest hospital operator means that costs are lowered due to efficiencies of scale, and also gives Ramsay bargaining power over private insurance companies. Owning the largest and most popular hospitals gives Ramsay the negotiating power over insurance companies, whose customers could be excluded if Ramsay's fees are not accepted. There could be a limit to fee increases in the future, but at this stage Ramsay has found a nice balance between maintaining customers and growing earnings.
3. A stable, but growing market
Importantly, the private health insurance market is growing. The Australian government offers incentives, such as rebates and a reduction in the Medicare levy for individuals who take out private health insurance. This is aimed at reducing the cost to the government of caring for the elderly in the coming years and has resulted in a 48% participation rate in private health cover. The ageing Australian population should increase demand for Ramsay's services, while government incentives will also increase the proportion of young Australians with private health cover.
Foolish takeaway – Expensive but worth it!
There's no doubt Ramsay appears expensive. There's a possibility that government legislation or increased public infrastructure spending on hospitals could reduce Ramsay's strong growth profile in the years to come, however I believe this is unlikely. More likely is that Ramsay's monopoly of many regional and metropolitan areas is maintained and private health spending increases over time, leading to improved earnings and margins. Investors with a long-term investing horizon should consider Ramsay as part of a diversified portfolio.
