Why the Capitol Health Ltd share price has been savaged

Capitol Health Ltd (ASX: CAJ) saw its share price tumble 18.6% to 24 cents today after the company reported that government changes to Medicare rebates for diagnostic imaging could impact revenues by between 4% and 7% in the 2017 financial year (FY17).

The diagnostics imaging company has seen its share price lose 72% of its value since the start of this year, compared to the S&P/ASX 300 (Index: ^AXKO) (ASX: XKO) fall of just 7%.

It seems investors were non-plussed by the company’s acquisitions of Southern Radiology, Eastern Radiology Services and Sydney Radiology earlier in the year and then Liverpool Diagnostics in August, firstly expanding into NSW from Capitol’s home state of Victoria and then acquiring additional NSW diagnostic imaging centres.

Regulatory uncertainty acted as the largest drag on the share price after the government announced a review of the Medical Benefits Scheme (MBS) on April 22, 2015, and Capitol’s share price began sliding from there. The review outcomes aren’t expected to be announced until next year.

However, it was the federal government’s announcement yesterday that it was going to strip around $639 million over four years from bulk-billing incentives, including aligning diagnostic imaging incentives with those that apply to GPs and cutting the incentive for Magnetic Resonance Imaging (MRI) services from 15% to 10%, that caused today’s tumble.

Capitol recently reported that the uncertainty caused by the review had impacted revenue expectations in the four months to October by between 4% and 6% while underlying earnings per share (EPS) was down 31%, compared to the previous corresponding period. Some of the fall in EPS is due to the issue of around 90 million new shares in December 2014 and February 2015, taking the share count from 431 million shares to 522 million shares.

Capitol also receives the majority of its revenues from bulk-billed services, so is more at risk when governments make cuts to funding. Integral Diagnostics Ltd (ASX: IDX), by comparison, only receives around 50% of its revenues from bulk-billed services – but it too saw its share price hammered down 7% today.

Much depends on the outcomes of the MBS review, but some analysts believe that patients will be the ones that feel the pain, as imaging companies seek to make up the revenue falls by introducing co-payments for patients, and cutting expenses by closing unprofitable centres, and/or decreasing services to rural and regional areas.

It could also see more consolidation in the sector as smaller operators – unable to cope with the cuts – are forced to sell out or close up shop.

Foolish takeaway

Cuts to government funding are a never-ending, constant risk for medical services providers, particularly as our ageing population depends on higher and higher government funding. But it pays for investors to remember that companies like Capitol Health are there to make a profit for their shareholders and grow those profits over time, regardless of the government risk. I expect diagnostic imaging providers to find new and perhaps different ways of achieving their goals, whether

I expect diagnostic imaging providers to find new and perhaps different ways of achieving their goals, whether that’s by acquisition of operators unable to cope with cuts, slashing their own expenses, improving processes through the use of technology, or by asking patients to put their hands in their own pockets.

Discover the 'new breed' of blue chips...

Forget BHP and Woolworths. These 3 "new breed" top blue chips for 2016 pay fully franked dividends and offer the very real prospect of significant capital appreciation. Click here to learn more.

The report is free! No credit card required.

Motley Fool writer/analyst Mike King owns shares in Capitol Health. You can follow Mike on Twitter @TMFKinga

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. 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.

Two New Stock Picks Every Month!

Not to alarm you, but you’re about to miss a very important event! Chief Investment Advisor Scott Phillips and his team at Motley Fool Share Advisor are about to reveal their latest official stock recommendation. The premium “buy alert” will be unveiled to members and you can be among the first to act on the tip.

Don’t let this opportunity pass you by – this is your chance to get in early!

Simply enter your email now to find out how you can get instant access.

By clicking this button, you agree to our Terms of Service and Privacy Policy. We will use your email address only to keep you informed about updates to our website and about other products and services we think might interest you. You can unsubscribe from Take Stock at anytime. Please refer to our Financial Services Guide (FSG) for more information.