Why Primary Health Care Limited shares could be cheap

Primary Health Care Limited (ASX:PRY) pays a great dividend and could provide significant upside.

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The combination of market volatility and a disappointing annual report has led to Primary Health Care Limited (ASX: PRY) losing half its value in the last 12 months. At this price it now means that the company is paying out an estimated forward dividend yielding 6.1%.

This 6.1% dividend puts its 140 basis points ahead of the market average and more than double the current Health Care Equipment & Services sector average of 3.2%.

The disappointment that led to the shares plummeting stemmed from the company posting under consensus earnings thanks in part to subdued patient volumes brought about by a mild cold and flu season in comparison with a year previous. Furthermore, the whole industry took a hit in December, when the government proposed changes to bulk billing incentives for a number of healthcare services.

Analysts now expect earnings per share to drop year-over-year from 52.4 cents per share to 21.6 cents per share for the full year. I believe this drop has been priced in by the market now, hence why the shares are trading at a price-to-earnings ratio of just 7 currently.

To compare the shares fairly against its peers, Ramsay Health Care Limited (ASX: RHC) and Sonic Healthcare Limited (ASX: SHL), you have to look ahead and use their forward price-to-earnings ratio. The results of which I believe reveal the potential of significant upside for Primary Health shareholders.

Currently Primary Health Care shares trade at a forward price-to-earnings ratio of 11.4, whereas Ramsay Health Care and Sonic Healthcare trade at 25 and 17 times forward earnings, respectively. Looking at the entire sector as a whole shows that it is trading at 24.5 times forward earnings. It is worth noting also that the current price-to-book ratio is just 0.5, which could indicate that the shares are undervalued at the moment.

I feel that earnings have now found their bottom and we should begin to see mid-single digit earnings growth for the next few years. The share price could start to take-off to a similar forward price-to-earnings ratio as Sonic Healthcare if the news is positive when the company reports its interim results in the middle of February. Of course it is worth considering the consequence of earnings coming in lower. Despite the low levels it is trading at, it can still go lower, and almost certainly would do should full-year earnings be downgraded.

Foolish takeaway

I believe the above average dividend and the potential for significant share price gains makes Primary Health Care a great investment prospect in 2016.

Motley Fool contributor James Mickleboro has no position in any stocks mentioned. 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.

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