The last three months have been extremely kind to investors in Ramsay Health Care Limited (ASX: RHC), with the private hospital operator rising by 15% during the period. This even eclipses health care sector peer CSL Limited's (ASX: CSL) 10% gain during the same time period.
However, investors may worry that a fall is on the cards since Ramsay trades on a P/E ratio of 30 versus 17 for the ASX and 21 for the healthcare equipment and services sector.
Further, Ramsay's balance sheet is also heavily leveraged. Although interest rates are in a downward trend, Ramsay's net debt to equity ratio stood at 166% as at 31 December 2015. This could cause concern among investors who are already nervous regarding the outlook for the ASX and wider economy. And with Ramsay deriving 39% of its sales from France as well as around 9% from the UK, the potential challenges in Europe could cause Ramsay's financial outlook to come under pressure.
In addition, Ramsay's foray into China did not go as planned. The company withdrew rather abruptly from its joint venture in Chengdu and while there may be good reasons for this, a potential growth path for the company now seems to be less clear.
China is a major market for healthcare already and is set to become even more so. As such, Ramsay not having a foothold there may cause its valuation to come under pressure as investors become less bullish.
However, on the flip side Ramsay has expansion potential in existing markets. For example, it has an active M&A programme as well as development potential on brownfield sites.
The company's pipeline over the next year contains around 400 beds as well as 12 theatres and due to Ramsay having strong cash flow, acquisitions are on the cards while its debt level seems to be comfortable given its robust performance. For example, Ramsay's free cash flow has averaged $288 million over the last two years, with interest cover being healthy at 6.1 times last year.
This strong cash flow is being partially used to fund rapid dividend growth. Although Ramsay currently yields just 1.6% versus 4.3% for the ASX, dividends paid increased by 18.8% last year. With them making up 76% of free cash flow last year, there is scope for further rises. Sure, Ramsay may not be able to compete with dividend stalwarts such as Telstra Corporation Ltd (ASX: TLS) just yet, but in time it could become a strong income play.
However, perhaps the biggest reason why Ramsay's recent share price gains could continue is the demographic tailwind which it is set to enjoy. The combination of a rising population (the world's population is forecast to be a third higher by 2050), an increasing life expectancy and an ageing population mean that demand for Ramsay's services is set to rise.
With Ramsay being well positioned to take advantage of this through its 226 hospitals in five territories, it is well placed to continue to record index-beating share price growth.
