I'd much prefer to own shares in Fisher & Paykel Healthcare Corp Ltd (ASX: FPH) than Healthscope Ltd (ASX: HSO) at today's prices. That's even though Fisher & Paykel appears more expensive, with a Price to Earnings (P/E) ratio of ~38 compared to Healthscope's ~22.
Here's why I prefer Fisher and Paykel:
- It's got a better business
Although it's a manufacturer, Fisher & Paykel's business is less capital intensive and has a greater opportunity relative to Healthscope. Fisher & Paykel can more easily create new product lines and open new markets to itself, as well as take market share from incumbents.
- It earns much better returns on its investments
Fisher & Paykel's products are protected by patent and manufacturing can be outsourced to cheaper nations (Mexico), overall enabling the company to earn significantly higher operating profit margins than Healthscope, even with heavy research & development expenditure.
- It has a better balance sheet
Fisher & Paykel has no net debt and a management target of, on average, a 0% gearing position. Healthscope by contrast has $1.5 billion in debt, which eats up a meaningful part of its earnings each year. This is due to Healthscope investing heavily in expansion, but even so on balance I prefer Fisher & Paykel's balance sheet.
- It has a greater ability to grow earnings
Healthscope grows primarily by either a) building more hospitals, b) healthcare demand growing, c) charging patients more for services, and/or d) reducing costs. Building more hospitals is expensive and time-consuming, healthcare demand only grows at a nominal amount per annum, it is difficult to charge customers more, because the customers are typically big insurers like Medibank Private Ltd (ASX: MPL), and it's also difficult to reduce costs much without harming treatment quality.
Fisher & Paykel on the other hand, has clear growth opportunities including shifting manufacturing to Mexico and growing demand for its consumable devices.
In one sense, it may be unfair to compare a device manufacturer to a hospital operator as they are totally different businesses. However, investors need to make these types of comparisons in order to determine which businesses they should own. Speaking for myself, I'd much prefer to buy Fisher & Paykel Healthcare today.
