Even after a 45% plunge in its share price this year, I'm still not convinced Healthscope Ltd (ASX: HSO) is a standout buy.
My first concern is valuation, as the company has a price to earnings (P/E) ratio of 16x, which is around the market average. Second, Healthscope has an EV/EBITDA ratio (which accounts for debt) of 11x, which is above the average of around 8x. Given the lack of growth and a competitive market, I would want to buy the company at a discount.
Healthscope is not growing, with management forecasting flat EBITDA (earnings before interest, tax, depreciation and amortisation) in 2018, although the total number of beds available is expected to jump from ~5,000 to around 5,600 in 2019, a 12% increase. In my view the company is probably fairly valued.
However:
Industry dynamics also play a role in a company's success, and from my perspective Healthscope looks as though it is vulnerable to market pressure from insurers like Medibank Private Ltd (ASX: MPL) and Bupa, who can exert pressure on Healthscope to adjust its billing processes etc. For example, in some circumstances if a patient has to be re-admitted after being discharged from a hospital, the hospital has to wear the costs of readmission, not the insurer or the patient.
Overall this type of market power effectively puts a cap on Healthscope's profitability. The only way it can grow is either by building or buying new hospitals, which is expensive and debt-intensive, or by cutting costs. However, given that Healthscope's main expenses are employees and medical supplies, there is only so much that it can trim without affecting its service quality.
This means that the only way that Healthscope can grow is by growing revenues, either through new hospitals or through higher demand for services. With moderate organic growth in the healthcare market, expansion via new hospitals, and a 4% dividend, Healthscope should be a respectable performer over the long term.
However, I wouldn't call it a standout opportunity, which is why I am not a buyer today.
