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Hospital stocks like Ramsay Health Care Limited (ASX:RHC) face a new risk in FY19

The share prices of our revered hospital stocks have been under pressure as their earnings growth profile is under a cloud but this pressure could get worse following a report on the ABC last night alleging these companies are receiving “kickbacks”.

Shares in Ramsay Health Care Limited Fully Paid Ord. Shrs (ASX: RHC) and Healthscope Ltd (ASX: HSO) have underperformed the market with the former collapsing 27% over the past year while Healthscope is 1.3% in the red.

The only reason why Healthscope is faring much better is due to a takeover bid, otherwise I have little doubt it would be nursing much bigger losses.

In contrast, the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index has rallied 8% over the period and other stocks in the healthcare sector like CSL Limited (ASX: CSL), Cochlear Limited (ASX: COH) and RESMED/IDR UNRESTR (ASX: RMD), or ResMed, have been among the strongest performers on the market in FY18.

Hospital operators are struggling due to the fall in private patients, lower private health insurance coverage and allegations of overcharging in the industry.

Now a new battle front has opened up with the national broadcaster reporting that Ramsay and Healthscope are receiving big “kickbacks” from pacemaker manufacturers to use their devices in patients.

Kickbacks are illegal under Australian consumer law but the industry has defended the claims by calling the cash private hospitals receive as “rebates”. One man’s rebate is another man’s kickback.

Perhaps more damning is that these kickbacks, I mean rebates, sometimes total 40% to 50% of the cost of the device! To be clear, it is not suggested that all rebates are this big but the ABC is alleging that some are and that could add up to a lot of cash given that some pacemakers cost patients (or their insurers) up to $40,000.

The ABC estimates that there are around 120,000 to 240,000 Australians with pacemakers and the private hospitals have issued statements saying that they are acting ethically and there is nothing to look at here.

But this is not an issue that is likely to quietly disappear for a few reasons. Even if shareholders were willing to overlook any potential problem in this area (private listed hospitals do not breakdown rebates in their financial statements so it is hard to ascertain the proportion of their revenue that comes from rebates), the health insurers like Medibank Private Ltd (ASX: MPL) and NIB Holdings Limited (ASX: NHF) could be taking a much closer look at this issue given their war on rising costs and growing political pressure on their annual premium increases.

These allegations will also alarm private patients who are already seething from earlier media reports that they are being overcharged by some doctors in the private practice.

Add the fact that the federal election is around the corner and you can see why shareholders in Ramsay and Healthscope should be nervous.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Cochlear Ltd., NIB Holdings Limited, Ramsay Health Care Limited, and ResMed Inc. 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 Scott Phillips.

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