OFFSHORE (MIS)ADVENTURES
South African hospital groups chasing overseas markets in pursuit of growth have in general not met with much success – think of Mediclinic with Hirslanden in Switzerland and Al-Noor in the UAE, and Life Healthcare with Max in India and Scanmed in Poland. In 2006, Netcare paid roughly R2.3 billion in equity for its investment in BMI Healthcare in the UK. The company achieved negative earnings of around R600 million on a cumulative basis, and exited the business for next to nothing in 2018. Had the money simply been invested in the market, it would have yielded roughly R11 billion today, more than a third of the company’s current market capitalisation of R29 billion.
GENERATING VALUE
After its ‘Nexit’ from BMI Healthcare in March 2018, Netcare is now a pure play in South African healthcare. Despite its UK misfortunes, the company has actually been a decent return-on-capital business, comfortably outperforming its cost of capital over the past 20 years for its South African division. It’s therefore a business that has shown it can, on its own, generate shareholder value over time.
Netcare’s management focus is currently on running these assets better, and investing in electronic health records (to increase patient experience and make life easier for healthcare professionals) and non-acute care (most notably mental health and cancer care). Shareholder returns have been prioritised, with capital allocation focusing on:
- Normal dividends (around 65% of earnings paid out)
- Re-investing in the business (20% hurdle rate for new investments)
- Buy-backs or special dividends if more cash remains.
Over the past two years, the company has returned R2.79 per share in the form of dividends or buy-backs – around 14% of current market capitalisation. We believe that with current capital requirements, there’s room for more excess payments to shareholders.
SA HEALTHCARE MARKET
The healthcare market in South Africa remains challenging. With negligible employment growth, the total population with medical insurance has remained broadly constant over the past five years at 8.9 million lives. The supply side, on the other hand, has seen growth of 3-4% per annum over the past five years, led by independent hospital groups.
The mismatch has led to occupancy rates coming under pressure. It has also increased the bargaining power of medical schemes, which have exercised this power in the form of network options (a reduced tariff in exchange for being included on a scheme’s hospital list). Around 30% of Netcare’s revenue is currently linked to some kind of network option, and this figure is expected to grow.
Our base case is that the market will continue to be tough over the near term, and we don’t forecast a meaningful recovery in occupancy rates. The important point is that even with existing occupancy rates and pressure on tariffs, the investment case makes sense. A recovery in economic growth will be an added bonus.
WHAT ABOUT NHI?
A looming current investor concern is the National Health Insurance (NHI) Bill, which has been proposed for full implementation in 2026. What impact will this have on hospitals? On the one hand, it’ll increase the number of patients being admitted to private hospitals. In a 2017 study, Econex estimated that an additional 7.7 million public patients can be accommodated in the private sector simply by making better use of existing facilities. The flip side is that the additional patients will most likely pay reduced tariffs. Our own view is that the final impact on hospital financials when NHI is fully implemented will probably be net-negative.
We don’t, however, view 2026 as a feasible deadline for full implementation. In our view, NHI will be introduced in a phased manner, but the road is in all likelihood still a long one. We therefore don’t believe NHI poses an immediate threat to our investment case for Netcare.
INVESTMENT CASE
Netcare provides a pure defensive play in the South African market – in which we’re significantly underweight in our portfolios. Despite all the negative news on the local economy, we believe this has been sufficiently discounted in the current Netcare share price at a price-to-earnings (P/E) ratio of below 12 times and a 6% dividend yield. Despite pressure on tariffs, Netcare will remain a decent inflation pass-through business with strong cash flows. Due to the defensive nature of the business (relatively stable earnings) and the current low valuation, we view the downside risk of the investment to be limited.
