• FY17 underlying profit was solid and in line with guidance and our estimate, underpinned by continued strength in the domestic business helping to offset wellflagged ROW challenges.
• The domestic business has shown strong "resilience", despite industry volatility, with funding secured, cost-out leverage evident and brownfield gains, but 2H sales slowed and margins contracted more than historical seasonality.
• Importantly, while we expect continued domestic business strength and see upside from procurement and retail pharmacy expansion, continued ROW headwinds limit strong earnings gains and is likely to impinge on the typical 'beat and raise' cycle.
• We have modestly adjusted our FY18-20 earnings, with our DCF/SOTP target price decreasing (target price for Morgans clients only). We move to Hold.

Brief results analysis

Earnings growth across all divisions; but Aus the standout

FY17 core NPAT was solid and in line with guidance and our expectation (A$542.7m, +12.7%, Consensus/Morgans A$541m), on revenue that was slightly behind (A$8,705m +0.2%; Morgans A$9,010m; consensus A$9,032m). Underlying EBITDAR was up 2.2% to A$1,706m, with margins expanding 37bp to 19.6%.

All divisions contributed to earnings growth, but only Australia/Asia stood out for EBITDAR margin uplift, mainly on operational efficiencies (earnings +13%, margins +95bp to 17.9%; France earnings +0.6%, margins +6bp to 20.06%, challenging tariff environment; and UK earnings +1.8%, margins -69bp to 25.4%, lower-yielding NHS patients, tariff cuts and nurse shortage, albeit "well controlled" in 2H).

OCF (A$882m, -2.5%) declined on softer WC and higher tax provisions, with cash conversion (c92%), dividend mirroring underlying profit (134.5c, +13%; FF; c50% payout ratio) and B/S solid (2.2x ND/EBITDA; cA$500m headroom) to support brownfields (A$200m targeting) and other growth opportunities. FY18 guidance calls for EPS growth of 8-10% (282-288cps).

Diversity supports domestic business, but ROW a near term drag

CEO Craig McNally’s debut saw him flag no change to a “consistent” strategy, confident of moving in the "right direction" underpinned via sound industry fundamentals and a "powerhouse" domestic business showing strong "resilience" despite industry volatility, given numerous attributes (eg portfolio scale, geographic diversification, balanced payer/case mix).

While no reduction in volume growth was flagged, we note H/H sales slowed (-370bp) and EBIT margins contracted (-175bp to 13.2%) more than typically seen with historical seasonality.

Nevertheless, we are confident management can deliver on its guidance and expect gains from procurement and retail pharmacy expansions to be supportive, but an increasing near term ROW drag will likely keep growth in check.

Modestly lowering earnings outlook

Our FY18-20 core NPAT estimates decline up to 0.3%, mainly on lower revenue assumptions, partially offset by lowered D&A, interest expense and tax rate (c30%).

Investment thesis; Moving to Hold

While core fundamentals remain unwavering and the domestic business strong, intensifying ROW headwinds are likely to handicap strong near term outperformance. Our DCF/SOTP-based price target declines and we move to Hold.

More information

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.