Earnings softer, Oz strength offset by international weakness
1H18 results were softer than expected, with core NPAT up 7.5% to A$288m (Morgans est. A$294m) on product revenue of A$4,445.8m (+3%, Morgans est. A$4,585m). Lower tax/interest supported the bottom line, as EBITDAR increased only 3.7% to A$872.5m, with margins expanding modestly (15bp) to 19.6%.
Only the Australia/Asia division contributed to earnings growth and modest margin gain, mainly on procurement benefits (EBITDAR +9.5%, margins +93bp to 19.6%). Underlying profit in Rest Of World (ROW) went backwards on soft volumes and price pressure, with EBITDAR in France falling 5.8% (margins -90bp to 18.2%) and in the UK declining 4.6%, but with margins held flat on cost-outs. Operational Cash Flow improved (A$475m, +4%) and cash conversion was strong (c100%).
FY18 guidance was reaffirmed, with core Earnings Per Share growth of 8-10%, equating to 282-288 cents per share.
Domestic business remains in good health...
The domestic business is humming along nicely, putting up above market growth (4.3% vs 2.6% market), despite falling Private Hospital Insurance memberships and more day vs inpatient admissions, with the procurement strategy on track (2/3 complete; A$80-100m annual savings) and adding margin uplift. Notably, there was limited contribution from brownfields (A$57m came in late Nov/Dec), but it looks to ramp (A$147m in 2H18; A$156m in 1H19; A$500m over 2.3 years) and retail pharmacy growth was "muted" on regulatory hurdles.
...but ROW is on life support
Management is attempting to adjust its cost base against Rest Of World (ROW) soft volumes and pricing headwinds.
In France, a A$62.6m (A$22.7m post-tax/non-controlling interest) 3-year restructuring is being undertaken to centralise non-core hospital functions (eg. fin, admin, HR) under one service centre, but with seemingly little ROW (cA$8m/year) once complete.
In the UK, admittedly less predictable than France, management expects a return to normal volume growth over the "short to medium term". A little opaque and expectations may (in our view) prove optimistic, as the NHS remains under financial pressure.
Investment view – modestly lowering earnings
Our FY18-20 core NPAT estimates decline up to 0.3%, mainly on lower revenue assumptions, partially offset by lowered interest expense and tax rate (c29%). While core fundamentals remain unwavering and the domestic business strong, ROW headwinds are likely to handicap near term outperformance.
We retain our Hold recommendation.
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