This company knocked back a $20 billion takeover offer. Was it worth it?

This article was first published for Livewire Markets

To quote the partial title of a successful game show, "No Deal" was the theme of 2022 for one of the ASX's largest companies by market capitalisation.

Last year, private equity giant KKR attempted (more than once) to buy out Ramsay Health Care (ASX: RHC) for the tidy sum of $88/share. At first, it seemed like a really good deal at a sensational price. Ramsay is Australia's largest private hospital operator and it also has a major foothold in France and the UK. 

But after long-winded conversations, KKR and Ramsay management couldn't reach a deal. It's now up to management to prove to shareholders that it can grow the company beyond what it could have been sold for.

One of those backing RHC management is Jun Bei Liu of Tribeca Investment Partners - so much so that she named it as her top stock pick for 2023 in the Outlook Series:

The best-performing stock for 2023 in my view is going to be Ramsay. We're a big believer in the premium asset that it holds. Its share price is very depressed because of its earnings, which COVID has impacted. It is one of the very few companies that is still yet to recover to pre-COVID levels.

Another stock picker who's backing RHC over KKR is Ray David at Schroders. Today, I sat down with Ray to discuss the result and how he feels about the company now.

RHC vs ASX 200, 1-yr chart (Source: Market Index)

Note: This interview was conducted on Thursday February 23 2023. Ramsay Health Care is a top five holding in Schroders' Australian Core, Australian Equity Long-Short, and the Australian Opportunities funds.

Ray David, Schroders

Ramsay Health Care (ASX: RHC) H1 key results

• Revenues up 10% to $7.4 billion

• NPAT up 22% to $194.4 million

• Earnings per share of 82.9c/share

• Final dividend of 50c, up 3%

Key Company Data

Source: Market Index

MarketMeter

RHC ranked third in the ASX 100 for sustainability reporting. To learn more about Livewire's coverage of the MarketMeter research series, click here.

What were the key takeaways from this result? What surprised you the most?

The positive profit jaws are opening up in Australia for the first time in two years, with surgical volumes are up and COVID costs are declining. Conditions are returning to normal for the first time in two years which the market should start to like because that will see Ramsay deliver earnings growth again.

For RHC, there's four takeaways:

• Demand is recovering, surgical volumes are up 18% in Australia and 10% in the UK. There is a significant backlog and labour pressures are easing, which is a big positive for both revenues and costs. 

• COVID costs were $67 million in the first quarter and those costs are disappearing. 

• Over the last three years, RHC has faced high levels of inflation yet those the payer agreements with government and insurers didn't reflect current high levels of inflation. As these contracts roll off, RHC should now start to get inflation-linked increases in revenues.

• Committing more capital to Australia, reflecting a confidence in Australian market's demand. 

What was the market’s reaction to this result? Was this an overreaction, an under reaction or appropriate?

The reaction looks warranted. The second quarter has shown really strong earnings momentum because profits are snapping back quite quickly but now that the COVID costs have all but disappeared. If you look at the market's reaction over the last five years, RHC has been a material underperformer in spite of a very high quality asset base in Australia. 

The market's main scepticism is around Europe, which continues to deliver poor shareholder returns. Any improvement or restructure of these assets and operations will be taken well by investors. After all, this is why KKR bid for Ramsay because of the material underperformance over the long run and attractive Australian business.

Is this a result that will sit well with shareholders given the KKR bids of last year?

There were three main issues around KKR walking away. One was funding costs were starting to increase and that hasn't changed. Also, KKR did call out a deteriorating operating environment when they were doing due diligence. 

This result shows that the operational headwinds are now turning into tailwinds. I think this result should give any shareholder the confidence that conditions are returning to normal, profitability is improving, and that earnings are recovering. 

Would you buy, hold or sell Ramsay Health Care on the back of these results?

Rating: BUY

Ramsay is a core holding in our portfolios. We feel that it has very attractive Australian assets and the valuation of those assets are really being discounted by the European assets which continue to deliver sub-optimal results. Unlike Europe, Australia has a much more fragmented payer system and it's got very strong government support for private health insurance. The property ownership in Australia is also protecting shareholders from inflation to some degree because they are not exposed to continuing rent escalation. 

What’s your outlook on Ramsay Health Care and its sector over FY23?

The general outlook for the healthcare sector is mixed by company.

If you think about the pathology players, the outlook is quite soft because COVID testing volumes are falling away and their cost base has not been adjusted. That could be difficult for Sonic Healthcare (ASX: SHL) and Healius (ASX: HLS).

For CSL (ASX: CSL), it's a COVID recovery story because plasma collections deteriorated during COVID. Now, collections are improving which allows CSL to increase fractionation capacity to meet growing demand for IG. It's also a positive outlook Cochlear (ASX: COH). As Ramsay was, Cochlear was also impacted by the pause in surgical volumes during COVID, and as things return to normal, surgical volumes of cochlear implants should start to resume growth again.

Are there any risks to this company and its sector that investors should be aware of given the current market environment?

We see the Australian assets as more like infrastructure assets while the European assets are challenged assets because all the value actually accrues to the government in the sense that they set the pay rates for French hospitals and those tariffs have been escalating below CPI

while costs have been escalating at CPI. At the same time, land lords are getting CPI rent increases, so Ramsay is being squeezed in Europe.

If that tariff rate comes in below expectations, those French assets' earnings will come under a lot of pressure and there is a lot of debt that sits within those assets.

So if RHC can restructure those assets or reduce their ownership in those assets, that would be the big catalyst for RHC.

From 1-5, where 1 is cheap and 5 is expensive, how much value are you seeing in the market right now? Are you excited or are you cautious on the market in general?

Rating: 3-4

Parts of the market look overvalued, particularly healthcare and technology. Parts look attractive to us like energy, insurance, and even building materials. We don't think the headline multiples for the market are high because they are in line with historical multiples and yields. It's the earnings expectations that still look high and you've started to see some of that this reporting season with the exception of some staples like Woolworths (ASX: WOW) and Coles (ASX: COL). 

The clear issue corporations are facing is slowing demand, while lagging inflation costs are still coming through. Just look at the Domino's Pizza (ASX: DMP) result with its negative jaws and revenue growth is slowing but costs are still high. As the market starts to factor those in, the valuations will start to look attractive.

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Source: Market Index