The post-Brexit rally into reporting season has propelled market valuations further to a historical high of 16x, making it difficult to see any further multiple expansion unless it is supplemented with a positive pick-up in earnings.
The market has continued to strongly support quality companies outside the top 20 market stalwarts, which continue to build their revenue and earnings bases despite the subdued economic environment.
The chart below highlights the current environment an Australian investor is faced with.
The chart above is highlighting that the top end of town lacks earnings and is still expensive. Investors are starting to question the very definition of ‘Blue Chip’. Does a Blue Chip company have to be within the top 50 largest companies listed on the ASX? Or can it be a company that still dominates its sector and has all the qualities that represent a good company.
While the financial year 2015-2016 earnings season was a mixed bag, the ASX200 Healthcare index managed to outperform the broader market over the past 6 months (+4.93pc) and past year (+24.7pts).
Outperformance should continue as disease is independent of macros
Not only is the sector’s defensiveness a safe-haven in an environment characterised by macro uncertainties and increased volatility, with growing concerns over the true extent of China’s slowdown and the timing of the next interest rate rise in the United States, but it is also complemented by rare prospects for growth. For example for the next three years the earnings growth expected out of healthcare is on a compound annual growth rate of 11pc vs 5pc for the ASX 200.
Healthcare is also supported by structurally sound underlying fundamentals such as growing and greying population; medical innovation; mergers and acquisitions and a softening AUD tailwind for offshore earners.
Valuation appearing reasonable
While the ASX200 Healthcare index trades at approximately 7% above its long-term average (21.2x vs 19.8x). On a relative basis, the index trades at approximately 3pc above the long-term average. We believe current trading levels are appropriate, given the current operating environment and the focus on solid and consistent earnings growth, with multiples likely to be sustained over the near term.
A key pick within Healthcare: Healthscope (HSO)
Healthscope Limited (HSO) is one of Australia's private healthcare operators, providing services through three divisions: The operation of private hospitals in Australia (Hospitals), the provision of pathology testing services internationally (International Pathology), and the provision of pathology testing services and the operation of medical centres in Australia (Australian Pathology).
Hospitals: Healthscope's private hospital portfolio comprises 45 private hospitals, 32 acute hospitals, seven psychiatric hospitals, six rehabilitation and extended care facilities. The Hospitals division provides services to Accredited Medical Practitioners and their patients including access to operating theatres, patient accommodation, nursing and other clinical care and consumables. Basically it is divided into Healthscope Australia & ACHA Hospitals.
International pathology: The International Pathology division operates 50 laboratories across New Zealand, Malaysia and Singapore, with a small presence in Vietnam. The International Pathology division provides pathology testing services, focused on the examination of blood, tissue and other biological samples to diagnose disease.
Investment Case – the core hospitals business is delivering very solid revenue and margin growth, with the help of ongoing cost-removal, the brownfield growth pipeline and a strong balance sheet. The stock trades at a 7 point price earnings discount to Ramsay Healthcare, which we believe is too cheap.
- Boh Burima Financial Adviser | Authorised Representative: 000341081, Morgans Financial Limited | ABN 49 010 669 726 | AFSL 235410.