Investment guide: The private healthcare sector

The private healthcare sector in South Africa is comprised of three main players: Medi-Clinic International, Netcare Limited and Life Healthcare. According to Stefan du Toit, PSG Wealth Durbanville Stockbroking, Medi-Clinic is the largest of the three with a market capitalisation of R153 billion, followed by Netcare with R54 billion and Life Healthcare with R40 billion.

All three of these hospital groups are listed on the Johannesburg Stock Exchange (JSE). This guide looks at investing in the private healthcare industry, and how the three big healthcare groups compare.

Investing in the private healthcare industry

Despite the weakening of the economy, du Toit noted: “The demand for private healthcare is expected to remain resilient due to the defensive nature of the business and the state of the public health care system in South Africa.”

“Investment in the private healthcare industry has historically been viewed as lower risk due to high barriers of entry to new participants in these markets and the defensive nature of the business. However, with that in mind it is important to realise that it is a highly regulated industry and due to the uncertain nature of regulations in South Africa, companies have in the past diversified their income streams to include more offshore earnings.”

The defensive nature of these companies, as well as the good cash generation, have historically made private healthcare a good investment on the JSE. As a result, these companies “tend to trade at premium valuation multiples to the general market,” explained du Toit.

Currently, Netcare and Life Healthcare are trading at historic price-to-earnings multiples of 21 times.. “Life Healthcare currently pays out a bigger portion of free cash flow to shareholders with a dividend yield of 4.05% compared to the lower yield of 2.51% on Netcare. Both Netcare and Life Healthcare have experienced severe price pressure over the last 12 months as a result of regulatory uncertainty and competition commission inquiries, with Netcare shedding approximately 16% and Life Healthcare down seven percent,” added du Toit.

The impact of the NHI on the private healthcare sector

The government has plans to implement a National Health Insurance (NHI), which is a government-funded system allowing free medical access to citizens. According to du Toit, this proposal “may lead companies to reconsider its current investment options. The NHI is currently in its proposal phase.  Whether an already overburdened public sector can afford this is another question, but the proposal of greater access to free medical services and resultant price reductions will in all likelihood have a negative impact on profitability and margins in the long run.”

Du Toit added: “We believe the private healthcare industry is a quality industry with good historic margins, cash generation and return on equity. Most of these companies have quality management, which are not negotiable. Over the long run the management teams and companies tend to reward investors with decent returns and wealth creation.”

Life Healthcare fined

The healthcare industry faces a number of obstacles at times due to the strict regulatory environment in which they operate. For example, due to failure to notify the Competition Commission of a planned merger between Life Healthcare and Joint Medical Holdings (JMH), both groups have agreed to pay a fine of R10 million.

In a document released by the Competition Tribunal, it revealed that the Commission received a complaint from the National Hospital Network regarding a merger between Life Healthcare and JMH. The complaint stated that the merger was a violation of the Competition Act, as consent from the Competition Commission had not been received prior to the merger taking place.

Du Toit clarified: “Parties to large mergers are required to disclose the nature of such transactions to the competition authorities to assess if it is in the best interest of the general public.”

Following this, Life Healthcare (LHG) agreed that it would disinvest from JMH. The Tribunal explained: “The Respondents have agreed that LHG would disinvest from JMH and that JMH would acquire nearly all of LHG's shareholding by way of a share buy-back arrangement and that some existing doctor shareholders would acquire the balance of LHG's shareholding. This transaction would result in the termination of the current shareholders agreement between JMH and its shareholders. This transaction it is believed, did not result in one or more firms acquiring or establishing control of JMH and would therefore not constitute a merger. The transaction was completed on 26 February 2014 and as such the co-operation between LHG and JMH which concerned the Commission also ceased.”

André Meyer, CEO of the Life Healthcare Group, said: “Life Healthcare Group acknowledges that the Competition Tribunal has confirmed the consent agreement between ourselves, the Competition Commission and Joint Medical Holdings.

“Life Healthcare Group is committed to complying with the terms of the consent agreement which includes payment of a fine, within three months of the date of the confirmation.”

The severity of the fine levelled against Life Healthcare, according to du Toit, “shows how serious the competition commissions will take any contraventions.”

Du Toit concluded: “Investors that do not have exposure to the private healthcare industry, should definitely consider adding the industry to their portfolios by investing in these quality companies on the JSE.”