Healthcare at a reasonable price

Vince Pezzullo

Perpetual Asset Management (Australia)

Healius Limited (ASX: HLS), formerly Primary Health Care, is an Australian healthcare company that operates pathology, diagnostic imaging, day hospitals and IVF clinics. In this wire, equities Analyst, Michael Croser discusses his views on HLS and we considered it a compelling investment opportunity for the PIC portfolio.

We have followed HLS for many years and seen them struggle with an excessive debt load and the troublesome Medical Centre business whose operating model was no longer resonating with doctors. 

Recruitment and retention of good doctors was a major issue and very time consuming for management. It also consumed a lot of cash. That was until HLS found BGH Capital, an Australian-based private equity business who agreed to buy the business in July 2020 for what we believed was a very good price. 

In doing so, it solved our two major problems with the stock: a poor balance sheet and a primary care business (medical centres, health practices and dental clinics) that was no longer fit for purpose and dragged down the two good businesses in pathology and diagnostic imaging.

What emerged was the second-largest domestic Pathology operator and the third-largest Diagnostic Imaging operator in Australia with a very clean balance sheet and a management team which could now focus on improving those businesses.

 In our view, these are stable cash generative businesses which are very difficult and expensive to replicate. Importantly, the company’s management now had the opportunity to get them back to their best.

We believe the margins of HLS are well below their peers, a result partly due to the limitations of a stretched balance sheet and the inefficiencies in recruiting and retaining good doctors for medical centres. We see the medium-term opportunity for HLS being to restore these margins against peers. Management has laid out a pathway to get them there which they estimate will deliver roughly $250 million of EBIT (Earnings Before Interest and Tax) by FY23, which is more than double last year’s.

Our view is that the market has underestimated or not factored this in as it would not be trading at such a cheap multiple (11x EBIT) for the quality of the assets. We think this is anchoring at work as the memory of the old HLS lingers. We, however, are looking at the business afresh and think they have the right mix of medical and corporate leadership to make the required changes and we are only expecting them to return to peer performance with no heroics required.

We also think they may be sitting on a real undiscovered gem. If we follow the experience in USA in regard to healthcare, then surgical day hospitals are expected to become a much larger part of the private hospital landscape in Australia in years to come. We believe it will be the fastest-growing segment in Australian healthcare and HLS has a small but growing surgical day hospital business. HLS is the only listed company on ASX that provides exposure to the surgical day hospital business and we expect HLS to garner more attention over time.

Lastly, whilst they are benefiting from COVID testing at the moment, that will pass and it provides a bridge for them to improving margins, improving investor confidence, and ultimately an improving share price.

As at 31 January 2021, HLS comprised 1.9% of the PIC portfolio.

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Vince Pezzullo
Deputy Head of Equities
Perpetual Asset Management (Australia)

Vince is the Deputy Head of Equities at Perpetual Asset Management Australia and is the Portfolio Manager for Australian Share, Geared Australian Share and the Perpetual Equity Investment Company Limited (ASX:PIC).

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