Healthscope remains a core holding

Healthscope's FY17-19 underlying earnings increase by 6.5%, but are offset by higher D&A and interest. With underlying earnings ticking higher and shares trading at a discount to RHC, we continue to view HSO as a core portfolio holding and maintain our Add rating.

"Sound" and above expectation on an underlying basis

1H17 result was "sound" and slightly above expectations, with operating NPAT down 4.2% to A$96.1m (Morgans A$93.3m) on revenue of A$1,192m (+3.9%; Morgans A$1,185m).

While net profit was impacted by higher D&A (+18.9%) and interest expense (+36.5%), underlying EBITDA was up 5.1% to A$216.8m and margins expanded 20bp to 18.2%. OCF was solid (A$24.5m, +25.2%), with WC well controlled (cash conversion 103.5%) supporting the dividend (3.5cps; payout ratio 67%).

The balance sheet is strong (ND/EBITDA 2.56x (ex-Northern Beaches Hospital) with ample capacity.

Core biz delivering rev/margin growth; ROW path/med centres soft

The core Hospital division held its own (EBITDA A$186.7m, +2.2%; margin -10bp to 18.5%), despite lower industry volume growth and increased case mix volatility, with two expansion projects competed (added 2 theatres; 1 ED).

NZ pathology was the standout (EBITDA A$30.5 m, +31.5%; EBITDA margin +290bp to 24.8%), while growth in Other (ie Malaysia, Singapore pathology; Australia medical centres) was modest (EBIT A$9.4m, +1.4%, margins +50bp to 16.1%), as strength in Mal/Sing was offset by medical centre weakness (EBITDA -13.5%) on regulatory and higher costs.

Soft industry trends; but brownfields unaffected & pipeline robust

While management expects continued near term variability in the hospital segment, flagging similar H/H earnings growth, we note it is not deteriorating and may prove conservative.

Our confidence that growth will continue to come through is underpinned by:

• increased focus on better cost alignment with volume/mix
• labour/procurement savings
• little impact on completed brownfields, which are growing above market rates
• a remaining robust brownfield pipeline that has yet to fully contribution to earnings (792 beds and 49 theatres by end of FY19).

Contributed by Derek Jellinek, Senior Analyst, Healthcare. Original blog here:  (VIEW LINK)