FY17 underlying results were below expectations, weighed down by continued soft conditions, cost pressures and volatile case mix in the core Hospital division. 
Increased competition and ramping VIC greenfields further pressured Hospital earnings, pushing it below expectations and guidance, and offsetting strong above market gains from brownfields, which remain on track and on budget. 

While guidance targeting flat Hospital profit isn’t a confidence builder, not unlike Oct-16 profit warning, brownfields are ramping, core portfolio growth is improving and fundamentals remain unchanged, setting a conservative bar for the new CEO.
We have lowered our FY18-20 earnings estimates modestly, with our DCF/SOTP target price declining to A$2.53. Shares are too cheap...we maintain our Add rating. 


FY17 result – Below expectations on an underlying basis…

FY17 results were below expectations, with underlying EBITDA increasing 3.5% (Morgans A$428m; Bloomberg consensus A$430m) on revenue of A$2,318m (+3.8%).  Underlying NPAT fell 5.6% to A$180m (exclude A$17.4m in non-recurring charges), impacted by higher D&A (+17.4%) and net interest expense (+20.3%). Underlying operating margins contracted 10bp to 17.7%. OCF A$481.2m (+6.89%) was solid and cash conversion strong (101.6%), supporting a 70% payout ratio (Final div 3.5c, -10%) and B/S (ND/EBITDA 2.7x; ex-Northern Beaches Hospital debt as it is refunded upon project completion YE18).

…but core biz hit by ‘temporary’ VIC issues; ROW path solid

The core Hospital division disappointed (rev +3.4%; EBITDA +1.3%; margin -40bp to 17.8%), impacted by several well-flagged issues (eg soft market, case mix variability and higher costs) and recent concerns (eg VIC competition and ramping greenfields).  Excluding VIC issues (A$11m), the division would have met guidance (EBITDA +2.3% vs +2.2% guided). NZ pathology was the standout (rev +8.9%; EBITDA +17.7%; margin +180bp to 24.6%), while growth in Other (ie Malaysia, Singapore pathology) was impacted by FX (rev -1.3%; EBITDA -0.4%, margins +30bp to 29.5%), but improved on a local currency basis (Singapore EBITDA +2.9%; Malaysia +4.2%).


Sell off is overdone; retain Add

Understandably, HSO needs to show strong hospital earnings growth to rerate. While this will not happen overnight, shares look attractive, especially on a multiyear view.

Contributed by Derek Jellinek, Senior Analyst, Sectors Covered: Healthcare: (VIEW LINK)


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