The broker pitch goes something like this: “People won’t stop getting sick in a downturn and operating earnings have risen for 20 consecutive years. Ramsay Health Care is recession proof. That, Mr Jones, is why you should BUY.”
On the face of it, that argument makes sense. Ramsay Health Care is a phenomenal business and now accounts for 26 per cent of the private hospital industry.
Healthcare stocks: Primary vs Ramsay
Primary Health Care and Ramsay Health Care share similar exposure to promising demographic trends, but one of them has a clear competitive edge, says Bennelong’s Julian Beaumont.
The sheer size of the business gives it extra leverage to squeeze out cost advantages when purchasing medical consumables like bandages and syringes, and the company has significant negotiating power with private health insurers.
Ramsay’s international expansion has also been well managed, which has reduced its reliance on Australian revenues, and the company is set to benefit from an ageing population more than almost any other.
Ramsay is undoubtedly a high-quality business. But the stock is anything but cheap. Photo: Bloomberg
The odd elective surgery may be postponed but, for the most part, Ramsay really is recession proof.
Unfortunately, this is the point where the broker’s argument falls apart; recession-proof businesses are not the same as recession-proof investments.
Other risks
For one thing, Ramsay faces other risks, such as a highly leveraged balance sheet, growing pressure from private health insurers to reduce “unnecessary” care, and the ongoing health-care funding reviews that aim to improve affordability and efficiency.
Ramsay may be recession proof, but it certainly isn’t government proof.
Then there’s the fact that in the short term, share prices don’t necessarily track a company’s intrinsic value. Ramsay’s revenue and earnings stoically marched higher throughout the global financial crisis, but – peak to trough – the stock still plunged 30 per cent.
During recessions, investors are less willing to pay up for earnings, so the price-to-earnings ratio of most stocks tends to shrink. Cyclical stocks get a double whammy – a lower multiple paid for lower earnings – but high-quality businesses can be hit just as hard if they go into the crisis with overvalued shares.
Ramsay is undoubtedly a high-quality business. But, with a price-to-earnings ratio of 28 and free cash flow yield of just 2.3 per cent, the stock is anything but cheap.
Ramsay may be recession proof, but it certainly isn’t government proof.
Potential fallout
So what might the fallout be if things didn’t go according to plan?
At its 2008 low, Ramsay’s enterprise value was around 11 times operating earnings. Given today’s earnings, if the stock were currently trading at that valuation the share price would be around $28 – 54 per cent below its current level. Recession proof or not, shareholders can still get creamed.
If Ramsay won’t recession proof your portfolio, what might?
Listed companies like Sydney Airport, Woolworths, CSL, RedMed, Computershare, Hansen Technologies, Spark Infrastructure and InvoCare should survive an Australian recession relatively unscathed.
Unfortunately, only a couple of these stocks offer good value right now.
Safety margin
The important point is not whether a company is recession proof but whether you can invest in it with a margin of safety given the various risks.
Why? Because your best defence against recession is to own a collection of well-managed, high-quality companies purchased at sensible prices.
And right now, Ramsay is only two of those three things.
Graham Witcomb is an analyst with Intelligent Investor. This article contains general investment advice only (under AFSL 282288). Authorised by Alastair Davidson. To unlock Intelligent Investor stock research and buy recommendations, take out a 15-day free membership.