SA’s ageing medical scheme population will provide long-term support for private healthcare companies, according to Sanlam Private Wealth (SPW).
The wealth manager, which has more than R200bn in assets under management, said the performance of the private healthcare sector hinged on economic growth and demand.
“In terms of economic growth, there is also low-hanging fruit. The Bureau for Economic Research estimates that if only the structural reforms currently in progress (for example, rail and electricity) are completed, GDP growth can lift from about 1% currently to closer to 3.5%. If this growth is sustained, it can make a meaningful difference to employment as well as to medical aid membership,” SPW investment analyst Christiaan Bothma said.
“An additional supportive trend for hospitals is the ageing medical aid population. Although scheme membership is not growing, the existing pool is expected to use more healthcare services over time as they age.”
SPW picks Netcare as one company in the sector it expects to do well.
Most private healthcare stakeholders have been fretting over the enactment of National Health Insurance (NHI). Their concern stems from how private healthcare and medical schemes will fit into the system once the NHI is fully implemented, since the NHI Act specifies that medical schemes will not be able to cover services covered by the NHI.
Bothma added that the NHI document suggests a system where medical schemes are phased out, creating a single buyer of healthcare services from both private and public facilities for all citizens. Although this could increase patient volumes for private hospitals, the pricing power of a single buyer is likely to ultimately have a negative effect.
“While we are cognisant of the risks of NHI to our investment case for Netcare, we still believe that not much is likely to change for at least the next decade. NHI faces severe funding constraints, not to mention legal pushback against many of its clauses, including those setting out where medical professionals should work and disallowing private medical schemes entirely for services already covered by NHI,” Bothma said.
Additionally, the primary focus will be on clinics and primary healthcare, which will not have a direct effect on private hospitals. In the short term, the most significant affect could be the potential emigration of medical practitioners due to concerns about future developments.
By the end of 2015, hospital groups were highly valued in investment portfolios, having greatly outperformed the market over the previous 15 years thanks to the rapid growth of the private medical sector.
For example, a R1m investment in Netcare from 2000 to 2015 would have grown to just over R50m, compared to R10m from a similar investment in the JSE All Share index (30% annual return vs 16% for the market, with dividends reinvested), according to SPW.
The decline in performance over the past decade is mainly due to a stagnant medical scheme pool, as the SA economy did not expand its formal sector employment. The number of medical scheme members has stayed nearly constant at nine-million over the last 10 years. This has resulted in an excess of hospital beds, allowing medical schemes to gain more bargaining power and secure network deals at much lower prices than the market rate.
SPW deems the current situation unsustainable — either demand for private healthcare needs to pick up or supply must be rationalised.
Despite challenging market conditions, Netcare’s valuation remains attractive due to its strong cash generation. The company’s earnings are nearly equivalent to free cash flow, as capital spending on new facilities is minimal, aside from some expansion in mental health facilities, which reflect a growing societal issue.
“Based on our estimates, without assuming any meaningful growth in patient visits, the current market cap can be repaid by dividends or buybacks in roughly seven years, with the business trading on a forward free cash flow yield of more than 10%. By another measure, we estimate that the hospital groups have market values worth only 50% of the replacement cost of their entire hospital portfolios,” Bothma said.
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