Stuck in ICU

RESULTS

Need To Know

• Slight FY23 revenue beat materially offset by poor performance from Santé, Elysium as well as higher finance costs and tax, driving a ~15% miss on EPS
• July surgical admissions exit run rate +16.4% on FY19 levels is strong, with RHC expecting ‘mid single digit’ top line growth for FY24, driven by higher reimbursement rates
• Higher tax rates and interest costs will lead to downgrades, with the margin recovery also taking longer than anticipated with ongoing inflationary pressures

FY23 result overview vs consensus:

Revenue $15,339m +12%yoy vs $15,232m

EBIT $1,021m +15%yoy vs $1,054m

EPS $1.25 +7.5%yoy vs $1.47

DPS 0.75cps -22.7%yoy vs 0.99cps

Investment Implications

RHC is seemingly stuck in the intensive care unit as its margins in Elysium and Santé remain on life support. The stock appeared priced for another earnings miss, which was promptly delivered. Higher interest and tax costs also impacted the underlying earnings, despite stronger top line growth across Australia, Asia and the UK. Cost inflation and labour shortages are still weighing on the group into FY24, although are beginning to show some signs of easing. When pressed, management weren’t willing to provide whether they see margins rising or falling in FY24, where our read is that despite some underlying improvement, a step up in investments is likely to push the recovery to FY25. The dividend also was significantly stepped down at the bottom end of the 60-70% payout ratio to improve the balance sheet.

Australia's volume momentum is showing some positive signs, with July surgical admissions up 16.4% on FY19 levels, and 4Q margins increasing 200bps. RHC expect earnings to improve on the back of mid single digit volume growth and productivity improvements from labour management and cost saving initiatives. RHC also called out increased spending on its digital and data transformation project into FY24, with more details to be provided at an investor day in November.

UK volume growth is forecast in the mid-high single digits from both public and private sector, with RHC targeting higher acuity levels. The Elysium earnings were materially impacted by staffing shortages hampering the ramp up of new facilities and resulted in higher use of agency staff. RHC has implemented a number of initiatives to reduce vacancies and drive occupancies, with the 4Q result a significant improvement on Q2 and Q3. RHC also expect positive EBIT, more in-line with expectations at the time of the acquisition.

Santé remains challenged with Government revenue and cost support declining 27.8% to $290.2m during the year reflecting reduced reliance on subsidies as volumes returned post Covid. The decline in earnings reflects the impact of inflationary pressures on costs, including higher staff absenteeism impacting utilisation rates that have not been reflected in annual tariffs. RHC is expecting top line volume growth of low single digits in France and better in the Nordics supported by acquisitions made over recent years.

The Sime Darby sale process is still underway having received a number of non-binding indicative offers. RHC expect to provide more detail before the AGM in November, noting there is no certainty of a completed transaction. Any proceeds will be used to pay down debt.

The balance sheet saw some marginal improvement, with the leverage ratio down to 3.2x from 3.5x in December 2022. RHC continue to target a ratio of <2.5x. Interest rates significantly impacted the result, with the weighted average cost of debt rising to 4.73%, up from 3.24%. Interest costs for FY24 are expected to be $570-600m, well above the ~$490m the market was expecting. The tax rate of 33.2% in the period was impacted by non-deductible interest costs in the UK, although is expected to fall back to ~30% in FY24.

Investment View

Whilst the exit run-rate for July looks promising, RHC is still expecting significant headwinds to its margin recovery, which continues to be pushed out. There are some green shoots emerging, with a strong 4Q margin result in Australia, although offset by weakness in Santé and Elysium. RHC is expecting to step up investment in improving its efficiencies through digital capabilities, although the benefits will unlikely be seen until FY25. The upcoming sale of the Sime Darby remains a key catalyst for RHC to reduce its debt costs. The investor day planned in November looms as an important update from management to redirect its strategy and demonstrate that it can return to profit growth.