• Marcus Bogdan

One stock idea for the next correction

Livewire Markets Alex Cowie recently interviewed Marcus Bogdan CIO of Blackmore Capital on stock selection in times of periodic market corrections. You can read the article at Livewire Markets or see the full transcript below.

The last quarter of 2018 was a bloodbath for markets, with much of the carnage taking place during 'Red October'. While many were panicking like GFC 2.0 was here, cooler heads were instead seeing 'Grand Sale' signs hanging above the market, and '20% off' stickers on the stocks.

Rummaging through the archives, we found a wire from Marcus Bogdan at Blackmore Capital published on 28th November 2018, just as the market hit correction territory, laying out the thesis for 4 stocks to consider after Red October. He calmly wrote:

The recent share price volatility has created opportunities to invest in high-quality companies at far more attractive valuations. Here we share an overview of 4 such stocks, namely Macquarie, Cleanaway, Ramsay, and Xero.

Led by Xero and then Ramsay, these stocks have since gained 46.2% on average (or 48.7% with dividends), versus the ASX200's gain of 24.2%.

I rudely interrupted his holiday to ask him to update us on one of the stocks above and to nominate a new stock for the shopping list for future corrections. Read on to see who he picked.

Q: Marcus, can you please pick one of the four stocks above and summarise your view at the time. Did it play out as expected?

A sizeable retracement in the ASX 200 in October 2018 provided a golden opportunity to invest in Ramsay Health Care (RHC).

Ramsay’s share price had already undergone a material de-rating over the previous 18 months with its price-earnings ratio falling from c.27 times in FY17 to c.19 times in FY19.

Growing pressure on government tariffs and concerns around healthcare affordability resulted in a markedly slower trajectory in earnings per share growth. Indeed, the consistency of achieving double-digit eps growth had withered to low single-digit growth. Nevertheless, the medium and long-term thematic of rising chronic disease and ageing demographics were supportive drivers for health care providers. We firmly believed, as one of the world’s largest private hospital operators, Ramsay remained well placed to be a beneficiary of the irreversible ageing of populations.

Ramsay’s acquisition of Capio (a vertically integrated European health care provider) highlighted Ramsay’s recognition of the potential benefits in broadening its revenue base across the ageing populations of Europe. The acquisition provided valuable scale to its existing European business and exposure to new adjacent revenue streams in primary and specialist care.

It was our belief that Ramsay’s de-rating of its share price adequately captured concerns over health care funding and affordability.

In November 2018 as investors were experiencing a painful repricing in global equities as tightening liquidity conditions and heightened geopolitical concerns weighed heavily on investor sentiment, we purchased Ramsay at an average price of $55.52. Ramsay’s share rebounded notably over the course of 2019, finishing the year at $72.53, up 30% on our original purchase price.

Q: Please provide an update on Ramsay. Does it still look like an attractive investment proposition?

With the recent reporting delivering a myriad of downgrades and weaker profit outlooks, the Healthcare sector offered greater stability and few negative earnings surprises. Ramsay’s FY19 was in line with guidance with most segments delivering modest growth.

In Australia (RHC’s largest division) delivered a solid result despite the ongoing pressures in private health insurance relating to affordability and volume growth. The tariff headwinds of its UK and France operations had abated and cost reductions remained a key focus. Conversely, the synergistic benefits of the acquisition of Capio were taking longer than expected to materialise and would not be EPS accretive until FY21.

Ramsay continues offer investors a level of stability with low single-digit earnings growth. The demand for healthcare is well supported as developed world populations grow older, with the proportion of people over 65 years and older rising over the next decade. However, we would contend that this is now largely captured in Ramsay’s valuation, with the stock trading at a price earnings ratio of c.22 times in FY20.

Q: Which other stock would you like to buy in the event of another major correction?

The long -term demand for healthcare services remains a compelling investment proposition. However, the premium awarded to Healthcare stocks over the last 12 months has been significant as valuations now largely reflect the growth opportunity in the sector.

The exception is Healius (ASX:HLS), formerly Primary Health Care, a leading Australian healthcare company that operates medical centres, diagnostic imaging and pathology services.

Healius’ footprint in Australia’s healthcare system is significant with its bulk billing medical centres processing over eight million GP visits annually, the diagnostic imaging business providing three million exams each year, and the pathology business testing one in three pathology samples in Australia.

Despite Healius’ formidable industry position in the healthcare sector, a dark shadow has bedevilled its earnings and operational history warranting it to trade at a stubbornly persistent discount to its peers.

In recent years HLS has undergone significant restructuring of its operations. Under the stewardship of Chief Executive Dr Malcolm Parmenter (appointed in November 2017) HLS has recapitalised its balance sheet and restructured its underperforming GP and pathology businesses.

The turnaround in HLS has been challenging, with HLS modestly reducing its FY20 earnings guidance. Nevertheless, HLS remains well-positioned to lift its returns over the forecast period as industry conditions in medical centres benefit from additional Federal Government funding of primary healthcare and productivity programs in its diagnostic and pathology operations are implemented.

In the event of an equity market correction, we would actively consider buying Healius given its defensive earnings characteristics, improving industry dynamics, and favourable valuation of c.10 times Enterprise/EBITDA for FY20.

Moreover, as demand for healthcare continues to grow supported structurally by an ageing population, corporate activity is potentially a further driver of higher returns. In January 2019 the Healius Board rejected a highly conditional cash offer of $3.25 per share (current share price c.$2.77) from its existing China-based shareholder Jangho.

Thanks, Marcus, now get back to enjoying your holiday!

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Blackmore Capital Pty Ltd (ABN 72 622 402 895) (Blackmore Capital) is a Corporate Authorised Representative (CAR) of Artesian Venture Partners Pty Ltd (AFSL 284492)