It’s not often that management talks up the challenges facing the business they head. But Spire Healthcare’s chief financial officer Jitesh Sodha went to great lengths to point out why increased clinical and other operating costs would hinder a return to historically stronger profit margins, in a three-page defence of its decision to recommend a bid from its rival Ramsay Health Care.
Since the 250p-a-share offer failed to win enough support in the shareholder vote this month, some heat remains in the private hospital operator’s share price. At 223p, the shares are trading at a near two-year high after a torrid performance in recent years.
The recovery rally did predate the takeover interest from its Australian rival. A higher proportion of self-paying patients and more complex procedures meant private revenue has recovered faster than expected after private elective surgeries were initially suspended in April last year. Adjusted operating profits for 2020 came in ahead of expectations, despite being about a third lower than the previous year.
Revenues over the first five months of the year were above 2019 levels and the expectation from management and among analysts is that the backlog of patients on waiting lists built up during the pandemic will result in higher demand from self-pay patients and more referrals from the NHS.
Analysts have forecast a 14 per cent rise in revenue this year to £1.05 billion, alongside a 22 per cent increase in earnings before interest, taxes, depreciation and amortisation (ebitda) to £196 million. Both figures would be the highest since the group listed its shares in 2014.
Surely the faith placed in Spire by investors that voted against the deal, including Toscafund, the No 2 shareholder, should prove well placed? It might not be that straightforward.
Spire’s shares have been held back by a series of profit warnings. NHS belt-tightening led to lower elective referrals in 2017 and 2018, while it incurred higher costs associated with improving clinical quality. During 2017 it was also hit with £27.2 million in costs relating to compensation for the 750 victims of the disgraced former consultant Ian Paterson.
Given that it is the NHS referral side of business that has created the biggest obstacle for Spire’s revenue growth in recent years, the strategy adopted by the chief executive Justin Ash of boosting the proportion generated from private patients is sensible. But since Ash’s appointment in 2017, the proportion contributed by private patients has not markedly risen, stalling just below 70 per cent.
A previous target of generating 80 per cent of revenue from private patients by 2022 has been replaced by a hope to boost those revenues to above 70 per cent of the group total.
There is also the cost of continuing to improve clinical quality — where Spire has made considerable progress — and increasing treatment capacity as we emerge from the pandemic. While management expects operating efficiencies, such as digitalising more administrative functions, it has said that those achieved before 2017 are a thing of the past. Higher costs could also mean any repeat of past falls in NHS referrals prove more painful.
An offer of 250p a share might have seemed paltry when judged against the group’s IPO price of 210p. Yet it was a price the shares hadn’t been able to muster in almost three years. The market is not yet convinced that Spire’s profit potential has much improved, placing an enterprise value-forward ebitda multiple just shy of the average since mid-2017. This is a better company than Ash inherited, but you could forgive some investors for wanting to cut and run with Ramsay’s cash.
ADVICE Hold
WHY A lack of consistent earnings growth is adequately reflected in the shares’ undemanding valuation
Cranswick
Investors were convinced of the resilience of Cranswick’s earnings early on in the pandemic. After falling to a six-month low at the time of the market crash in mid-March last year, just a week later the shares were back trading at a record high.
Since then the FTSE 250 company has proved deserving of investors’ confidence. A shift towards home cooking during lockdown boosted demand for the pork and poultry producer and meant that its performance for 2020 beat market expectations. However, Cranswick is proving to be more than just another short-term lockdown winner.
After revealing an impressive jump in revenue of almost a quarter this time last year, the group has reported a rise of just under 10 per cent over the 13 weeks to June 26, putting its revenue for the first quarter 31 per cent ahead of the 2019 level. Retail has remained solid but was accompanied by a recovery in the food-to-go and food service categories.
Cranswick invests heavily in its facilities to boost production but also improve efficiency. During its first quarter that translated into an increase in production from its Eye poultry facility in Suffolk, from 1.1 million to 1.4 million birds per week, which helped to boost the top line. There is plenty of room for more investment to further increase the group’s capacity. Net debt has risen only modestly since the end of March, when it stood at just £92.4 million or 0.6 times ebitda (earnings before interest, taxes, depreciation, and amortisation).
A 16 per cent increase in the dividend for 2020 constituted the 31st consecutive year of growth in shareholder payments. A smaller increase is forecast for this year and analysts expect a dividend of 73.4p a share. At the present share price that equates to a potential dividend yield of 1.8 per cent — a track record that gives you an indication of the quality of Cranswick’s earnings.
As Shore Capital, the broker, notes, potential challenges include rising UK and EU pig prices and labour shortages. However, neither of those concerns justify the shares’ valuation of 18 times’ forward earnings, which is a discount to the five and three-year averages.
ADVICE Buy
WHY Opportunity to gain exposure to longer-term earnings potential
