Join our community of smart investors

The NHS: after the bleak midwinter

As the NHS grapples with the rising costs of healthcare, some of its private peers are feeling the heat too
March 15, 2018 and Jonas Crosland

Imagine an industry where customer numbers grow in direct line with the population. Where obesity, smoking and other modern vices are great for business. And where the only major competitor is so inefficient it can’t handle the pressure and is falling apart.

Surely this is an ideal market for a well-run business to scoop up custom?

Not so if that market is healthcare. As the NHS emerges from its most bruising winter yet, many of its private peers and providers are also feeling the heat. The problem – they say – is funding.

After the NHS admitted in February that it only assessed 85 per cent of accident and emergency (A&E) patients within four hours – its worst performance since 2004 – The Royal College of Emergency Medicine claimed the crisis was "wholly predictable" and "due to a failure to prioritise the need to increase healthcare funding on an urgent basis". 

And it's only getting worse. As the ‘beast from the east’ pummelled Britain last month, a whopping 1.8m people flocked to A&E, forcing NHS England to postpone 22,800 non-urgent procedures in an attempt to ease the pressure. But The Times told its readers to “blame ministers, not flu”, for the damages to public healthcare services, while Jonathan Ashworth, Labour’s Shadow Health Secretary, said the government had "let NHS patients down”. 

But while MPs and the political media are busy pointing fingers, another question looms over the heads of investors with positions in private British healthcare companies: what does the future looks like for the NHS and does the current climate make it too risky to own stocks which have any link with public health?

Looking at EMIS (EMIS), Ideagen (IDEA) and Medica (MGP) the answer seems to be yes. All three have experienced a revenue slump from their NHS partnerships as funding pressures stunt the amount of money government is willing to spend on technology. Indeed, Ideagen bosses cited NHS budget constraints and limited new business opportunities as the reason to stop bidding for low-margin service-based contracts within the UK public sector.

Mitie (MTO) too has extracted itself from the public health space after a squeeze on local authority budgets resulted in £11.7m of losses at its two healthcare businesses in the year to March 2016. Mitie was forced to sell its domiciliary healthcare business – which it bought for £111m five years ago – for just £2.

But current market trends can look more attractive on a long-term basis. Indeed, in 2017, hospital operator Spire (SPI) welcomed more self-pay patients as long NHS waiting times drove more Brits into the private sector. The group’s chief executive, Justin Ash, thinks that demand for healthcare provision by the independent sector "will continue to rise rapidly" as the NHS remains "severely financially constrained and waiting lists and rationing, especially for elective work, continue to grow.”

Of course, not all is well at Spire. The decision by public healthcare officials to remove the target wait times for non-emergency procedures means joint reconstruction, sports injury and soft tissue damage have fallen to the bottom of the NHS’s list of priorities. Thus, fewer of these patients are being referred to private providers where the wait times are barely existent. Spire has therefore received fewer referrals from the NHS and – due to a tariff cut – lower revenue per patient. According to management, these trends are likely to continue in 2018.

Then there's the risk of hospital outsourcing, which has claimed more than one victim over the past few years. In 2011, Circle became the first independent company to be put in charge of managing a public hospital. Less than four years in, funding cuts meant that the contract was no longer sustainable and the group withdrew. Circle never recovered from the share price collapse that followed its failure and it was taken over by private equity in 2017 for a fraction of its former market value. It's also thought the construction of two NHS hospitals was one such contract to push Carillion off the edge. Selling the contracts to Serco (SRP) was one of the outsourcer’s final acts before being forced into liquidation.

 

Investment opportunities in British healthcare

There’s no doubt challenges in the public sector hurt prospects for private healthcare companies in 2017, and the outlook for 2018 looks no better. True, population trends are conducive to growth, but the political issues surrounding the NHS make it a risky sector for investment. Still, there are two areas of British healthcare we think hold greater promise.

 

Favourites

We have buy ratings on several primary healthcare property companies: when it comes to low risk, predictable income and a well-covered, generous dividend, Primary Health Properties, MedicX Fund and Assura are hard to beat.

We are also bullish on CareTech. Analysts expect a 9 per cent dividend hike in the year to September 2018 and the payout is underpinned by the company’s robust operating cash flow and a modestly geared balance sheet. At the last count, net debt of £147m (down from £157m 12 months earlier) represented a loan-to-value ratio of less than 50 per cent of CareTech’s freehold estate, which has a valuation well north of £300m.

We also recently upgraded our recommendation on Spire. After a truly terrible year, we think the private healthcare provider has turned a corner. We are hopeful that new management – who recently topped up their holdings – will form a clearer strategy which will spark a recovery in revenues and profits. Over the long term, we think Spire is well placed to benefit from long-term market trends.

Outsiders

EMIS – a former Alternative Investment Market (Aim) high-flyer – is in a bit of a pickle. In January, the software group revealed that its web services product failed to meet service levels and reporting obligations to GPs surgeries. Broker Numis estimated the financial impact as a one-off £8m charge, wiping 5 per cent off 2018 financial year guidance. But it's nearly impossible to judge if there will be any long-term implications, particularly now the group has sustained reputational damage. We were impressed with how quickly the new chief executive discovered the problems, but downgraded our view while the full repercussions come to light.

Cambian has dealt with its banking troubles far better than we expected. In late 2017, it moved into a net cash position by selling its adult care homes and has even returned some of the cash from the sale to shareholders. Now it's focusing on improving the margins at the children’s business (which was the less impressive of the group’s two divisions). But we've yet to fully trust management again after the overly ambitious expansion plans and poor handling of the balance sheet cost investors last time around.