A poor performer with a good prognosis?

Co-founder of the Switzer Report
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The saying that “every dog has its day” doesn’t always apply in markets because some companies are just so inept that they end up on the corporate scrap heap. So it is with much trepidation that I punch into the keyboard these words suggesting an investment thesis to consider Primary Health Care (PRY).

Primary has had a horror run, and as the following share price graph depicts, has been a dog for investors.

Primary Health Care (PRY) – 11/13 to 11/18

At last Wednesday’s AGM, Chairman Rob Hubbard proudly announced that the “last of the legacy issues” were behind Primary. This has included an ATO ruling on upfront payments to GPs in 2015, the write-off of goodwill from the Symbion acquisition, an unexpected Fair Work Commission ruling regarding pay levels for pathology collectors and couriers at the Dorevitch pathology centres in Victoria and underpaying a number of staff in Primary’s Medical Centres. Non-legacy issues have included 3 CEOs in the last 4 years and a change of Chairman.

New CEO Dr Malcolm Parmenter (he has been in the job since September 2017) also confirmed that the company was on track for underlying net profit after tax for FY19 of $100m. While this assumes a stronger second half (the first quarter was impacted by a low incidence of flu during the winter season), recent volumes have moved back up towards normal levels. Comforted by this guidance, and the absence of any new bad news, Primary’s shares rose, adding 6% over Thursday and Friday.

Primary’s evolutionary strategy

Primary is Australia’s second biggest provider of pathology services with a market share of 34% (Sonic is the leader with a share of 43%). Through almost 2,300 collection centres and 108 laboratories, the pathology division generates $1.1bn in revenue and about 60% of Primary’s EBIT.

Many of the pathology referrals come from GPs and other health professionals working in Primary’s 75 multi-disciplinary medical centres. Primary employs the nurses, practice managers and support staff, while the GPs partner with Primary on a contractual basis. The medical division generates around 20% of Group revenue and EBIT.

A third division, diagnostic imaging, provides xray, ultrasound, mri and other imaging services at 28 hospitals, 62 specialist imaging centres and 52 of Primary’s medical centres. It also contributes about 20% of group revenue.

Primary’s strategy, which is evolutionary rather than revolutionary, is to deliver a comprehensive renewal of its operating model for its medical centres and to upgrade its technology platforms in pathology and imaging. For the medical centres, Project Leapfrog involves an investment of $140m over three years in people, processes and property initiatives. The aim is to attract and retain healthcare professionals, increase operational efficiency, improve the patient experience, optimise space utilisation and introduce new services.

With the pathology market mature and the Government reluctant to increase Medicare rebates, Primary is upgrading its core testing instruments and back-end laboratory system. This will support future growth and drive cost savings of $20m pa once embedded from automation, standardisation and efficiency. In diagnostic imaging, Primary is rolling out a new radiology information system.

The other major initiative for Primary has been in day hospitals with the purchase of  Montserrat, a leading high quality operator of day hospitals and haematology/oncology clinics. Funded by a capital raising in August at $2.50 per shares and due to complete this month, the business will allow Primary to participate in the international trend away from high-cost overnight hospitals into day hospitals, driven largely by improving technology. The acquisition will also provide Primary with a platform to grow in an aligned market that is diversified away from the bulk-billed Medicare revenue.

What do the brokers say?

The major brokers aren’t yet ready to re-rate Primary. Although the consensus target price is $2.94, some 16.7% higher than Friday’s closing price of $2.52, sentiment remains somewhat negative with  1 buy, 4 neutral and 3 sell recommendations.

According to FN Arena, the brokers see risks with pathology volumes and whether these can outpace rising costs, and execution risks around the strategy, in particular the magnitude and timing of the expected benefits.

Individual broker recommendations are set out in the table below.

Broker Recommendation Target Price
Citi Neutral $2.90
Credit Suisse Underperform $2.45
Deutsche Bank Hold $3.08
Macquarie Underperform $3.10
Morgan Stanley Equal-weight $3.20
Morgans Hold $2.90
Ord Minnett Accumulate $3.20
UBS Sell $2.70
Consensus $2.94


In regards to pricing, the Brokers have Primary trading on a multiple of 16.5 times forecast FY19 earnings and 15.5 times FY20 earnings.  Assuming a dividend payout ratio of just over 60%, this implies a dividend yield (fully franked) of 3.8% for FY19 and 4.1% for FY20.

Bottom line

On the numbers, Primary is reasonable value, not outstanding value. Given its recent track record, it is understandable that the brokers are reluctant to “get on board”.

However, as Primary’s earnings are fairly predictable, it should be a low volatility, defensive stock that trades at a higher multiple. A re-rating is possible if all the “bad news” is out and the Management team can execute on strategy.

Primary could be impacted by a possible change of Government in May, but on balance, I think the medium term impacts are more likely to be positive.

My hunch is to back the new management team and its almost “back to basics” strategy.  This is a solid business with leading market position in an industry with strong tailwinds. A patient buy – one for the shopping list in market weakness.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.

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