Spire Healthcare Profit Warning: Warns on FY18, Shares Tumble 30%

Spire Healthcare (LON:SPI), the leading independent hospital group in the United Kingdom today put out a profit warning – rather difficult to miss as the RNS was entitled ‘Revised
Outlook’. When that happens, it’s a fairly safe bet that it isn’t going to be upwards. The company gets straight to it, and in their words it is pretty plain:

Having reviewed results for the period 1 January 2018 to 31 July 2018, and assessed likely market conditions for the balance of the financial year, the Company announces that it now expects EBITDA for the full financial year 2018 to be materially lower than for 2017.

There is no additional guidance to what materially lower means, although from their investor site, EBITDA for 2017 was £150.0m. On one hand, this is not an unprofitable company – margins have being pushing double digits for the last couple of years, and healthcare is a pricy product for which arguably demand is not seasonal. NHS referrals are a major part of the business, which provide a steady stream of premium customers. It has a large network of private hospitals – given the values of land nowadays, this would be incredibly difficult for a competitor to recreate.

On the downside, Spire have been a perennially poor performer since floatation a few years back. Their share price almost touched 400p in the second half of 2016, but there have been several sharp falls on the way, and looking back at previous reports, this is a company for whom missing expectations is not rare. At today’s low of 178.5p, they are well under their price at market entry. Whilst the share provided many good exit opportunities for earlier investors, it is likely that there will be quite a few disgruntled holders here. There have been dividends paid, but only at a small yield.

Last years results were dented further by the revelations around former surgeon Ian Paterson. An publicised £37.2 million was needed for settlements with former patients, with the majority of this having to be paid by Spire. Whether there will be any longer term effects – for example additional claims, or other rogue employees is yet to be known.

One potential floor for the share price would be the interest of Mediclinic, which owns 30 per cent of the shares. A takeover deal was rejected last year which valued the company at £1.3bn – which is much above the latest valuation today.

One thing is that this profit warning is not too much of a surprise. The broker estimates for EPS have been steadily in decline for the past year. The company has posted steady profits, but in a rather erratic way. The Stockopedia scores don’t like it much, giving it a score of just 38 – and value is the worst metric here at 34. Even before the latest warning, it was trading on a P/E of 16.4 (the Google price is calculated after exceptionals). This isn’t a particularly cheap share.

Investment Case

Revisiting the RNS this morning does not give many clues as to what caused this warning. The CEO cites:

The current difficult market conditions – also seen by other operators – had a greater impact on our business in the seven months to 31 July 2018 than we had expected.

This is not very specific, on the face of it. One possible reason can be found later in the piece, where NHS revenues are down 9.5%, and the outlook for the NHS is not good either, as ‘continuing weaknesses’ are predicted in the NHS business for the rest of the year. Last year’s NHS income totalled £287.3m, so for this full year it may be looking at £250m or less. The burning question will be how much this affects the end result. In H1 this was almost offset by the increase in Self-Pay and Insurance revenues.

One of the responses is cost savings, but notably it does not include what ‘significant’ means:

In parallel we have identified and initiated substantial cost saving exercises in other areas of the business, including central functions and procurement. These savings are expected to have a significant impact on our cost base from 2019 onwards, with some benefit in H2 2018.

Far more detailed is a reduction in capex:

In addition we have introduced a much tighter capex environment, and capex for FY 2018 will be approximately £90 million compared to £100 million original guidance and £118 million in FY 2017.

That is a fair decrease year on year, with £28m being saved. I am not entirely sure whether this is a good thing; a major selling point of private hospitals is that they are much better than their NHS equivalents. It’s entirely possible that the other major selling point may be more useful (the ability to have treatments without long waiting lists), and it seems as if Spire are heading this way, emphasising the need for ‘clinical quality’. I would guess after the Paterson scandal, trust needs to be rebuilt with personnel as opposed to technology. It seems that this is one of the items that is weighing on profit:

We have invested significantly to improve our clinical quality and to drive our private payor proposition, including embedding new and enhanced standards, set and audited by our expanded clinical team. This is being effected with a number of one-off step-up costs, which in turn has led to overall hospital costs increasing ahead of our original estimates. The impact on earnings has therefore been more marked than anticipated.

I do wonder if these some of these costs will be one-offs. Getting in good people costs a great deal of money, which will have to be paid every year unless other efficiencies can be found.

The overall health of the company is mixed. The balance sheet comes with a hefty £425m in loans, including leases there is a cool £502m of obligations. But balancing that out is a cool £666m of freehold property, giving a good margin of security. Underlying this, the book value of the share is in the region of 260p, so the current valuation of the share trades much below that.

It is hard to know what to make of this warning. Companies in this sector are quite vulnerable to other factors, such as the whim of governments. Any guidance cannot be given with a massive degree of accuracy, which could explain the various missed expectations in the past. On the flip side, demand for the final product is constant and if there is to be consolidation I would think Spire are in a good place to be acquired at closer to their book value price although with the Mediclinic price in poor health as well, now might not be the best time.

I am inclined to rate this as 3/5; the company has good asset backing for its debt and reputable customers, but unsure what the future holds.

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