South Africa: Challenging Times for Private Hospitals

South Africa has been a difficult market for private hospital stocks over the past year. The shares of the three leading companies (Life Healthcare, Mediclinic, and Netcare) have posted an average return of -8% in local terms over the past year. The rand’s 20% appreciation relative to the US dollar over this period has masked the challenges.

Growth at Home is Stagnant

That said, the “trading environment” for these companies is difficult. Economic growth is sluggish with GDP +0.3% in 2016 and possibly picking up to +2% this year. Unemployment was 26.5% in Q4:16 and has been 24-27% since 2010. These statistics are not typos. The country has structurally high unemployment because of its welfare system. As a result, enrollment in private health insurance plans (“medical aids”) has declined from a peak of 9.7 million lives in 2013 to 9.5 million lives in 2015 (source: Stats SA).

Growth in hospital admissions drove sharp (10%+) increases in health insurance premiums in 2016. As a result, medical aids have pushed back harder on hospital claims. In fact, one insurer (Bonitas) excluded 14 hospitals operated by Life Healthcare from its Designated Service Provider network. Life ultimately responded by waiving the 30% co-payments at those hospitals. Netcare reported a small decline in patient days for the six months ended March 31, citing (mainly) the weak economic backdrop and tighter case management by health plans. In contrast, Mediclinic’s South Africa volumes are growing modestly. Margins are under pressure across the industry.

The Politicians Are Killing Confidence

The political environment is difficult, but the impacts most likely are indirect. President Zuma fired his well-regarded Finance Minister Pravin Gordhan in March and installed Malusi Gigaba who has been willing to support “radical economic transformation” which means redistribution of land and wealth. Credit ratings and the rand dropped on the news. The change in rhetoric may just be a ploy, but it doesn’t boost confidence. Moving to healthcare specifically, the Health Market Inquiry of the Competition Commission has missed its November 2015 deadline. The commission has waded through extensive reports and analyses of the industry, resulting in low progress. The latest deadline is December 15, 2017, but don’t bet on it. There is a possibility of negative headlines at some point, but similar inquiries into other sectors did not result in changes in policy.

The Industry is Diversifying Geographically

These companies started diversifying geographically to different degrees several years ago in response to limited acquisition opportunities at home. Mediclinic is the most diversified with 52% of EBITDA from Switzerland, 34% of EBITDA from South Africa, and 14% EBITDA from the Middle East. NetCare’s revenue is almost evenly split between South Africa and the UK, but the UK operations contribute virtually nil to net income because of an expensive sale-leaseback deal of its real estate. Life Healthcare has acquired businesses in India, Poland, and most recently a diagnostics business in the UK/EU. South Africa generates 82% of EBITDA, UK/EU generates 17% of EBITDA, and Poland/India chip in ~ 1%.

Challenging Policy and Economy Mute the Outlook 

The outlook for these companies is a function of South Africa’s political and economic backdrop. The political environment likely will remain noisy and volatile over the balance of the year. As noted earlier, the economy should improve modestly over 2016. Unfortunately, significant economic reform looks unlikely. Continued geographic diversification should mitigate the risk over the next few years. As noted in our December 2016 post “You’re Not Alone Nashville!” diversification brings its own risks.  

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