By Andrew Main

Judging by the mauling that private hospital operator Healthscope received having announced last week that revenue growth in the first quarter was less than expected, the market is certainly nervous.

The shares were whacked almost 19%, dropping 55 cents to $2.38 on Friday just after the announcement, a further 14 cents to $2.24 on Monday, before finally picking up some ground to close yesterday at $2.28.

This is a stock that relisted out of private equity more than two years ago, in July 2014, at $2.10.

What’s going on? After Ramsay Health Care, this is the biggest private hospital group in Australia with 18,000 employees.

On Monday, the brokers put out their research on the stock and out of seven reports, only one of them, from UBS, was a Buy and that wasn’t an upgrade.

By comparison, Citi downgraded it from a Buy to Neutral and all the others put it in the Goldilocks basket. Ord Minnett and Morgans, both private client specialists, were the most bullish of that group with an Accumulate and “Add” recommendation, while others were just plain neutral.

What may really be going is the slight popping of a bubble of excess optimism, caused by the assumption that revenue in the sector should take off like a homesick angel as armies of oldies get their knees and hips done.

There’s been some negative press around. As the well-regarded MD Robert Cooke put it, “over the last 12 months we have seen a heightened level of public commentary in relation to healthcare affordability and consumer confidence in private health insurance in Australia”.

He’d know. As chairman, Paula Dwyer noted at the Annual Meeting that followed the sort-of-downgrade, “private hospitals are a key pillar of the Australian healthcare system, performing two thirds of all elective surgery in Australia”.

She amplified Cooke’s point about consumer blowback, citing affordability concerns, product complexity, increasing exclusions and the rise of what she called “junk” policies that severely limit private hospital access.

So what this means is that consumers are unhappy with the way their private medical insurance is working and some of them are holding off elective surgery for that reason.

No one’s saying the private hospitals are doing a bad job and in fact it’s well known in the industry that private hospitals do a good job of keeping an eye on the costs of all those artificial knee, hip and similar operations. That’s their bread and butter.

This doesn’t look like a rerun of the recent crunch on the aged care stocks such as Estia, because that was all about the Government cracking down on the operators charging oldies for services they might not be getting.

This one is between the potential patients and the insurers, with the government playing a less obtrusive (but still important) role in pushing people towards private health insurance to reduce the burden on the public health system.

If you stand back objectively and work out what has to happen, the government is going to make damn sure the private system keeps going, because otherwise we’re going to go back to the bad old days of seeing crowds of people from their mid-50s upwards hobbling around for want of a hip operation.

And the private health insurers had better lift their act. Certainly, Medibank’s been paying attention. New CEO, Craig Drummond, a recovering analyst who can spot a trend a mile off, recently told shareholders that “we need to put our customers at the centre of everything we do”.

This was an insurer which found last year that while it enjoyed a legislated premium increase of 6.59%, the actual premiums paid were only up 5.1% and customer numbers also fell by 2.6%.

Note the word “legislated”. The government controls what insurers can charge and can also dictate how much some inputs cost. For instance, UBS points out it recently announced a cut of 10% in the price that can be charged for cardiac and intra-ocular devices and a 7.5% cut to the price of hip and knee joints.

“A new price referencing mechanism is expected to be applied to the list using global reference prices that are as much as 50% below list rates,” says UBS.

But one reason the broker keeps a rare Buy on Healthscope is that it’s less likely to be seen an impact on actual earnings than on sentiment.

If you assume private hospitals can’t in future charge as much for prostheses, that will bring the insurers’ and the patients’ costs down, which in the long run will be a positive for the patients, the private hospitals and the insurers. It’s no surprise at all to find the overseas manufacturers of these widgets have been ripping us all off blind for years. If retailers used to call Australia “Treasure Island” for our habit of happily paying too much for goods, imagine how the manufacturers of prosthetics must have felt.

Let’s stand back again and look at the big picture. Hips and knees and all those other wearing out parts will need renewing more than ever, and every year that ticks by with fewer people going in for elective surgery, simply bumps up the number who will end up having to go in anyway, at a future date.

It’s like going to the hairdresser. If you choose not to go because of other more pressing considerations, you will still end up going.

And we all know we’re living longer.

So is Healthscope a buy? It’s more of one now than it was, but it will be up to the insurers to reassure potential patients on actual costs. Until that happens, members of the public will hold off increasing their insurance and the private hospital operators will have to wait.

It will all come good, but just not for a while and it’s hard to estimate how long that will be. Maybe one for the bottom drawer.

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