Gamble of the week: healthcare firm with profit potential

Last week rumours abounded that the government wants to introduce a one-off £20,000 death tax. This would be levied on an individual’s estate, providing a means of recovering the heavy cost of state care for the elderly. And Southern Cross Healthcare (SCHE) would be a winner from what could be an £8bn-a-year money-spinner.

Southern Cross Healthcare is Britain’s largest retirement home provider with around an 8% share of an £11.8bn market managing 750 care homes with 38,452 available beds. Its premises are designed for both the elderly (95% of sales) and for young people with learning and physical disabilities (5%). Three-quarters of residents have been deemed unable to live on their own by social services, and require round-the-clock care.

So why the 75% fall in the share price since November 2007? Well, during the go-go days of cheap credit, Southern Cross expanded too rapidly and saddled itself with huge debts. When the credit crunch struck, not only did funding dry up, but the value of its property also dropped like a stone. That left Southern Cross in breach of its banking covenants. Since then, a new chief executive with turnaround experience has been appointed and has already taken the company by the scruff of its neck. And, following a series of asset disposals, net debt is now a comfortable £29.5m.

Southern Cross Healthcare (LSE: SCHE)

Furthermore, the board is tackling the inconsistency of service across the group’s portfolio of homes. A new inspection system has been rolled out nationally, and standards are already improving. Indeed, occupancy levels are at 87.6%, with 79% of all the group’s sites rated either ‘excellent’ or ‘good’.

The City is predicting 2010 revenues and earnings per share of £979m and 18.7p respectively, rising to £1.02bn and 21.2p by 2011. That puts the stock on cheap price/earnings (p/e) multiples of 8.0 and 7.1. It also offers a forward dividend yield of 3%. However, I would value the group using a six-times earnings before interest, tax, depreciation and amortisation (Ebitda) multiple. After adjusting for debt, that generates an intrinsic value of more than £2 per share.

As usual, there are some risks involved. These include Southern Cross Healthcare’s high operational gearing (fixed costs form a large proportion of total costs), further falls in commercial property values, and cut-backs from cash-strapped councils and the NHS (which account for 78% of turnover – a typical resident at one of Southern Cross Healthcare’s homes costs the government around £27,000 per year).

All the same, the company should benefit from long-term demand from an ageing population, a contraction in the number of homes available as rival sites close due to stricter regulation, and access to cheaper labour.  

Recommendation: SPECULATIVE BUY at 150p

Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments

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