Shares digital

Southern Cross Healthcare (SCHE) – 389p, stop loss 311p

SHARES SUMMARY

Panic selling seems to have subsided after February’s reassuring trading statement, and long-term demographics favour this well-positioned firm.

Business:

The UK’s leading provider of care homes, with 727 homes and over 37,000 beds nationwide.

Vital stats:

Market value: £732.1 million

Historic PE: 405.2

Prospective PE 2008: 14.4

Prospective PE 2009: 11.6

Sector PE (next 12 months): 17.3

1-month relative strength: -5%

1-year relative strength: -12.8%

Yield 2008: 3%

NMS: 3,750

Spread: 0.19%

It may have looked like 2007 was plain sailing for the provider of social and personal care services for the elderly and disabled, but 2008 has been anything but, so far at least. Southern Cross Healthcare’s shares all but doubled last year, soaring from 310p to a December peak of 599p. Yet in the space of just two months, nearly all of those gains had been wiped out. Directors’ selling of 6.65 million shares at 550p following the full-year results in December and the unexpected departure of both chief executive Philip Scott and finance director Graham Sizer spooked investors, and the shares reached 332p in January.

Yet chairman Bill Colvin and long-standing financial controller Jason Lock swiftly filled the vacant posts, ensuring continuity. The acquisition of 11 care homes across a pair of deals in February and March, and a reassuring trading statement in February, also suggest it is still very much business as usual and, if the May’s interim figures show further progress, the shares should continue their recent rally.

Under the auspices of two brands, Southern Cross Healthcare and Ashbourne Senior Living, the company’s care homes for the elderly provide social, personal and nursing care services. Southern Cross also operates specialist services for people with disabilities, under the Active Care Partnerships brand.

The portfolio of care homes largely consists of purpose-built with a high percentage of single rooms. Occupancy rates for the elderly stand at around 90%.

February’s trading update revealed 30% sales growth for the first quarter of the new financial year, which will end on 30 September. Good organic growth of 5.4% was supplemented by a number of acquisitions, and both trends are expected to continue.

Firstly, long-term demographic trends point inexorably toward an aging population. Private sector care provision should also grow faster than the overall market, as the state continues to withdraw direct provision of professional care for pensioners who are basically healthy.

Secondly, Southern Cross’s UK market share is less than 10%, even though it is market leader. Further consolidation is likely and the company recently boosted its acquisition facility from £46 million to £106 million. Healthy free cashflow and an ongoing strategy to sell and leaseback properties as a means of releasing cash, means servicing the current £65 million net debt position should not be an issue.

There are risks. Regulatory intervention has hampered this sector in the past, as have occasional capacity binges, although neither look likely at the moment. More pressing are rising food, medical supply and utility costs. However, a 5.6% price increase with private clients should help absorb these, and a 4.2% payroll settlement.

A deal for a 4.38% increment in Scotland, where Southern Cross has just over 5,500 beds, or 15% of its portfolio, also bodes well. Talks with local authorities who, in conjunction with the NHS provide some 70% of the company’s revenues, are due to conclude shortly. The outcome of these is due for release in May, alongside interim figures. Progress here should confirm the attractions of a stock on a prospective PE of around 14, which even throws in a 3% prospective yield for good measure.

by: Russ Mould