AFKI Africa Stock Showdown: Life Healthcare vs. Netcare

By Ryan Hoover AFKI Original Published: December 11, 2013, 2:28 pm

It’s time for the AFKI Africa Stock Showdown, the contest that pits two similar African companies against each another to determine which boasts the best combination of profitability, growth and value.

Our contenders this week are two heroes of healthcare.

The first challenger is Netcare. This Johannesburg-based holding company operates the largest network of private hospitals and emergency services in South Africa. It also runs expansive operations in the U.K., where it is the largest private acute care health provider. The U.K. division has struggled, but management is optimistic that group restructuring will put the company on the path to greater profitability.

And, in the opposite corner is Life Healthcare Group (LHG). Founded in 1983, LHG operates private hospitals throughout South Africa and Botswana. It also runs specialized rehab, mental health, and dialysis facilities. CEO Michael Flemming is leading the firm in an expansion drive that will see it add 325 new hospital beds within the next 15 months.

The match will consist of six rounds, each focused on a different facet of the business. The company that wins the most rounds will be declared the victor.

Let’s get ready to rumble.

Round 1: Profitability

A business isn’t much of a business if it’s not profitable, so that’s where our showdown begins. We want to see which company does the best job of deploying the resources available to generate cash in the bank. To do this, we compare return on assets (ROA), which measures the amount of net income a company earned in proportion to its average assets over the past year. We also want to see whether the companies are becoming more or less profitable, and we’ll do this by measuring the change in ROA over the preceding year.

ROA
Life Healthcare: 18.3%
Netcare: 15.0%

% change in ROA
Life Healthcare: 8.5%
Netcare: 314.4%

Life Healthcare’s ROA is higher, but Netcare’s is expanding more rapidly thanks to its recent restructuring efforts. I’m calling this round a draw.

Winner: Draw

Round 2: Growth

Profitability is essential, but great companies also consistently find ways to grow. While growth is often measured in terms of earnings, I prefer to use cash flow from operations (CFO). Why? Because it measures the amount of cash that is actually moving in and out of the business as a result of its daily operations. Earnings figures, meanwhile, often include non-cash items and are more easily manipulated with accounting tricks.

CFO Growth
Life Healthcare: 13.8%
Netcare: -7.9%

Life Healthcare takes this round decisively. Its cash from operations increased while Netcare’s shrank.

Winner: Life Healthcare

Round 3: Efficiency

Now, let’s consider how much of each company’s sales is eaten up by inventory, distribution, and administration costs. To do it, we’ll compare their operating margins (which is simply operating profit divided by revenue). We want companies with high, widening operating margins.

Operating Margin
Life Healthcare: 24.9%
Netcare: 11.0%

% change in Operating Margin
Life Healthcare: 7.1%
Netcare: -27.3%

With a high operating margin that expanded over the past year, Life Healthcare clearly deserves the round.

Winner: Life Healthcare

Round 4: Leverage

Big debt loads squeeze profit margins and can be a constraint to growth. We should look for companies that have low levels of long-term debt in relation to total assets, and for management teams that do a good job of reducing this ratio from year to year.

Long-term Debt/Assets Ratio
Life Healthcare: 16.6%
Netcare: 22.1%

% change in LT Debt/Assets Ratio
Life Healthcare: -20.3%
Netcare: -63.8%

Life Healthcare has a lower debt load in relation to its assets than does Netcare, but because of some de-consolidation of its businesses, Netcare has reduced its interest-bearing liabilities at a quicker pace. Gotta call it a draw.

Winner: Draw

Round 5: Liquidity

We also need to make sure that the company is able to meet its short-term cash obligations like taxes and accounts payable. To do this we will compare the health of both companies’ current ratios. This helpful metric simply divides current assets (like inventory, cash, receivables) by current liabilities. The higher the ratio, the more nimbly the company can deploy capital.

Current Ratio
Life Healthcare: 0.74
Netcare: 1.01

% change in Current Ratio
Life Healthcare: -4.3%
Netcare: -3.5%

Netcare has to work quickly if it wants a chance to win this bout, and, with a healthier current ratio, it wins the Round 5 decision.

Winner: Netcare

Round 6: Valuation

Finally, we need to see which company is least favored by the market. We’ll do this by comparing two important value metrics – the price/book ratio, which measures the price placed on the company’s net assets, and the price/cash-flow ratio, which shows us how much the market currently values each dollar the company generates. In both cases, lower ratios indicate less-demanding valuations.

P/B Ratio
Life Healthcare: 7.3
Netcare: 3.1

P/CF Ratio
Life Healthcare: 15.7
Netcare: 14.3

With a lower price/book ratio and lower price-to-cash flow ratio, this round goes to Netcare.

Winner: Netcare

In a stunning, unprecedented comeback, Netcare has evened the bout. But we can’t let our third Africa Stock Showdown end in a tie, can we?

To break the tie, we’re going to select the winner of what is, in my view, the most important of the six rounds – valuation. Why? Because study after study has shown that stocks with less demanding valuation ratios tend to outperform their more expensive counterparts over time.

So, based on this hopefully not-too-arbitrary rule change, Netcare wins the showdown in dramatic fashion.

Now, it’s time for you to have your say. Did Netcare deserve the victory? Let us know in the comments.

Ryan Hoover is an investment analyst with Africa Capital Group and the founder of InvestingInAfrica.net. Contact him at ryan@investinginafrica.net.

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