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Strategic Report:

Financial
Review

“Strong cash flow generation is key to delivering on the long-term success of the Group.”

Jurgens Myburgh

Chief Financial Officer

INTRODUCTION

During the year under review, the changes in the regulatory environment, particularly in Switzerland, and its impact on the operating profit of the business, have tested the resolve of the financial strategy and the Group’s approach to maintaining responsible leverage.

The role of the Finance function at Mediclinic is to support the Group’s strategic position as an international leader in the provision of private healthcare services while ensuring we deliver sustainable long-term shareholder value through return on invested capital. While our recent profitability has challenged the achievement of appropriate returns, the invested capital of the Group remains underpinned by our philosophy of property ownership. Mediclinic as a group has a stated preference of, where possible, owning the properties at which it operates. In Switzerland, we own 15 of the 18 hospital properties; in Southern Africa, 50 of the 51; and in the Middle East, we own both Mediclinic City and Mediclinic Parkview hospitals in Dubai that are situated in so-called free zone areas. As highlighted previously, our preference is premised on both operational and financial benefits:

  • From an operational perspective, the ongoing ability to adapt our hospitals to the changing care settings driven by the needs of medical practitioners and patients, and facilitated by information, communication and medical technology, puts us at an advantage regarding the quality and speed of execution.

“Strong cash flow generation is key to delivering on the long-term success of the Group.”

Jurgens Myburgh

Chief Financial Officer

INTRODUCTION

During the year under review, the changes in the regulatory environment, particularly in Switzerland, and its impact on the operating profit of the business, have tested the resolve of the financial strategy and the Group’s approach to maintaining responsible leverage.

The role of the Finance function at Mediclinic is to support the Group’s strategic position as an international leader in the provision of private healthcare services while ensuring we deliver sustainable long-term shareholder value through return on invested capital. While our recent profitability has challenged the achievement of appropriate returns, the invested capital of the Group remains underpinned by our philosophy of property ownership. Mediclinic as a group has a stated preference of, where possible, owning the properties at which it operates. In Switzerland, we own 15 of the 18 hospital properties; in Southern Africa, 50 of the 51; and in the Middle East, we own both Mediclinic City and Mediclinic Parkview hospitals in Dubai that are situated in so-called free zone areas. As highlighted previously, our preference is premised on both operational and financial benefits:

  • From an operational perspective, the ongoing ability to adapt our hospitals to the changing care settings driven by the needs of medical practitioners and patients, and facilitated by information, communication and medical technology, puts us at an advantage regarding the quality and speed of execution.
  • From a financial perspective, our property portfolio offers security to our debt financing, providing capital to the Group at competitive borrowing rates. We manage our leverage on a responsible basis with respect to both the cost and maturity/refinance risk of the borrowings. All divisions have been recently re-financed on medium- to long-term maturity profiles with options for further extension. Further, the possible inflexibility of lease agreements and charges through business cycles can potentially impact the operating cash flows and restrict ongoing investment and upgrades that support the sustainability and future growth of the business.

On the balance sheet, the Group carries the value of its land and buildings at cost less accumulated depreciation and impairment. Cost was based on fair value at the acquisition date, as appropriate. In Switzerland, there is an annual independent valuation performed on behalf of the banks on the property portfolio for covenant compliance purposes by independent real estate experts, Wüest & Partner. They apply a consistent methodology across key assumptions to determine the rental charges based on appropriate and market-related metrics, which is discounted using a market-related discount rate to determine the value of the properties.

Strong cash flow generation is key to delivering on the long-term success of the Group. Supporting this is our focus on profitable growth and disciplined capital allocation to generate returns in excess of the bottom-up hurdle rates we establish for each division. Through our structured annual financial planning process, we ensure that the appropriate capital is allocated to each division to maintain, upgrade and expand. We will continue to prioritise investment in our existing divisions because we believe that this is where we have a greater line of sight on risks and returns and where we are able to leverage existing infrastructure. In doing so, we will improve the overall return on invested capital.

Having completed a multi-year investment in the Middle East with the opening in September 2018 of the AED680m Mediclinic Parkview Hospital, re-calibrated the annual maintenance and expansion capital investment in Hirslanden to align with the new regulatory environment and nearing completion of a multi-year maintenance upgrade cycle in Southern Africa, we expect to deliver an improvement in the free cash flow generation of the Group over the medium term.

In conclusion, with the current challenging healthcare environment, our diligent approach to financial management across the Group presents Mediclinic with medium-term sustainability and flexibility to invest in incremental growth propositions across the continuum of care, manage the level of debt to covenants across all divisions and improve shareholder returns.

GROUP FINANCIAL PERFORMANCE

Group revenue increased by 2% to £2 932m (FY18: £2 876m) for the reporting period. In constant currency terms, FY19 revenue was up 4% in a challenging environment.

EBITDA was 4% lower at £493m (FY18: £515m), with adjusted EBITDA margins declining from 17.9% to 16.8%.

Adjusted depreciation and amortisation was up 12% to £163m (FY18: £145m), in line with the continued investment to upgrade and expand the asset base, supporting future growth, enhancing patient experience, and clinical quality and driving efficiencies.

The Group recorded an operating profit of £81m in FY19 (FY18: operating loss of £288m). Adjusted operating profit decreased by 11% to £330m (FY18: £370m). Operating profit was adjusted for the following exceptional items:

  • recognition of an impairment charge to Hirslanden property, equipment and vehicles. Non-financial assets are considered for impairment when impairment indicators are identified at an individual cash-generating unit (“CGU”) level. During the year, the CGUs in Hirslanden were tested for impairment. For certain CGUs, the carrying value was determined to be higher than its recoverable amount and as a result an impairment charge of £186m was recognised in the income statement;
  • recognition of an impairment charge to the Hirslanden trade name and the Linde trade name. As part of the CGU impairment testing, the carrying amounts of these trade names were determined to be higher than their recoverable amounts and, as a result, impairments of £39m and £16m respectively were recognised in the income statement;
  • accelerated depreciation of £5m in Hirslanden relating to abandoned building project cost aligned with the disciplined approach to capital allocation; and
  • a loss on disposal of certain non-core businesses at Mediclinic Middle East of £1m.

Adjusted net finance costs decreased by 19% to £57m (FY18: £70m), benefiting from the refinance in all divisions during the current and prior years.

The Group’s reported effective tax rate is significantly skewed by exceptional non-deductible expenses which include: impairment of properties and trade names; impairment of the equity investment and accelerated depreciation. A prior year adjustment relating to a change in the basis of estimating deferred tax on the Swiss properties led to the recognition of a tax credit of £17m. Adjusted taxation was £57m (FY18: £64m), with an adjusted effective tax rate for the period decreasing to 20.4% (FY18: 20.8%) reflecting a lower average tax rate in Switzerland. After adjusting for the amortisation of intangible assets recognised in the notional purchase price allocation of the equity investment, the FY18 income from associates was £2.7m (FY18: £2.8m).

The Group recorded an earnings loss of £151m in FY19 (FY18: £492m). Adjusted earnings decreased by 10% to £198m (FY18: £221m). Adjusted EPS were 10% lower at 26.9 pence (FY18: 30.0 pence). Earnings were adjusted for the following exceptional items:

  • recognition of an impairment charge on the equity investment in Spire of £164m. During the year, the Group performed an impairment test updating the key assumptions applied in the value-in-use calculation performed at 31 March 2018. In particular, the Group adjusted the value-in-use calculation for the guidance announced by Spire in September 2018 on the current financial performance and on the related impact on short- and medium-term growth rates, and revisited other key assumptions in this context. As a result, an impairment loss of £164m was recorded against the carrying value; and
  • a change in the basis of estimating deferred tax on the Swiss properties giving rise to a tax credit of £17m.

ADJUSTED NON-IFRS FINANCIAL MEASURES

The Group uses adjusted income statement reporting as non-IFRS measures in evaluating performance and as a method to provide shareholders with clear and consistent reporting. The adjusted measures are intended to remove volatility associated with certain types of exceptional income and charges from reported earnings. Historically, EBITDA and adjusted EBITDA were disclosed as supplemental non-IFRS financial performance measures because these are regarded as useful metrics to analyse the performance of the business from period to period. Measures like adjusted EBITDA are used by analysts and investors in assessing performance.

The rationale for using non-IFRS measures:

  • it tracks the adjusted operational performance of the Group and its operating segments by separating out exceptional items;
  • non-IFRS measures are used by management for budgeting, planning and monthly financial reporting;
  • non-IFRS measures are used by management in presentations and discussions with investment analysts; and
  • non-IFRS measures are used by the directors in evaluating management’s performance and in setting management incentives.

The Group’s policy is to adjust, inter alia, the following types of significant income and charges from the reported IFRS measures to present adjusted results:

  • cost associated with major restructuring programmes;
  • profit/loss on sale of assets and transaction costs incurred during acquisitions;
  • past service cost charges/credits in relation to pension fund conversion rate changes;
  • accelerated depreciation and amortisation charges;
  • mark-to-market fair value gains/losses relating to derivative financial instruments, including ineffective interest rate swaps;
  • impairment charges and reversal of impairment charges;
  • insurance proceeds; and
  • tax impact of the above items, prior year tax adjustments and significant tax rate changes.

EBITDA is defined as operating profit before depreciation and amortisation and impairments of non-financial assets, excluding other gains and losses.

Non-IFRS financial measures should not be considered in isolation from, or as a substitute for, financial information presented in compliance with IFRS. The adjusted measures used by the Group are not necessarily comparable with those used by other entities.

The Group has consistently applied this definition of adjusted measures as it has reported on its financial performance in the past as the directors believe this additional information is important to allow shareholders to better understand the Group’s trading performance for the reporting period. It is the Group’s intention to continue to consistently apply this definition in the future.

EARNINGS RECONCILIATIONS

FOREIGN EXCHANGE RATES

Although the Group reports its results in pound sterling, the divisional profits are generated in Swiss franc, UAE dirham and South African rand. Consequently, movements in exchange rates affected the reported earnings and reported balances in the statement of financial position. Exchange rate movements also had a significant impact on the statement of financial position. The resulting currency translation difference, which is the amount by which the Group’s interest in the equity of the divisions increased because of spot rate movements, amounted to £142m (2018: decrease of £310m) and was credited (2018: debited) to the statement of comprehensive income. The main reason for the increase was the strengthening of the period-end Swiss franc and UAE dirham rates against the pound sterling.

Foreign exchange rate sensitivity:

  • The impact of a 10% change in the £/CHF exchange rate for a sustained period of one year is that profit for the period would increase/decrease by £8m (2018: increase/decrease by £12m) due to exposure to the £/CHF exchange rate.
  • The impact of a 10% change in the £/ZAR exchange rate for a sustained period of one year is that profit for the period would increase/decrease by £7m (2018: increase/decrease by £9m) due to exposure to the £/ZAR exchange rate.
  • The impact of a 10% change in the £/AED exchange rate for a sustained period of one year is that profit for the period would increase/decrease by £5m (2018: increase/decrease by £4m) due to exposure to the £/AED exchange rate.

During the reporting period, the average and closing exchange rates were the following:

CASH FLOW

The Group continued to deliver strong cash flow and converted 91% (FY18: 90%) of adjusted EBITDA into cash generated from operations.

INTEREST-BEARING BORROWINGS

Interest-bearing borrowings increased from £1 937m at 31 March 2018 to £1 982m at 31 March 2019 to fund expansion.

ASSETS

Property, equipment and vehicles decreased from £3 590m at 31 March 2018 to £3 524m at 31 March 2019. This included an increase of £204m on capital projects and fixed asset additions in line with the continued investment programme expanding the asset base to support growth and enhancing patient experience and clinical quality. In addition, the closing balance increased by £20m as a result of the Clinique des Grangettes acquisition. In addition to the depreciation charge, the balance was further reduced by the impairment charge of £186m recognised on property, equipment and vehicles in Hirslanden and increased by the change in the closing exchange rate.

Intangible assets increased from £1 406m at 31 March 2018 to £1 587m at 31 March 2019. This included the recognition of goodwill of £99m resulting from the Clinique des Grangettes acquisition and on other smaller business combinations of £8m, as well as an increase of £28m on capital projects. In addition to the amortisation charge, the balance was further reduced by the impairment charge of £55m recognised on trade names in Hirslanden. The closing balance increased by the change in the closing exchange rates.

Adjusted depreciation and amortisation was calculated as follows:

TRADE AND OTHER RECEIVABLES

Trade and other receivables increased from £607m at 31 March 2018 to £732m at 31 March 2019. The increase in the balance was largely due to the effect of HIT2020 billing system implementation and the acquisition of Clinique des Grangettes.

SWISS PENSION BENEFIT OBLIGATION

Hirslanden provides defined contribution pension plans in terms of Swiss law to employees, the assets of which are held in separate trustee-administered funds. These plans are funded by payments from employees and Hirslanden, taking into account the recommendations of independent qualified actuaries. Because of the strict definition of defined contribution plans in IAS 19, these plans are classified as defined benefit plans. Since the funds are obliged to take some investment and longevity risk in terms of Swiss legislation. The IAS 19 pension liability was valued by the actuaries at the end of the year and amounted to £52m (2018: £4m), included under “Retirement benefit obligations” in the Group’s statement of financial position. The increase in the pension liability was largely due to the decrease in the discount rate from 0.75% to 0.45%, as well as changes in actuarial assumptions.

DERIVATIVE FINANCIAL INSTRUMENTS

Through the acquisition of Clinique des Grangettes, the Group entered into a put/call agreement over the remaining 40% interest of Clinique des Grangettes and Hirslanden Clinique La Colline. At the end of the year, the fair value of the redemption liability, related to the written put option amounted to £88m (2018: nil).

DEFERRED TAX LIABILITIES

The deferred tax liability balance decreased from £467m in the prior year to £423m at 31 March 2019. The impairment of the trade names and properties in Hirslanden led to the release of deferred tax liabilities of £12m and £35m respectively. A prior year adjustment relating to a change in the basis of estimating deferred tax on Swiss properties led to the recognition of a tax credit of £17m.

FINANCE COSTS

Adjusted net finance costs decreased by 19% to £57m (FY18: £70m), benefiting from the refinance in all divisions during the current and prior years.

INCOME TAX

The Group’s effective tax rate changed significantly for the period under review to 5.4% (FY18: 1.1%), mainly due to exceptional non-deductible expenses which include the impairment of properties and trade names, impairment of the equity investment and accelerated depreciation. In addition, a prior year adjustment relating to a change in the basis of estimating deferred tax on Swiss properties led to the recognition of a tax credit of £17m. Excluding these exceptional items, the effective tax rate would be 20.4% (FY18: 20.8%) for the reporting period.

Adjusted income tax was calculated as follows:

TAX STRATEGY

The Group is committed to conduct its tax affairs consistent with the following objectives:

  • complying with relevant legislation, rules, regulations, and reporting and disclosure requirements in whichever jurisdiction it operates; and
  • maintaining mutual trust and respect in dealings with all tax authorities in the jurisdictions the Group does business.

While the Group aims to maximise the tax efficiency of its business transactions, it does not use structures in its tax planning that are contrary to intentions of relevant legislation. The Group interprets relevant tax laws to ensure that transactions are structured in a way that is consistent with a relationship of co-operative compliance with tax authorities. It also actively considers the implications of any planning for the Group’s wider corporate reputation.

In order to meet these objectives, various procedures are implemented. The Audit and Risk Committee has reviewed the Group’s tax strategy and related corporate tax matters.

REFINANCING OF DEBT

The borrowing facilities in Mediclinic Southern Africa and Mediclinic Middle East were refinanced during the year. In both instances, the terms of the loans were extended with favourable pricing. The effective date for the funding and the closing was 26 September 2018 and 29 August 2018 respectively. In Mediclinic Middle East, a new term loan of £192m (AED920m) and revolving loan facility of £38m (AED184m) were put in place.

In Switzerland, an amendment to the financing agreement was entered into in March 2019, adjusting the covenants to reflect the impact of the recent regulatory changes on the profitability of the business. There was no change to the interest margin of the debt facility.

SPIRE HEALTHCARE GROUP

Mediclinic has a 29.9% investment in Spire.

Spire’s underlying performance for the 12 months to 31 December 2018 resulted in underlying revenue decreasing 1.3%, underlying EBITDA decreasing 23.3% and the underlying EBITDA margin decreasing to 13.4%. Adjusted basic earnings per share (excluding exceptional and tax one-off items) decreased by 52.1%. Underlying inpatient and day case admissions declined 4.6%, driven by volume declines more than offsetting growth in self-pay.

Mediclinic’s investment in Spire is equity accounted. Spire reported profit after tax of £11.3m for the financial year ended 31 December 2018 (31 December 2017: £16.8m). Spire’s adjusted profit after tax for the year was £27.5m (31 December 2017: £57.9m). After adjusting for the amortisation of intangible assets recognised in the notional purchase price allocation of the equity investment, the FY19 income from associate was £2.7m (FY18: £2.8m). The underlying and adjusted measures referenced above have been extracted from Spire’s results announcement for the year ended 31 December 2018.

As at 30 September 2018, the market value of the investment in Spire was £169m, which was below the carrying value. An impairment test was performed by updating the key assumptions applied in the value in use calculation performed at 31 March 2018. The impairment test was prepared based on the Group’s updated expectations of Spire’s future trading performance and considered external sources of information, including investor analyst valuations and target prices published. Key assumptions related to cash flow growth rates in the short- and medium-term were adjusted in the value in use calculation. As a result, an impairment loss of £164m was recorded against the carrying value in the first half year. At year-end, another impairment test (updated for latest guidance announced by Spire in March 2019) was performed and no further impairment charge was required.

OUTLOOK

The Group provides the following guidance for FY20 before the effect of adopting IFRS 16, which remains unchanged since the April 2019 Trading Update:

  • Hirslanden: In FY20 Hirslanden expects modest revenue growth from an increase in average bed capacity for the year, reflecting the continued integration of Clinique des Grangettes. Under the current regulatory environment, Hirslanden will be impacted by a further nine months’ comparative effect in FY20 from the national outmigration care programme that was implemented from 1 January 2019. The anticipated cost management and efficiency savings are likely to be more than offset by reductions in tariffs and the operational effects of outmigration, with the FY20 EBITDA margin expected to be around 15%. Over the medium-term, and assuming no further regulatory changes are implemented, the operating performance is expected to be supported by benefits from the Hirslanden 2020 strategic project and structural efficiencies being implemented in the division.
  • Mediclinic Southern Africa: In FY20 Mediclinic Southern Africa expects volume growth of around 1% reflecting the additional capacity from the Intercare day case clinics that were consolidated from December 2018. In line with the Group’s strategic objectives and a continued focus on improving clinical quality and patient experience, further investment will be made in employees and ICT during FY20. This, together with the expected lower margin contribution from Intercare and the ramp up of the new Mediclinic Stellenbosch facility, is anticipated to result in an EBITDA margin of around 20%.
  • Mediclinic Middle East: In FY20 the Middle East division is expected to deliver revenue growth of around 10% supported by the continued ramp-up of the new Mediclinic Parkview Hospital. A gradual improvement in the EBITDA margin is expected in FY20 to around 14% incorporating the ramp-up of the Mediclinic Parkview Hospital and investment in the hospital expansion and new cancer centre at Mediclinic Airport Road Hospital, which is scheduled to open in the first half of calendar year 2020. The division continues to target an EBITDA margin of around 20%.
  • The Group’s capital expenditure budget, in constant currency, for FY20 is expected to decrease by 12% to £207m (FY19: £232m). This comprises £70m in Hirslanden (FY19: £72m), £71m in Mediclinic Southern Africa (FY19: £65m), £66m in Mediclinic Middle East (FY19: £94m) and £nil (FY19: £1m) in Corporate. The decrease largely results from the conclusion in FY19 of the major new Mediclinic Parkview Hospital project in the Middle East and continued focus on capital allocation in Switzerland to reflect the current regulatory environment. Average FY19 exchange rates used: CHF1.30; ZAR18.01; and AED4.82.

The Group will adopt the new IFRS 16 accounting standard (addressing the definition of a lease, recognition and measurement of leases and establishes principles for reporting useful information to users of financial statements about the leasing activities of both lessees and lessors) from 1 April 2019 and comparatives will not be restated. The EBITDA margin guidance for FY20 under IFRS 16 is set out below, together with the indicative corresponding margin for FY19:

  • Hirslanden: around 17% (FY19: 18.1%)
  • Mediclinic Southern Africa: around 21% (FY19: 21.7%)
  • Mediclinic Middle East: around 17% (FY19: 16.1%)

DIVIDEND POLICY AND PROPOSED DIVIDEND

The Group’s existing Dividend Policy targets a pay-out ratio of between 25%–30% of adjusted earnings. The Board may revise the policy at its discretion. Given the impact of IFRS 16 accounting changes, the Board deems it appropriate to adjust the future payout ratio to 25%–35% of adjusted earnings.

The Board proposes a final dividend from retained earnings of 4.70 pence per ordinary share for the year ended 31 March 2019 for approval by the shareholders at the Company’s 2019 annual general meeting (“AGM”) on Wednesday, 24 July 2019. Together with the interim dividend of 3.20 pence per ordinary share for the six months ended 30 September 2018 (paid on 18 December 2018), the total proposed dividend for the year reflects a 29% distribution of adjusted Group earnings attributable to ordinary shareholders.

Shareholders on the South African register will be paid the South African rand cash equivalent of 86.24500 cents (68.99600 cents net of dividend withholding tax) per share. A dividend withholding tax of 20% will be applicable to all shareholders on the South African register who are not exempt therefrom. The South African rand cash equivalent has been calculated using the following exchange rate: £1: ZAR18.35, being the five-day average ZAR/£ exchange rate (Bloomberg) on Friday, 17 May 2019 at 15:00 GMT.

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