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Why FTSE 100 growth stock NMC Health could trash the GSK share price

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Healthcare stocks can be attractive and defensive buys when market conditions are uncertain. Demand for medicine and medical care tends to be fairly consistent.

The two stocks I’m going to look at today have both outperformed the FTSE 100 so far this year. Should investors keep buying, or are the shares now starting to look fully priced?

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Growth ahead of expectations

The share price of Abu Dhabi-based  healthcare centre operator NMC Health (LSE: NMC) rose by 5% in early trading this morning after the firm said that its 2018 profits would be higher than expected.

Full-year revenue is now expected to rise by 24%, up from previous guidance of 22%. And full-year earnings before interest, tax, depreciation and amortisation (EBITDA) are now expected to be $480m, 3.2% above previous guidance of $465m. My sums suggest this should give a healthy EBITDA profit margin of 24%.

It’s good news for shareholders, who’ve seen the value of their stock fall by more than 25% from August’s all-time high of 4,376p. But NMC shares aren’t cheap. Does today’s update do enough to earn this £6bn business a buy rating?

My verdict

The company said that “strong organic growth” is also expected in 2019 and new facilities continue to ramp up. Revenue is expected to rise by a further 22%-24% and EBITDA is expected to rise by 18%-20%.

Profit margins will be slightly lower as a result of investment in new facilities, but, given such strong growth, that seems reasonable to me.

My only concern is about the group’s valuation. The group’s $1.1bn net debt equates to 2.8 times trailing EBITDA, which is above my preferred maximum of 2 times. NMC stock also looks expensive, on 28 times 2018 forecast earnings.

The firm’s rapid earnings growth means that I expect the shares to grow into this demanding valuation. But NMC’s current share price doesn’t leave much room for disappointment. A buy for growth investors only, I think.

One stock I’d buy for safety

One limitation of NMC for investors who need an income is that the stock’s forecast dividend yield is currently just 0.6%.

If you’re looking for a mix of income and growth, one option would be to combine a shareholding in NMC with a position in pharmaceutical group GlaxoSmithKline (LSE: GSK).

In July, Glaxo upgraded its earnings guidance for the full year. The successful launch of new shingles vaccine Shingrix and the buyout of the remaining share of its Consumer Healthcare business mean that adjusted earnings are expected to rise by between 4% and 10%. Previous guidance was for -3% to +7%.

These forecasts cover a wide range because profits will be affected by the timing of the delayed launch of a generic rival to the group’s Advair asthma treatment. When this happens, profits from Advair will fall sharply.

I’d keep buying

Chief executive Emma Walmsley says that she is “increasingly confident in our ability to deliver mid-to-high single-digit” annual growth in adjusted earnings over the period to 2020.

Free cash flow doubled to £821m during the first half of the year, reducing the chance of a dividend cut. A rumoured $3bn sale of the group’s Horlicks business in India could provide a further cash boost.

I think the shares look good value on 15 times 2018 forecast earnings, with a 5.1% dividend yield. A stock I’d buy and hold.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended NMC Health. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.