Sonic’s Non-Australian Pathology Volumes Expected to Remain Lower for Longer, Reduce FVE

The extent of narrow-moat Sonic’s pathology revenue declines, at around 40% in the current quarter in both Australia and the U.S., is more than we initially expected. However, we do not expect pathology revenues across the company’s key geographies to behave alike in the medium term and anticipate a faster recovery in the better-funded healthcare systems, like Australia, which contributes 25% of group revenue. In the U.S., which also makes up a quarter of revenue, much of healthcare spending is linked to employment and is consequently more cyclical. Similarly, European pathology contributes approximately 35% of revenue and is typified by extremely constrained government funding. We cut our fiscal 2020 forecast revenue for the pathology division by 3% to AUD 5.7 billion from AUD 5.9 billion, which is net of a 10% tailwind from a weakening Australian dollar. Due to the high fixed cost base, only 20% of costs are volume-variable, we expect underlying EBITDA margins to reduce to 16.8% in fiscal 2020 from 17.7% in fiscal 2019. The subdued medium-term outlook results in us reducing our fair value estimate to AUD 22.50 from AUD 27.00. The combination of operating leverage, fluctuating currencies and increased revenue uncertainty leads us to change our risk rating to high from medium.