Company Reports

Sonic Healthcare’s “medical leadership” model recognizes the importance of the referring doctor as the company seeks to differentiate itself on service levels. Success in the model is evidenced by organic growth consistently tracking ahead of the market, suggesting market share gains. In an industry where absolute volume is an important component in achieving greater cost advantage, organic growth supplemented by appropriate acquisitions continues to add value for shareholders.

Narrow-moat Sonic reported fiscal 2024 underlying organic revenue growth of 6% to AUD 8.9 billion and a group EBITDA of AUD 1.6 billion, both meeting our expectations. The result was driven by strong organic sales growth in Australia and Europe. Although recent acquisitions and cost pressures have weighed on group profitability, the second-half group EBITDA margin expanded roughly 150 basis points on the first half to 18.6% on margin improvement initiatives.

Sonic Healthcare’s “medical leadership” model recognizes the importance of the referring doctor as the company seeks to differentiate itself on service levels. Success in the model is evidenced by organic growth consistently tracking ahead of the market, suggesting market share gains. In an industry where absolute volume is an important component in achieving greater cost advantage, organic growth supplemented by appropriate acquisitions continues to add value for shareholders.

Narrow-moat Sonic’s top line continues to grow at a steady clip, with organic revenue up 6% so far in the second half of fiscal 2024, following 6% growth in the first half. Our fiscal 2024 revenue forecast of AUD 8.9 billion is broadly unchanged and in line with company guidance.

Top pathology providers remain significantly undervalued following the supportive pathology policy changes announced in the federal budget.

Top pathology providers are significantly undervalued. Shares in narrow-moat Sonic Healthcare, no-moat Healius, and no-moat Australian Clinical Labs have fallen by roughly 60% on average since the beginning of 2022 and now trade at an average 35% discount to our fair value estimates of AUD 32.00, AUD 3.00, and AUD 3.50, respectively. Within the healthcare sector, pathology stocks screen attractively. The subsector trades at an average price/fair value estimate of 0.65 versus the healthcare sector average of 1.11. Our special report, 'Pathology Providers Are Down but Not Out,' published on May 13, 2024, delves deep into the key drivers supporting our forecast margin recovery for the industry.

Narrow-moat Sonic Healthcare's first-half group revenue grew 5% to AUD 4.3 billion, driven by acquisitions and strong organic performance in Australia and Germany. However, EBITDA fell 20% to AUD 737 million. This was largely due to higher-margin coronavirus revenue falling 90%, wage inflation, and Sonic still removing legacy coronavirus-related labor and infrastructure costs.

Sonic Healthcare’s “medical leadership” model recognizes the importance of the referring doctor as the company seeks to differentiate itself on service levels. Success in the model is evidenced by organic growth consistently tracking ahead of the market, suggesting market share gains. In an industry where absolute volume is an important component in achieving greater cost advantage, organic growth supplemented by appropriate acquisitions continues to add value for shareholders.

Sonic’s “medical leadership” model recognizes the importance of the referring doctor as the company seeks to differentiate itself on service levels. Success in the model is evidenced by organic growth consistently tracking ahead of the market, suggesting market share gains. In an industry where absolute volumes are an important component in achieving greater cost advantage, organic growth supplemented by appropriate acquisitions continues to add value for shareholders.

Australian Clinical Labs intends to withdraw its takeover offer for Healius after opposition from the Australian Competition and Consumer Commission. The ACCC concluded the acquisition would likely substantially lessen competition in Australian pathology services markets. The ACCC considered current competitors, including narrow-moat Sonic Healthcare, and believes it is unlikely that a new or existing provider could enter or expand in a timely way and to a scale sufficient to address the potential loss of competition.

Narrow-moat Sonic Healthcare continues to benefit handsomely from its involvement in coronavirus testing throughout Europe, the U.S., and Australia. The ultimate earnings benefit from COVID-19 testing that will accrue to Sonic is challenging to forecast with the pandemic remaining highly dynamic. Nonetheless, we raise our fiscal 2021 revenue and EBIT forecasts by 7% and 50% to AUD 8.4 billion and AUD 1.8 billion, respectively, with rates of coronavirus testing likely to remain elevated throughout the remainder of fiscal 2021 in Sonic’s key geographies. Reflecting our upgraded fiscal 2021 earnings estimate, we increase our fair value estimate by 4% to AUD 25.70 per share. Sonic continues to screen expensively, trading at a sizable 32% premium to our revised valuation.

Sonic’s “medical leadership” model recognises the importance of the relationship with the referring doctor as the company seeks to differentiate itself on service levels rather than purely price. Evidence of the success of the model is the organic growth rate ahead of the market, suggesting market share gains. In an industry where absolute volumes are an important component in achieving cost advantage, Sonic’s source of moat, the organic growth supplemented by acquisitions continues to add value for shareholders.

In a surprise twist to the election season, the Democrats are very close to winning the remaining two U.S. Senate seats in the Georgia runoffs. If the elections go to the Democrats, we suspect Joe Biden's administration will seek to implement further healthcare reforms. However, with such a slim majority in the Senate, compromises on ideals espoused by the Biden campaign may be required to get healthcare legislation passed with support from moderate Democrats. With significant compromises possible in the next several months as the legislation is crafted, we will keep steady on our moat and valuation views until more clarity emerges on the potential changes to the healthcare industry.

Sonic’s “medical leadership” model recognises the importance of the relationship with the referring doctor as the company seeks to differentiate itself on service levels rather than purely price. Evidence of the success of the model is the organic growth rate ahead of the market, suggesting market share gains. In an industry where absolute volumes are an important component in achieving cost advantage, Sonic’s source of moat, the organic growth supplemented by acquisitions continues to add value for shareholders.

Narrow-moat Sonic Healthcare’s involvement in coronavirus, or COVID-19, testing in Europe, the U.S., and Australia delivered eye-popping sales growth of 29% in early fiscal 2021. The ultimate duration and severity of the global pandemic are unknowns, which in turn delivers substantial uncertainty as to the precise magnitude and persistence of demand for COVID-19 tests. Nonetheless, we anticipate COVID-19 testing in Sonic’s key geographies of the U.S., Europe, and Australia will remain elevated throughout the remainder of fiscal 2021.

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.

Sonic’s “medical leadership” model recognizes the importance of the relationship with the referring doctor as the company seeks to differentiate itself on service levels rather than purely price. Evidence of the success of the model is the organic growth rate ahead of the market, suggesting market share gains. In an industry where absolute volumes are an important component in achieving cost advantage, Sonic’s source of moat, the organic growth supplemented by acquisitions continues to add value for shareholders.

At face value Sonic Healthcare reported a solid first-half result with organic revenue growth of 5% in constant currency. However, we estimate the equivalent EBITDA growth lagged that at between 2% and 3% up on the previous corresponding period, or pcp. We did not expect this margin contraction and consequently trim our underlying EBITDA margin forecasts for fiscal 2020 and beyond, as well as our fair value estimate to AUD 27 from AUD 28 per share. While Sonic’s geographic spread diversifies regulatory risk, we surmise reduced exposure to Australian laboratories contributed to margin decline in the half, while the company also faced price cuts on certain services in the U.S. Sonic has stated it intends to continue making acquisitions outside Australia and hence we now view the margin reduction as longer term in nature.

Sonic’s “medical leadership” model recognizes the importance of the relationship with the referring doctor as the company seeks to differentiate itself on service levels rather than purely price. Evidence of the success of the model is the organic growth rate ahead of the market, suggesting market share gains. In an industry where absolute volumes are an important component in achieving cost advantage, Sonic’s source of moat, the organic growth supplemented by acquisitions continues to add value for shareholders.

At today’s AGM, narrow-moat Sonic Healthcare maintained its constant currency EBITDA guidance of 6% to 8% growth in fiscal 2020, behind our forecast for 10% gains. Our forecast comprises 5% organic growth plus a 5% boost from the acquisition of Aurora Diagnostics in January 2019 which only contributed for five months in the previous corresponding period. We expect organic growth to be ahead of what is implied by the company guidance and include an expanded EBITDA margin of 17.7%, in line with the second half of fiscal 2019, from 17.4% for the full fiscal 2019 base year. We also expect a 2.6% currency tailwind in reported EBITDA given Sonic’s broad geographic exposure, with no changes to our key exchange rate assumptions of AUD/USD of 0.68 and AUD/EUR of 0.61. Longer term, our estimate of sustainable EBITDA growth is unchanged at between 6% and 7% per year. Favourable pricing on a recent debt issuance will reduce interest cost, resulting in our forecast core EPS for fiscal 2020 growing by 5.4% from 4.5% previously, but this has no impact on our five-year EPS growth of 8.8% or AUD 28.00 fair value estimate. The shares screen as fairly valued.