Sonic Healthcare: Coming off peak COVID testing

About the author:

Author name:

By Dr Derek Jellinek

Job title:

Senior Analyst

Date posted:

25 August 2022, 8:30 AM

Sectors Covered:

Healthcare

• Sonic Healthcare's (ASX:SHL) FY22 results were above expectations, with COVID testing continuing across all laboratories, helping to expand margins and support double-digit profit growth.
• Notably, base testing (ex-COVID) remains solid, up on pcp and h/h despite the Omicron wave, while growth in Imaging and Clinical Services was subdued on impacts of the pandemic.
• While no FY23 guidance continues to reflect the pandemic’s uncertain trajectory, the peak appears to be behind us, and although testing is expected to continue “forever” at some level, profitability is likely to be under pressure despite an improving base business, good cost control and ample liquidity for capital management and M&A.
• We have adjusted FY23-24 estimates and rolled forward valuation multiples, with our target price decreasing to (login to view). Hold.

Event

FY22 results were above our expectations (NPAT A$1,461m, +11% in cc; Morgans A$1,410m) on revenues of A$9,340m (+6.5% in cc).

Underlying earnings were solid (EBITDA A$2,830m; +11% in cc), with margins expanding 761pp to 30.3%, all time highs.

OCF was up 9% to A$2,226m, with strong cash conversion (95%) supporting an 9% increase in the final dividend (A$0.60; 100% franked).

FY23 guidance was not provided due to “COVID-related unpredictability”.

Analysis

COVID testing (US$2.4bn) underpinned organic laboratory revenue growth (60% of divisional 5% uplift in cc; c30% of total revenue), but was softer h/h (1H +16%) and mixed geographically, with strength seen in Australia (+134%), Switzerland (+27%) and Germany (+9%), partially offset by softness elsewhere (US -38%; UK -41%; Belgium -13%), as testing followed the Omicron wave.

The base business (ex-COVID) posted recorded revenues (+2.1%; A$6.9bn), with 2H holding up on pcp (flat; A$3.5bn) and growing sequentially (+3.4%), despite the Omicron wave which saw +8% gains in COVID testing revenue. 

Imaging (8% of total revenue) and Clinical Services (5% of total revenue) continue to struggle, with underlying growth going backwards or staying in the red, respectively, impacted by the pandemic and cycling strong comps (Imaging +15%).

While no quantitative FY23 guidance was provided, we highlight key takeaways including:

1. COVID-19 testing to remain “forever”, but continues to wane and settles at a baseline level 10-20% off peak over medium/longer term (but exact level depends on pandemic evolution).
2. Jul-22 COVID testing revenue A$94m (annualising at A$1.1bn, -53%).
3. Base business is expected to accelerate given strong industry fundamentals and potential rebound in postponed testing, with Jul-22 organic revenue growth +3.9% (+11% vs pre-pandemic).
4. Strong cost control, with inflationary pressures managed and no consumable price increases.

Forecast and valuation update

We have adjusted COVID testing assumptions, resulting in modest changes to underlying profit, but higher net interest and tax, which sees NPAT decline up to 7%. 

FY23-24 earnings changes combined with rolling forward valuation multiples see our blended DCF and SOTP valuation-based target decrease to (login to view).

Investment view

While SHL remains in a strong position for continued base business growth and has ample liquidity for capital management and M&A, the inevitable slowing of COVID-19 testing will put pressure on profitability until a ‘new normal’ is established.

Price catalysts

AGM 17 Nov-22; Final dividend payment 21 Sept-22 (record data 7 Sept-22).

Risks

Changes to COVID and base business testing, margin adjustments, changes in the degree of competition, acquisition integration and synergy capture, regulatory intervention and market share gain/loss.

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.