Sonic Healthcare: 1H inline but time required to adjust to new normal

About the author:

Dr Derek Jellinek
Author name:
By Dr Derek Jellinek
Job title:
Senior Analyst
Date posted:
22 February 2022, 9:00 AM
Sectors Covered:
Healthcare

  • 1H underlying results were in line with expectations, underpinned by COVID-19 testing (c30% of total revenue), pushing OPM to highs and boosting OCF (+28%).
  • The base business (ex-COVID) continues to perform well, while Imaging and Clinical Services were softer due to negative impacts of the pandemic.
  • While no FY22 guidance reflects the pandemic’s uncertain trajectory and we continue to model COVID-19 testing, we think the peak is behind us despite an improving base business, A$500m share buyback and ample liquidity for capital management and M&A, medium-term profitability is likely to be under pressure.
  • We have adjusted FY22-24 estimates, with our target price decreasing to (login to view). Move to Hold.

Event

1H underlying results were broadly in line with expectations (EBITDA A$1,540m, +18%, +19% in cc; Consensus A$1,536m) on revenues of A$4,757m (+7%; +8% in cc; Consensus A$4,746m).

Operating margins expanded 290bp to 32.4%, an all-time high, with net margins up 210bp to 17.4%.

OCF grew 28% to A$1,041m, with cash conversion a bit softer (85%), due to increased DSOs and inventories on a Dec-21 uptick in COVID testing, but still supported by an 11% dividend increase (A$0.40; 100% franked).

Management announced a share buyback up to A$500m.

Analysis

COVID testing (A$1.3bn) underpinned organic laboratory revenue growth (16% in cc; c30% of total lab revenue), with strong growth in Australia (+215%), partially offset by declines in US (-34%) and lower growth in EU (Germany -15%; UK -20%; Belgium -2%), although Switzerland was up 15% as Omicron peaked earlier. 

Base business testing (ex-COVID) showed continued resilience, +4.3% on pcp (+2.3% vs 1HFY20), while organic growth was soft in Imaging (+3%) and margins compressed on COVID, while Clinical Services (+7%), was supported by gains across occupational health, but profit modest due to soft medical centre volumes.

SHL has started a JV with Harrison.ai, a world leader in healthcare AI, investing an undisclosed amount for a 20% stake to develop AI solutions for anatomical and clinical pathology.

No FY22 guidance was given, “as COVID revenues remain unpredictable”, although Jan-22 revenue was up 18% (15% organically) to A$818m, with COVID testing hitting an all-time monthly high (>A$300m; c37% of total revenue), and with Feb-22 testing remaining high in EU, but slowing in Australia and the US.

Management expects continued base business growth, flagging the potential for a stronger rebound on previously postponed tests. However, the trajectory of COVID testing “depends on progression of the pandemic” across various geographies, believing (as do we) there will be some sustainable level into the future, on the need for routine screening, variant testing and whole genomic sequencing.

Forecast and valuation update

Adjusted FY23/24 COVID testing and margins assumptions lower, with higher D&A and tax, resulting in NPAT declining up to 12.5%.

Our blended DCF and SOTP valuation-based target decreases 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

DGX (not covered) 1QCY22 results 28 Apr-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.

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