24 October 2021
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A Covid-19 winner – but can Sonic continue?

Paul Rickard
26 August 2021

There aren’t too many companies winning out of Covid-19, but one is Australia’s largest provider of pathology services, Sonic Healthcare (ASX: SHL). The name behind “brands” such as Douglass Hanley Moir, Melbourne Pathology and Clinpath Pathology, it reported profit growth for the year of 149% to $1.32bn. In constant currency terms, it was even better at $1.38bn.

Revenue surged by 28% to $8.8bn and EBITDA by 81% to $2.6bn as Sonic provided 30 million PCR tests for Covid-19 and 2 million serology tests to detect antibodies. In Australia, Sonic is a leading provider of Covid testing, has the Federal Government contract to provide testing for Australia’s aged care facilities and is the largest non-government Covid vaccination provider. It is also the largest provider of Covid testing in Germany, accessing 30 Sonic laboratories, and a significant provider of testing services in the USA, UK, Switzerland and Belgium.

Away from Covid, base revenue rose by 6% to $6.6bn and by 4% on FY19 levels. Base revenue excludes Covid revenue, and normalises for currency, acquisitions and disposals and non-recurring gains. Sonic said that the base business has become increasingly resilient to the impacts of the pandemic, and with the underlying growth drivers unchanged, it expected ongoing growth of the base business.

Sonic’s largest operating division, USA pathology/laboratories, grew base revenue by 5%. Contributing 25% of Sonic’s total revenue, the USA narrowly exceeds the German and Australian pathology/laboratories businesses with 23% each, the UK with 8% and Switzerland with 7%. Sonic’s imaging and radiology business in Australia generated 7% of group revenue. On revenue growth of 19% (which included the acquisition of Epworth Medical Imaging in Melbourne), the imaging division grew revenue by 19% and EBITDA by 24%.

The company clearly sees that imaging is an area for expansion, having recently acquired the Canberra Imaging Group and planning to open 5 greenfield sites in FY22. It is “cashed up”, with net interest bearing debt down to less than $1 billion and a gearing ratio of 12.5%, the lowest in more than 20 years. In the company’s own words, it is “currently pursuing significant opportunities in Australia, USA and Europe” and has “current available headroom of approximately $1.5bn”.

Shareholders were reward with a final dividend of 55c (up 4c on FY20), taking the full year payout to 91c per share. Representing a payout ratio of 33%, this was less than the market expected, with one broker surprised that a “special” dividend wasn’t declared. However, Sonic maintained that the increase was in line with its progressive dividend policy and provided flexibility for balance sheet growth by acquisition.

Looking ahead, Sonic is confident of base revenue growth, with geographical diversification providing increased opportunities for expansion and risk mitigation. Testing volumes for Covid were lower in the second half of FY21 than in the first half, but are now increasing again with the spread of the Delta variant. The company says that it “expects demand for Covid PCR testing to continue into the foreseeable future”.  

What do the brokers say?

Each of the major brokers rose their target price following the result. According to FNArena, the consensus target price is $43.58, just 2.9% higher than the last ASX price of $42.35. In a tight range, the low is $40.50 from Macquarie through to a high of $45.00 from Credit Suisse. There are 3 ‘buy’ recommendations and 3 ‘neutral’ recommendations.

A precis of Macquarie’s research sums up the collective opinion: “a favourable near term outlook with a degree of uncertainty over the medium term”.

The brokers are factoring in a decline in revenue and earnings from Covid testing, forecasting a reduction in EPS (earnings per share) from 275.5c in FY21 to 224.2c in FY22 and 152.4c in FY23. (In FY20, it was 111.1c). This puts Sonic on a prospective PE of 18.9 times FY22 earnings and 27.8 times FY23 earnings. The dividend yield is forecast to be around 2.5% (about 50% franked).

Bottom line

Covid-19 is a bonus for Sonic and there is no way of knowing how long the demand for PCR testing will continue. But that all said, it is hard to argue with the confidence Sonic is pursuing expansion and acquisition opportunities, and the underlying growth in the base business.

My sense is that the brokers’ prospective FY23 PE of 27.8 times doesn’t make Sonic look that expensive. Also, in a world free of Covid, it doesn’t look unachievable given that it represents a compound annual growth rate in earnings from FY20 to FY23 of 11.7%.

A solid, dependable stock for health care sector exposure.

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