Uncertainty Stymies Integral Diagnostics

This story features INTEGRAL DIAGNOSTICS LIMITED, and other companies. For more info SHARE ANALYSIS: IDX

Integral Diagnostics performed strongly in the first half and FY18 guidance was recently upgraded but not all brokers are happy with the outlook.

-Capitol Health bid creates uncertainty absent a board recommendation
-Cost reductions a major contributor to earnings upgrades, but will they hold?
 

By Eva Brocklehurst

Diagnostic imaging business Integral Diagnostics ((IDX)) is sustaining some early gains, with its first half performance accelerating on both a financial and market relative basis. Costs are down and favourable rates are being negotiated for premises against a robust radiology market.

Industry activity may well be improving but it is uncertainty over the completion of a takeover bid that leads Morgan Stanley to revert to a base case valuation and maintain an Underweight rating. The company reported its first half results not long after FY18 guidance was revised to 20% net profit growth, from “high single digits” previously.

Morgan Stanley considered this development surprising, in light of the two earnings downgrades that were made in under 12 months post the IPO, as well as the significant de-leveraging during the 2016 industry downturn.

Historically, earnings visibility has been poor and the broker considers the cost restructuring measures that the company has highlighted as the main contributor to the improvement are one-off in nature. Morgan Stanley also points to the relatively new turnover of management.

Capitol Health ((CAJ)) has offered 6.9 shares and $0.36 cash for each share on issue in Integral Diagnostics, implying a value of $2.46 per IDX share. Morgan Stanley suspects the stock will not trade on fundamentals while the board has not offered a recommendation to shareholders.

This keeps open the possibility the takeover bid will fail and implies downside risks. While the market may gravitate towards the offer price of $2.46, Morgan Stanley's base case target of $2.25 reflects its fair value estimate.

First half net profit of $9.2m beat Ord Minnett's estimates and signals growth of 24.1% on the prior corresponding half. A strong result was expected, following the recent upgrade to FY18 guidance. Cost reductions were flagged as the major contributor but the speed and magnitude surprised the broker.

Ord Minnett suggest revenue growth has also picked up noticeably and new initiatives should contribute in the second half and beyond. In contrast to Morgan Stanley, the broker remains highly positive on the trajectory of industry growth rates, as well as management's ability to execute on its plans.

Still, with the share price trading in line with target, Ord Minnett maintains a Hold rating with a target of $2.39. Management has previously outlined a plan to more effectively allocate resources according to volume, and the broker observes the first half result showed significant progress on this score.

Moreover, competition issues that previously affected the company have now washed through and referrals are accelerating. The broker now forecasts net profit growth of 25.6% in FY18.

The company is opening new clinics in Torquay, Victoria, and Miami Beach, Queensland, as well as making plans for a new prostate centre of excellence in FY19. This builds on previous experience with specialty centres in spinal and breast, and the clinics are expected to deliver a return on capital of around 25%.

Credit Suisse, while restricted on a rating and target at present, considers the results reflect internal and external tailwinds. The broker forecasts net profit growth in FY18 of around 20% and notes this forecast implies zero growth on the first half run rate.

Gearing is expected to remain comfortable although acquisitions are considered a possibility, despite a competitive market.
 

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