Conditions Improve For Integral Diagnostics

Small Caps | Jun 11 2020

Integral Diagnostics is increasingly confident business is returning to normal, making its second acquisition in New Zealand.

-Faster return to growth now considered possible
-Acquisition of Ascot Radiology highlights consolidation opportunities
-Scope for additional acquisitions

By Eva Brocklehurst

Integral Diagnostics ((IDX)) is negotiating the bumpy road of pandemic restrictions, which has been highlighted by a slump in patient volumes in April followed by a partial recovery in May.

Revenue declined by -24-50% across all business units because of the lockdowns in April but declines were only -5-16% in May as restrictions were eased. The company has indicated June has started on a positive note and revenue is continuing to gradually improve.

Elective surgery is resuming and expected to return to normal levels in coming months. During the crisis the company closed eight smaller community sites and has since re-opened three. Citi anticipates the other five sites will open by the end of June.

The new Hope Island site on the Gold Coast commenced operations in June and patient activity has been positive to date. Wilsons, not one of the seven stockbrokers monitored daily on the FNArena database, notes Integral Diagnostics took market share from hospitals in both PET/CT and MRI during the pandemic and such high-end areas are more conducive to private billing and optimal pricing.

As rates of community transmission of the coronavirus remain low in Australia, and New Zealand completely lifts restrictions, a faster return to growth is now considered possible. Still, with earnings and the share price approaching pre-pandemic levels, and amid some margin challenges in FY21, Credit Suisse downgrades to Neutral from Outperform.

A more measured approach is considered justified as the company's cost base is expected to return to pre-pandemic levels by July. That said, Credit Suisse acknowledges there is some scope for a surprise on the upside.

Integral Diagnostics has implemented some initiatives on the cost front, with up to -20% reductions in remuneration for some radiologists, board members and executives. Rental reductions have also been negotiated along with reduced service costs for equipment.

Renewed stability has provided management with confidence to execute the acquisition of NZ-based Ascot Radiology for NZ$50m, consisting of cash and scrip. The practice merges with the existing NZ business and offers sub-specialisation although avoids any overlap.

Ord Minnett expects an accelerated improvement in the business and pulls forward the expected return to pre-pandemic revenue levels. Citi also revises estimates upwards, assuming only a -20% decline in revenue in the fourth quarter of FY20.

The broker assesses the acquisition of Ascot Radiology will be 4.5% accretive to earnings per share in FY21, while Macquarie considers the acquisition is consistent with the company's growth strategy and will broaden the offering in the Auckland market.

Wilsons welcomes the acquisition, as Ascot Radiology has almost doubled earnings since 2017, when Abano Healthcare sold its stake, retaining an Overweight rating and $4.65 target.

Credit Suisse notes the price is not cheap but concedes this is a strategic tuck-in asset and pays to the notion of widespread distressed asset sales in radiology. Integral Diagnostics expects an operating earnings contribution of $5.3-6.1m in FY21.

Following completion of the acquisition the broker calculates FY21 gearing at 2.0x, which provides scope for additional acquisitions. Ascot Radiology, the company's second acquisition in New Zealand, has nine clinics in Auckland and contracts with 22 doctors.

There are three Buy ratings and two Hold on FNArena's database. The consensus target is $4.42, suggesting 6.6% upside to the last share price.

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