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Treasure Chest: Tough Luck For Integral Diagnostics

Treasure Chest | Jul 21 2022


FNArena's Treasure Chest reports on money making ideas from stockbrokers and other experts. JP Morgan expects Integral Diagnostics has a tough couple of years ahead and initiates coverage with an Underweight rating.

Whose Idea Is It?

Analysts at JP Morgan

The Subject:

Integral Diagnostics ((IDX)).

The long-awaited covid-recovery expected for Australia's number four largest diagnostic imaging provider, Integral Diagnostics ((IDX)), is slow in coming, as consumers, dispirited by successive rounds of covid lockdowns and long elective wait-lists, prove sluggish to return.

It is a situation exacerbated by covid staff absenteeism.

Integral Diagnostics is being squeezed on three fronts: volume, rising costs, and limited pricing power, which is crunching margins – a big fall for a company that once delivered some of the highest imaging margins in the industry, notes JP Morgan.

This squeeze should temporarily trump the strong positive fundamentals underpinning the stock, such as the mid-single digit growth demand for imaging; an ageing population; an expanding range of imaging; and a large backlog of demand.

Meanwhile, inflation-indexed payments of 1.6% in FY23 from the government are unlikely to match CPI estimates of 5%.

JP Morgan now expects Integral’s recovery to be protracted as labour shortages from covid absenteeism continue as infections grow a-pace.

The broker expects growth will increase late in FY22 but says nearly a year of growth has been lost and doubts Integral’s growth will return to former levels until FY24. 

Margin growth is expected to lag volume growth as cost growth remains an issue.

Company Specific Challenges

Integral Diagnostics also has its own demons to deal with relative to peers.

JP Morgan notes Integral experienced the sharpest margin erosion relative to peers, and sheets this back to referral losses in New Zealand to newly established self-referring practices.

The broker says Integral’s retention of radiologists is also at risk given an estimated 35% are remunerated partly through a shareholder program, which has become a less appealing prospect in a tight labour market and falling share market.

Also, the longer the recovery is protracted, the more time Integral’s competitors have to invest in similar technologies and play catch up, reducing the company's point of difference, and forcing its own capital-expenditure requirements to rise, notes the broker.

On The Upside

JP Morgan acknowledges that AI and teleradiology may boost productivity and offer radiologists greater flexibility, but doubts this will hold sway in the near term.

Many observers agree, expecting outside of staff retention, it will make little difference given it is unlikely to impact demand in the light of an overburdened hospital system which is likely to further discourage an ever-lengthening wait list for elective surgery in order to free up hospital beds. 

The MRI licensing rules should also act as barrier to entry to competitors, and while deregulation is on the cards over the next decade, the broker doubts the government is in a rush. Integral also operates in less competitive states.

JP Morgan’s forecasts sit well below consensus. The broker’s EPS forecasts fall -16.4% for FY22 and it has commenced coverage ("initiation") with an Underweight rating and $2.65 target price.

Ord Minnett white-labels JP Morgan research and recently re-initiated coverage with a Lighten rating and similar price target.

Integral Diagnostics listed on the ASX in late 2015 and its shares performed well up until mid last year with the global pandemic in 2020 leaving but a short-term blip in what seemed a continuous up-trend.

That trend seems to have broken since and the shares have gradually, but persistently, eroded in price towards $2.88 today (from more than $5 a year ago).

More Info:

Wilsons also recently downgraded Integral Diagnostics to Market Weight from Overweight and cut the target price to $3 from $5, based on weaker Medicare data.

Wilsons noted a protracted recovery weighs against the company’s strengths of higher operating margins, M&A execution and brown and greenfields orientation, which tend to shine in optimal industry conditions.

Other brokers still hold a positive bias.

Goldman Sachs released a Buy rating and $4.20 target price as at July 11, believing the company's AI algorithms should increase productivity, helping mitigate the near-term shortage of radiologists.

Morgan Stanley last updated its coverage on July 5 and holds an Equal-Weight rating and $3.51 target price, noting May Medicare data showed signs of an early recovery.

FNArena's Stock Analysis shows a consensus price target of $3.84, suggesting considerable upside for the shares, but three of the five brokers haven't updated since May. The two most recent updates (JP Morgan and Wilsons) have a negative slant, with a warning undertone.

FNArena monitors seven major stockbrokers daily, but JP Morgan and Wilsons are not included in these seven, but Ord Minnett is included.

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