Tag Archives: Health Care and Biotech

article 3 months old

AdAlta Advances With Pulmonary Fibrosis Treatment

AdAlta, a Melbourne-based drug developer, recently listed on ASX and NDF Research takes up coverage of the stock.

-Working on i-bodies, a treatment for Idiopathic Pulmonary Fibrosis in the first instance
-Assume product can be licensed to a partner by FY20
-Assume 14 years of commercial exclusivity


By Eva Brocklehurst

AdAlta ((1AD)) is a Melbourne-based drug development company with a focus on a new class of protein therapeutic called i-body. NDF Research initiates coverage on the stock with a 60c target and Speculative Buy rating and asks, if the company is that good, why is it only captalised on ASX at $24m?

The answer is it commenced trading on August 22, 2016, after raising $10m in an IPO at 25c per share. Consequently, the market is yet to know the stock. Moreover, the company is yet to go to the clinic with its AD-114 and there are risks related to the pre-clinical development of i-bodies.

What are i-bodies? The drug the company is working on has the same target and affinity as monoclonal antibodies but, importantly, is around 90% smaller. Monoclonal antibodies are key to modern medicine with NDF Research calculating global sales of over $US70bn per annum. These drugs are expensive to make and the molecule size makes them too big for use against many important drug targets. They also require heavy dosing and this must be delivered by intravenous infusion.

While antibodies are expected to remain the mainstay of the industry for many years, given the critical mass of products in development and the ease with which a drug candidate can be selected, the i-body is expected to be made more cheaply, easier to administer and capable of addressing diseases such as fibrosis.

AdAlta's first product from its platform is AD-114, initially for the treatment of Idiopathic Pulmonary Fibrosis (IPF), and targets inflammation in the lungs as well as reducing fibroblast migration to the lungs. NDF Research envisages considerable upside for the company, given the high valuation that validated platforms like this one tend to trade on. The researchers value AdAlta at 38c on a base case and 89c on an optimistic case.

NDF Research assumes another US$5-10m in expenditure for AdAlta to further develop the AD-114 and around 14 years of commercial exclusivity for the product. The risk weighting for the probability of clinical success is 20%, which the analysts consider reasonable given the in vitro evidence related to targeting, and the fact that IPF is an orphan disease, meaning it can quickly transition to mid and late stage clinical development.

They also assume the product can be licensed to a partner by FY20 for US$30-50m up front with subsequent milestones and royalty. Peak sales are assumed at US$300-600m, initially sourced from IPF treatment. The business is expected to be positive on earnings per share by FY19.

The risks specific to AdAlta the analysts have identified are, firstly, manufacturing, where the company may take longer to manufacture AD-114 than expected. There is also the potential that the intended Phase 1 study of AD-114 is delayed and may not happen as early as the start of 2018.

The US Federal Drug Administration (FDA) and other regulators may decline to approve the drug even if AdAlta considers its data adequate, and there is also the risk that there may not be significant commercial usage of the drug in IPF as other therapies come to the market between now and the end of AD-114's clinical development.

NDF Research also notes the industry has become very interested in fibrosis. The advance of drugs like Esbriet have led to strong commercial interest being shown by other companies in new drugs with an anti-fibrosis element. Cancer may also be the next indication for AD-114. AdAlta has favourable pre-clinical data on AD-114 as an antic-cancer molecule.

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article 3 months old

Sigma Pharma’s Expansion Strategy On Track

Sigma Pharmaceuticals is expanding its reach into hospital pharmacy while maintaining a stable base business. Brokers welcome the increased diversity.

-Non-PBS sales at 44% and an increasingly higher proportion of Sigma's business
-Capital releases may now be limited in scope
-Little visibility on supplier rebates and merchandising income


By Eva Brocklehurst

With its first half results, Sigma Pharmaceuticals ((SIP)) is seen spearheading its entry into the hospital pharmacy market amid expectations it will annualise $200m in sales by the end of the year.

The company ticked all the right boxes, Morgan Stanley asserts. Revenue growth was strong with like-for-like pharmacy brand sales up 7.2%. The company's confidence in its outlook is reflected in guidance being upgraded to 10% EBIT (earnings before interest and tax) growth for FY17 while estimates of over 5% growth are retained for FY18.

Yet the results produced a spate of changes to recommendations. UBS and Credit Suisse upgraded to Buy and Outperform respectively, while Citi downgraded to Sell. In sum, FNArena's database now has two Buy, one Hold and one Sell. The consensus target is $1.30 which suggests 7.5% downside to the last share price. Targets range from $1.15 (Morgan Stanley) to $1.40 (UBS).

UBS considers the results are a sign the inflection point has arrived for Sigma, in terms of new growth opportunities, at the same time the base business is steady and reliable. The broker acknowledges it underestimated the turnaround in underlying margins and, post the result, increases estimates for FY17 and FY18 by 7.3% and 9.7% respectively.

Non-PBS (Pharmaceutical Benefits Scheme) sales are now 44% and the company hopes to reach a 50:50 mix. PBS growth was reported as flat, with over-the-counter sales up 5%. Direct sales to China were not disclosed but the company suggests these are ahead of expectations, albeit modest.

The reported EBIT margin was diluted because of sales of the new drug Sofusbovir (hepatitis C), given the drug is high price but low margin. Inventory did build, affected by an additional $30-40m for the supply of Sofusbovir. UBS detects that the company is spending more time on expanding buying programs to extract higher rebates while at the same time investing in infrastructure.

The broker agrees that in terms of pharmacy wholesalers, the company has had lower exposure to the higher top line growth channels in the market, but observes an intention to grow the exposure to general retail. UBS notes the company has, nonetheless, also demonstrated an ability to manage its earnings mix and achieve a small margin uplift. The investment in hospital pharmacy is expected to provide greater exposure to an attractive growth market.

Citi envisages the outlook somewhat differently. Given poor prospects for PBS revenue and the end of working capital benefits from a pull-back in customer credit terms, the company is investing to maintain its margins and diversify its revenue sources. Sigma has been successful in pulling extended credit terms and reducing working capital and this has meant capital has been released to fund its buy-back and other initiatives. There is now limited scope in this regard, Citi believes.

The broker expects the company to outperform on guidance and upgrades earnings per share estimates by 4% and 6% for FY17 and FY18 respectively. Citi considers the stock now overvalued in a challenging environment for its main business, along with the risks that come with significant capital expenditure on investments.

Rising “other revenues”, which include supplier rebates and merchandising income, are suspected as accounting for a large proportion of profits but the broker finds little visibility in this area and remains wary of the long-term sustainability as a result.

PBS revenue may remain under pressure but higher growth in non-PBS revenue as well as the winding back of trade discounts should sustain gross profit growth, in Credit Suisse's view. Moreover, incremental wholesale opportunities such as hospital pharmacy and distribution centre optimisation should underpin the long-term. The broker also notes an un-geared balance sheet and the potential to pursue suitable acquisition opportunities.

Goldman Sachs, not one of the eight stockbrokers monitored daily on the FNArena database, also upgrades, to Neutral from Sell, with a target of $1.30. The broker's prior Sell rating was based primarily on a lack of valuation support as well as long-dated regulatory risk. Given the upgrades to FY17 and FY18 estimates, this situation has improved and, while long-dated regulatory risk remains, the broker does not believe it to be a near-term catalyst

Goldman Sachs believes the long-dated agreement with market leading Chemist Warehouse provides an ability to grow market share and underpins margins. There is also scope to leverage the balance sheet with further acquisitions share buy-backs and internal projects with an attractive pay-back time frame.

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article 3 months old

Is Cochlear Overvalued?

Cochlear has taken advantage of sales growth to reinvest in development. While brokers approve, they question whether the stock's current premium is justified.

-At weakest point in 4-5 year innovation and product cycle
-Services segment the strongest performing division
-Attention to development could boost sales in adult market


by Eva Brocklehurst

Cochlear ((COH)) has taken advantage of strong sales growth to reinvest in developments and while brokers approve of the move, some maintain that improved operating leverage is required to justify current stock multiples.

Processor upgrade and accessory sales grew strongly in FY16, with the company’s current penetration of the installed base at around 22%. Historically this has reached around 50% at the end of the cycle and management is instituting initiatives to better service its installed base and improve on this figure.

Acoustics sales were up 21% with BAHA up 10%, performing strongly across all regions. FY17 guidance is for profit in the range of $210-225m. Credit Suisse observes, while momentum in developed markets is strong, there is weakness in some of the emerging regions pulling group level unit sales growth back to 4% in the second half.

Meanwhile, the US market has picked up to reveal implants growth of 8-10% and growth in select developing markets such as China private pay and in India is very strong at 40-50%. Nevertheless, Credit Suisse awaits further evidence of a sustained acceleration in unit sales on a global basis, with management recently investing in its sales force to drive consumer engagement in Germany, China, Eastern Europe and Latin America.

UBS believes the slowdown in growth ex China is consistent with an expectation that competitor products and the cycle are emerging as headwinds, with Cochlear at the mid point and weakest phase in its 4-5 year innovation and product cycle. The broker contends the multiples make it difficult to reconcile the stock’s current 70% premium to peers.

UBS suspects investors have misread the recent recovery in growth and hedging gains, believing this is sustainable, without considering the phases of the innovation cycle, and this leaves estimates and valuation overly optimistic. The broker reiterates a Sell rating.

Macquarie acknowledges that once Chinese tenders are eliminated, global implant growth does decline to 7.8% versus 12.4%. Services – upgrades, accessories and patient services – was the strongest performing division, recording 20% growth as the business benefits from the N6 sound processor upgrades.

The broker believes the company’s strategy is be gaining traction, with unit sales growth of 9-10% in mature markets and a step up in the over-65 segment growth. Macquarie concedes the stock is not cheap but notes a return on equity of 47% and a 60% share of a growing and under-penetrated market, retaining an Outperform rating.

The broker contends operating leverage did not materialise as the company ramped up spending on development. Given the strong gains evident from new product launches, and the opportunity that presents if the company can successfully penetrate the large under-developed adult market, the broker lauds the investment in development.

Ord Minnett also observes the company forewent the opportunity to deliver a result above guidance as it brought forward reinvestment in its sales force and F&D, taking advantage of stronger-than-expected sales in FY16. The reinvigorated attention to market development could boost sales in the largely untapped adult market, the broker asserts. Still, Ord Minnett believes the outlook is fully reflected in the current share price.

 The highlight for the broker was the unit growth in the developed market, after a number of years featuring lacklustre sales. A focus on services should support continued growth and the uptake of N6 by the growing eligible patient pool in the US should continue towards 30% in FY17, ensuring sales grow despite the tough comparables.

Services/upgrade revenue is the key swing factor, leaving Morgan Stanley wondering whether this becomes a headwind in the next fiscal year. The broker notes the absolute value of the segment revenue was flat in the second half and may indicate a peak in the current cycle.  Hence, Morgan Stanley models a 5% decline in such revenue in FY17.

Otherwise the broker’s analysis suggests age-related hearing loss will drive growth in the number of cochlear implants in the over  50 category. Despite growth in the number of implant recipients, the analysis also indicates the annual incidence and prevalence of server/profound hearing loss will result in market penetration moving lower. All up, the broker is confident with respect to sustained growth potential within the implant market.

According to a recent survey by the company,  less than 20% of the general population is aware of cochlear implants and less than 50% of audiologists can correctly identify the appropriate characteristics for implant suitability.

Citi maintains Cochlear has a superior suite of products and will launch a new implant with novel electronics to win market share over 12-18 months. The growth in market share is likely to be at a more modest rate and the broker is wary of Advanced Bionics gaining traction in the short term with the launch of a thinner implant.

The broker considers the company’s investment in two ventures, the Earlens device and Saluda Medical, demonstrate a willingness to consider other means to growth in a measured way that should not divert resources from the main implant business.

The Earlens device is effectively a hearing aid with a transducer on the ear drum providing physical separation to behind the ear which should enable a higher gain and wider dynamic range to be achieved. Saluda Medical is developing a closed loop neutron-modulation implantable system for the treatment of neuropathic pain.

FNArena’s database has one Buy rating (Macquarie), five Hold and two Sell for Cochlear. The consensus target is $116.34, suggesting 10.5% downside to the last share price. Targets range from $94.10 (Deutsche Bank, yet to update on the results) and $130.00 (Macquarie).

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article 3 months old

Just Cough Into Your Phone

- ResAp offers smartphone diagnostic
- No additional hardware needed
- Global addressable market


By Greg Peel

ResApp Health ((RAP)) is developing a smartphone-based diagnostic for respiratory disease. Originally created at the University of Queensland, the system is able to detect from patient breathing and coughs whether or not the patient has respiratory disease, and what kind of disease, with a very high degree of sensitivity and specificity.

The technology is able to work with existing smartphones and requires no additional hardware, making rapid development a fairly straightforward proposition, life science research specialist NDF Research suggests, once approval is granted. A registration study will now follow ahead of a filing for US Federal Drug Administration approval in early 2017.

ResApp conducted a study of in excess of 600 Australian paediatric patients beginning in March last year. The study found that paediatric lower respiratory tract infections cases initially missed by experienced clinicians using a stethoscope could be detected by the ResApp System in 97% of cases. A study of adult patients commenced late last year.

Assuming initial FDA approval is granted, a process will commence whereby the FDA evaluates the system for each individual respiratory condition. NDF Research believes the data from this study and other Australian studies will provide the basis for approvals in Europe and other jurisdictions.

In the US, roughly one in ten doctor visits results in the diagnosis of a respiratory disorder, NDF notes. This translates into 125 million diagnoses annually, and the comparable global figure is believed to be in the order of 700 million, costing, NDF estimates, US6-7 billion per year for the established path of X-rays, CT scans and pathology tests. Much of this existing market is addressable for the ResApp system.

The stock has had a good run since listing in April, initially raising capital at 2c per share before another raise at 20c. The share price peaked at 45c in June and has since retreated modestly.  NDF has initiated coverage of ResApp with a Buy (Medium Risk) rating and an 85c twelve-month price target.

NDF anticipates a high value for ResApp’s technology given its apparent cost effectiveness and scalability in an era when digital health can be said to have truly arrived.

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article 3 months old

Uncertainties Prevail For Primary Health Care

-Management review continues
-Bulk billing still seen under pressure
-Lack of clarity on specific weakness


By Eva Brocklehurst

Primary Health Care ((PRY)) has cleaned up its balance sheet, signalling a more conservative approach to provisioning. Write downs in FY16, worth around $98m, will address the carrying values of a number of items.

The company expects to meet the lower end of its $110-115m profit guidance on an underlying basis. Further charges totalling $6m will be made and brokers calculate the net result is a downgrade in profit guidance to $104m. While the company suggests its revised guidance is entirely driven by non-operational matters, brokers are not so sure and remain cautious about the company's operating performance.

Citi suspects half the headline downgrade to guidance stems from slower trading conditions, which translates into an effective 5-6% downgrade to underlying profit. Given the government has been returned after the election with the slimmest of majorities the broker envisages little likelihood of a reduction to pathology funding in the short term, while industry volumes appear firm.

The presence of Jangho on the company's share register supports the stock, given the elevated risk of a takeover. This is countered, in the broker's view, by the high level of flux in the business, as a new management team with limited experience in health care continues to review and make changes.

Macquarie also believes the relatively minor reaction to the earnings announcement indicates the stock continues to trade largely on takeover speculation rather than fundamentals. Jangho's stake is around 16%.

The re-vamped balance sheet is welcome but Morgans notes FY16 has been marked down for a third time in 12 months while trading conditions have been in line. The broker suspects that while the divestment of a number of non-core assets will help to reduce the cost base, the fact that bulk billing is under pressure cannot be denied.

Funding changes remain on the horizon and there is uncertainty regarding the impact of profit improvements already underway or planned, such as increased private billing, selective co-payments, new medical centres and cost savings.

Morgans revises FY16 estimates down 8% but raises its price target by 20% to roll forward and increase depressed valuation multiples. This reflects progress on the company's plans amid uncertainty regarding how strategic initiatives will actually play out.

UBS suggests the update represents a modest 3.6% underperformance against its estimates and the net effect of the trading update is not material to valuation. On the issue of the implementation of Medicare reform, the broker suspects the election outcome could bring about a weakening of the government's resolve, citing media speculation the coalition government will consider undoing the freeze on the Medicare rebate and overturn the cuts to bulk billing.

The broker's forecasts incorporate the unwinding of the bulk billing incentive reductions via top-up deals for pathology and diagnostic imaging, but for FY17 only. Further changes could be of benefit in FY18, as could any change in the stance on the freeze to the Medicare rebate indexation.

Addressing legacy issues on the balance sheet is a good sign but Morgan Stanley expects more might be needed before the company arrives at a structure which can support its future strategy and improve capital recycling. While an improvement in cash flow and returns is expected, the broker considers FY16 in the near term looks a little light versus expectations, with a lack of clarity regarding specific areas of weakness.

The issues at the start of 2016 are becoming a little clearer with the results of the election, with the possibility the funding cuts in the government's MYEFO announcement may not happen, although these are incorporated into the broker's forecasts. Meanwhile, the company's issues with GP remuneration still need to be cycled through and the impact on the financials remains to be seen.

The broker maintains the story is about creating confidence in management's strategies and more certainty is required as to whether Primary Health Care has reached an inflection point on earnings. Until this is achieved, Morgan Stanley remains on the sidelines.

There is one Buy rating on FNArena's database - UBS. Besides this, there are seven Hold ratings. The consensus target is $3.47, suggesting 8.2% downside to the last share price. Targets range from $2.80 (Macquarie) to $4.11 (UBS).

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article 3 months old

Weekly Broker Wrap: Financials, Health, Strategy And Insurers

-Growth spurt expected in managed accounts
-Are health care stock valuations more reasonable?
-Equity correction restores overall value, not relative
-GI has fewer constraints, distractions versus banks


By Eva Brocklehurst

Financial Disrupters

Morgan Stanley believes the business models of wealth and asset managers face disruption from managed accounts/separately managed accounts. Managed accounts are considered better at cornering customers because they meet more of their needs than managed funds. This drives higher flows and market share towards progressive industry players.

The broker contends that managed account business models centre on the retail customer not the product manufacturer and this is driving disruption. A tipping point is signalled between 2015-20, with managed accounts expected to grow funds under administration at a 35% compound rate, to $60bn, in which case they could deliver around 75% of industry flows.

Winners in this tussle are considered more likely to be the wealth managers, as opposed to asset managers, as financial planners seek to deliver more value to customers. While progressive asset managers are expected to grow earnings, Morgan Stanley envisages headwinds for Platinum Asset Management ((PTM)), downgrading the stock to Underweight from Equal-weight.

Among wealth managers IOOF ((IFL)) is in a fragile position, the broker contends, although the risks are largely factored into the price. BT Asset Management ((BTT)), on the other hand, is considered well placed for growth.

Health Care

The renewal of enterprise bargaining agreements (EBAs) for nurses in Victoria should mean that accelerating wage inflation is the largest single cost for hospital operators until FY20, Morgan Stanley contends.

The broker notes the structure of salary increases is intended to accelerate Victorian public sector nurse wages growth to bring them into line with NSW peers by 2020. Public sector wage have served as state-wide benchmarks for private hospital wage increases in the past.

Ramsay Health Care ((RHC)) and Healthscope ((HSO)) are both due to renew their Victorian EBAs this year. The broker's scenarios suggest valuation downside of around 4% for Healthscope and less than 1% for Ramsay.

While incrementally negative, given the agreements would run over the next five years, a signing of the proposed EBAs would create certainty on a significant portion of employment costs for the hospitals, Morgan Stanley acknowledges. The broker envisages two possible offsets to the impact to earnings. These are a continuation of the lowering of the skill mix and greater funding for nurses from private health funds.

Credit Suisse observes multiples for Australian listed health care companies have re-rated over the past few months. While are number are trading at levels ahead of historical averages, valuations appear more reasonable to the broker on a relative basis, given the commensurate re-rating of industrial stocks.

The broker assesses stock-specific multiples and, overall, finds CSL, Cochlear ((COH)), Sonic Healthcare ((SHL)) and Sigma Pharmaceuticals ((SIP)) are expensive relative to their respective global sub-sectors.

Ansell ((ANN)), Australian Pharmaceutical Industries ((API)) and ResMed ((RMD)) appear inexpensive, while Healthscope, Primary Health Care ((PRY)) and Ramsay are considered fair value. The broker's preferred exposures remain Ramsay, where fundamentals are intact for medium to longer term growth, and ResMed, which is underpinned by a strong market position.

Equity Strategy

ASX20 stocks have underperformed over recent years and Macquarie suspects this will not end until relative earnings growth and the return on capital differentials begins to stabilise, and ultimately improve. If these stocks were to test the relative performance low seen in 2000-07 then the broker suggests they need to fall another 15%. The deterioration in fundamentals this time, nonetheless, signals this may not be the current floor.

The stocks, or mega caps as the broker calls them, are no longer high relative return-on-equity stocks and within this group the only ones that are substantially over earning are the banks. Structurally, Macquarie considers these stocks are de-rating candidates, as long as relative growth and return on capital continues to decline.

CSL is considered most likely to remain an under-earner while Transurban ((TCL)), Westfield ((WFD)) and Scentre Group ((SCG)) are considered most likely to normalise back to earnings weightings, rather than retain relative growth status, outside of further declines.

The broker's preferred stocks in the mega cap space are CSL, Transurban and Westfield. Outside of mega caps Macquarie highlights Amcor ((AMC)), oOhMedia! ((OML)) and Aristocrat Leisure ((ALL)).

UBS observes the equity correction recently has restored some value to the market overall but has done little to restore relative value within, given already expensive defensive sectors held up somewhat better than the rest.

The rising risk aversion is exacerbating stretched valuations, in the broker's opinion. Defensive yield segments at the same time, best represented by the real estate investment trusts (AREITs), are still looking relatively expensive, but benefit from very low bond yields.

UBS remains underweight on mining, AREITs and consumer staples, neutral on energy stocks and overweight on banks. The broker continues to hold selective exposure to both US dollar earners and domestic cyclicals.

General Insurance

Bell Potter believes the general insurance sector is fundamentally sound and favours the sector over the banks for the next 6-12 months, based on fewer operational distractions and regulatory constraints.

The broker believes the environment for general insurers has significantly improved in the last two quarters, as they begin to increase rates to offset claims inflation. In terms of margins, the downward trend in the banking sector could still eventuate, the broker maintains. In contrast, insurer underwriting and insurance margins have been trending higher since 2012.

Increasing loss buffers are also in stark contrast to the banks' decreasing provisions. Moreover, the compulsory nature of the industry and lower sensitivity to GDP swings suggests to Bell Potter the sector is more able to withstand any future global crises, including fall-out from a potential exit of Britain from the EU.

Breville Group

The share price of Breville Group ((BRG)) has eased off recent highs and Bell Potter considers it timely to review the company's strategy. The broker reduces inventory/sales assumptions and strengthens medium to long-term growth estimates. The net effect is a 1% increase to FY18 estimates and the target rises to $8.25 from $7.70. A Buy rating is retained.

The broker considers a more efficient inventory position should serve as a leading indicator and first signs this is happening are expected in the first half of FY17. Ultimately, the broker expects earnings growth will accelerate as the company concludes its transition into a global, innovation-driven business. Other prongs in the company's strategy include selling more effectively in existing geographies as well as obtaining control of the global product flow from manufacture to purchase.

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article 3 months old

Robust Outlook Maintained For Fisher & Paykal Healthcare

-Positive impact of direct US distribution
-Opportunity in high flow oxygen therapy
-Gains market share in masks
-Loses share in flow generators


By Eva Brocklehurst

Fisher & Paykel Healthcare ((FPH)) extended its track record of beating earnings guidance for another year, delivering FY16 net profit ahead of most broker forecasts and proffering FY17 guidance that appears conservative.

Deutsche Bank envisages upside risks to guidance at current FX rates. At spot FX rates the company is expected to enjoy a NZ$9m currency tailwind to earnings. The broker is attracted to a decade-long growth story in and considers FY17 profit guidance of NZ$165-170m is conservative. Moreover, the company has a consistent record of upgrading guidance that is provided in May three months later.

FY16 is the fourth year in a row the company has delivered strong double digit growth in profit as it continues to gain traction in its Obstructive Sleep Apnea (OSA) masks and new Respiratory & Acute Care (RAC) applications. Deutsche Bank believes the result is even better than it appears at first glance, given disruption was expected from a move to directly distributing RAC products in the US.

Citi also notes industry sources had indicated the internalisation of US sales, previously distributed by CareFusion, would provide an opportunity for competitors, as hospitals seek one-stop shops for respiratory care. Yet, the broker observes no material impact, and suspects this is due to F&P Healthcare's large and dominant market share in humidification circuits.

Earnings were up 24% in FY16, slightly below Citi's expectations. The RAC division grew revenue by 16%, with consumables from new applications growing 30%. Revenue was helped by higher US pricing, achieved through internalisation. Gross margins expanded 280 basis points on a constant currency basis, which Credit Suisse attributes to a shift in mix to a higher margin product and the ongoing skew in production to the Mexico facility.

The broker calculates new applications revenue within the RAC segment increased 23% in the second half, after adjusting for the positive impact of the transition to a direct distribution model. The broker's discussions with management have highlighted the positive leverage potential that exists across RAC therapies.

All humidified therapy has the potential to be interlinked. In theory, therefore, the growth achieved in one category should act as a positive lever for growth in another. Credit Suisse also believes this could act as a natural barrier to increased competition.

Brokers observe there is considerable opportunity for high-flow nasal oxygen use. These new applications now account for 50% of RAC consumables revenue. Citi believes high flow oxygen therapy is in a sweet spot, as it provides for lower nursing and cost burden than standard oxygen therapy and, hence, continued strong growth is likely. Both UBS and Credit Suisse also note this is main driver of underlying RAC revenue growth.

Citi likes the annuity style of much of the RAC consumables revenue and believes, despite stiff trading multiples, the stock is attractive based on the high quality RAC division. The broker also observes wound humidification offers a further avenue for growth but requires significant investment, given a presence in surgical suites would be required.

Meanwhile, OSA masks continue to gain market share and Citi highlights the prospective launch of a nasal pillow mask in FY17 to round out the product portfolio. One area where the broker observes the company losing market share is in OSA flow generators and wonders whether F&P Healthcare can be a viable player in the OSA market if it only sells OSA marks, which the broker estimates contribute 80% of OSA division revenue.

This may not matter in the short term but there could be consequences for the longer term, Citi suspects, if bundling leads to disintermediation in the US DME channel, or if either ResMed ((RMD)) or Philips implement a technological lock on their flow generators.

The company expects profits to double in the next 5-6 years and Macquarie is comfortable with this forecast for the medium term. The broker explains the stock's strong multiple by the increasing proportion of revenue from consumables, increasing gross margin and strong market position.

While Macquarie acknowledges it is becoming more difficult to justify the valuation with a discounted cash flow model, the company does have a history of positive surprises. The main risk to the investment thesis, the broker contends, is the NZ currency.

While the company continues to show good execution on a strategy which has transformed the business, with the share price up 63% over the past year, UBS believes growth is more than captured in the price and this leaves little room for execution risk.

This is considered particularly the case against a backdrop of a maturing OSA product and NZ dollar volatility. Hence, the broker has a Sell rating, the lone one on the FNArena database. Otherwise, there are three Buy ratings and one Hold (Credit Suisse).

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article 3 months old

What’s In The Pathology Deal For Sonic And Primary?

-Substantial rent savings
-Neutralises bulk billing cuts
-Concerns over GP reaction


By Eva Brocklehurst

The Commonwealth government and Pathology Australia have reached an agreement, whereby rent reforms for Approved Collection Centres (ACCs) will be introduced to counter the cuts outlined to bulk billing incentives in the Mid Year Economic and Fiscal Outlook (MYEFO).

The measures could support pathology earnings by up to $50-60m, Macquarie maintains, if they are successful at reducing collection centre rents. The broker estimates that the average rent for a collection centre could fall to $12,000 from $70,000 today. With Primary Health Care ((PRY)) and Sonic Healthcare ((SHL)) having around 2,000 centres each, this amounts to a substantial saving.

The government will introduce provisions to clarify the meaning of market value and link this with relative commercial rents. Information required to register ACCs will be expanded to allow for assessment by the Department of Health as to whether an application is compliant. No mention of an appropriate rent was made but Macquarie notes that Pathology Australia has been lobbying for a 20% limit above the local per-square metre rate.

The removal of bulk billing incentives will commence at the date that the changes to the regulatory framework take effect. The government has also promised not to change the pathology services table for the next three years without consultation with the sector. The legislation is expected to be implemented from January 1, 2017.

Cuts will be effective in the second half of FY17 while the rent benefit will accrue over 12 months as licence renewals are staggered through the year. Macquarie observes it will be FY18 before earnings tailwinds are experienced and FY19 before the full benefit flows through.

So, what does the end result mean for providers? Credit Suisse previously included a 50% impact from the bulk billing cuts in the government's MYEFO, with the introduction of patient co-payments, and now introduces reduced rents on centres. This results in a neutralising of the removal of incentives.

There are some assumptions that need to be made, the broker acknowledges, such as general practitioner (GP) referral rates for pathology being unchanged despite reduced rental income. The broker upgrades Sonic Healthcare on the back of the news, to Neutral from Underperform in keeping with its rating on Primary Health Care.

Macquarie retains Neutral ratings on both Sonic and Primary, highlighting the uncertainties that exist. Obstacles to achieving the desired outcome include the government failing to win the upcoming election, rent reductions being offset in other ways to compensate GPs for directing pathology to a specific provider, and whether other loopholes to the legislation are found.

On the back of the agreement, Citi reinstates the forecasts for both stocks that were in place prior to the MYEFO cuts were announced. The broker maintains a Neutral rating for Primary and a Sell rating for Sonic. Morgan Stanley on the other hand believes there is increased upside risk for the stocks now, with the ability to charge increased co-payments potentially at risk but with greater benefit from the win on rents.

The broker highlights the lack of reaction from general practitioners so far, given the non-indexation of their funding is extended to FY20. A reduction in collection centre rents may further undermine the profitability of their industry.

Addressing ambiguities to better define fair market value for collection centre rent has potential to reduce the overspending on rents, which UBS estimates is more than $150m per annum. The broker highlights this as a vexed issue for some decades, with no legislation seemingly effective and operators finding ways around it. In return the industry ha agreed not to expand co-payments.

If the government is re-elected on July 2 it will call a moratorium on any opening of new collection centres. UBS suggests this has potential to create a race to open new centres in the next six weeks – if labs are prepared to bet on a Coalition win. The broker also notes the broader potential impact in that owner GPs stand to lose income.

Regardless, the broker considers the election of either major party will neutralise the impact of cuts to Sonic Healthcare and Primary Health Care, given that Labor rejects cuts to the bulk billing incentives all together. What remains is a timing issue around rent reviews and any issues regarding effectiveness of the enforcement of regulations. UBS notes there were no comments on incentive cuts to diagnostic imaging and assumes the policy is unchanged.

Sonic Healthcare has four Buy, three Hold and one Sell (Citi) rating on FNArena's database. The consensus target is $20.23, suggesting 7.0% downside to the last share price. Primary Health Care has one Buy (UBS) and seven Hold ratings. Consensus target is $3.46, suggesting 4.3% downside to the last share price.

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Integral Diagnostics A Compelling Buy

-Compelling Buy, brokers suggest
-Further purchasing scale to be had
-Indicative of acquisitions available


By Eva Brocklehurst

Brokers are keen on Integral Diagnostics ((IDX)), lauding its decision to purchase Western District Radiology and the other 50% of South West MRI it does not own.

While the enterprise value of the acquisition is not considered large, at $5m, it is strategically sensible, in Credit Suisse's view. The broker observes the stock trades at a material discount to its pure-play peer Capitol Health ((CAJ)), despite having lower gearing and less exposure to bulk billing.

Growth trends in outlays for medical benefits were pared back extensively in the first half and Credit Suisse notes this extends to MRI (magnetic resonance imaging) which, along with CT scans, provides the highest margins for the group.  The states of Queensland, Victoria and Western Australia comprise 45%, 36% and 19% of the company's revenues respectively,

Yet, the broker believes Integral Diagnostics has not sustained the same extent of negative mix-shift experienced by its competitors, given its bias towards high end examinations and the fact that these episodes are referred by sources less likely to be affected by public commentary.

A combination of hospital exposure and incremental MRI additions in regional locations across the second half are expected to support forecasts. Hence, Credit Suisse believes a short-term valuation gap has emerged in the stock and upgrades to Outperform from Neutral.

The broker acknowledges there remains a regulatory overhang, with the Medical Benefits Scheme review ongoing. Nevertheless, with forecasts still including the full impact of the government's MYEFO changes from FY17, amid doubts about whether this initiative will ultimately be actioned, Credit Suisse considers its approach is conservative enough.

The company is considered the best capitalised radiology group, with a desire to selectively consolidate the market, and remains well positioned to execute on further acquisitions. Brokers agrees this latest deal sits well within a hospital environment and bolsters the company's presence in regional Victoria, with an existing contract with the St John of God Hospital in Warrnambool.

Morgan Stanley maintains the company's regional position drives its above-industry average growth, as suggested by the company's first half result. The latest acquisition currently generates annualised revenue of $4.3m and earnings of $1.2m and the broker estimates this to be 1.0% accretive to FY17 earnings forecasts.

The company will use 75% debt funding and 25% scrip, issued to the four radiologists who own the practice and who will remain with the business. Western District Radiology is based in Warrnambool and is likely to gain from cross referrals, given it lies adjacent to the company's Geelong regional footprint.

The stock is a compelling longer term value proposition at current levels, UBS maintains. There is also scale to be obtained with equipment purchases, and this is fundamental to margin gains for Integral Diagnostics.

The broker believes the company has demonstrated discipline on the price and, furthermore, this acquisition has low integration risk. The acquisition is also considered indicative of the accretive, low multiple opportunities that are available. UBS notes this is particularly the case given Integral's existing footprint over three states.

UBS upgrades profit forecasts by 2.8% for FY17 and expects the company to deliver three-year forward earnings growth of 10%, around 15% above its ASX industrial index peers.

On FY17 price/earnings ratios Integral currently trades at a 30% discount to the ASX200 and a 25% discount to listed peers, UBS observes, despite the materially higher growth outlook for diagnostic imaging. The broker also believes the reaction to government reviews is overdone, particularly as cuts to the bulk billing incentive are now likely to be delayed.

FNArena's database has three Buy ratings for Integral Diagnostics, with a consensus target of $1.88 that suggests 28.5% upside to the last share price. Targets range from $1.70 (Credit Suisse) to $2.10 (UBS). The dividend yield on FY16 forecasts is 3.9% and on FY17 it is 6.1%.

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Weekly Broker Wrap: Budget, Renewables, Aged Care, Classifieds, Outdoor And Telstra

-Mixed impact from federal budget
-Key solar agreement at wind parity
-Lower organic growth probable for EHE, JHC
-APO, OML on track for upgrades?
-National listings to offset Sydney weakness
-Telstra losing regional share


By Eva Brocklehurst

Commonwealth Budget

Good for property, bad for equities is how Credit Suisse describes the 2016 budget. The absence of an expansionary budget, with the deficit forecast to shrink to 2.2% of GDP from 2.4%, is expected to put pressure on the Reserve Bank to cut the cash rate further and be a positive for the bond market.

The broker considers the impact on the Australian dollar is mixed, with lower interest rates a negative but a tighter fiscal position a positive. The budget does provide some positives for equity investors, the broker acknowledges, but this is likely to be offset by planned changes to superannuation. Credit Suisse envisages less money flowing into the Australian pension pool and, hence, less flowing into equities.

The sectors most set to benefit from the budget's proposals include: building materials - renewed demand for investment property and infrastructure spending; retailers - personal income tax cuts and small business write-offs; and media - a reduction in licence fees.

The sectors likely to suffer include: fund managers - super changes; health care - changes to Medicare; and banks - associated costs for the Australian Securities and Investments Commission and less self-managed super fund demand.

Utilities And Renewables

Origin Energy ((ORG)) has signed a power purchase agreement (PPA) with the first non-government backed, large solar project at a price below parity with wind power, which Credit Suisse suspects signals an important stage in the transition to renewables.

The 13-year agreement with the 100MW Care solar farm is for the purchase of energy output plus renewable certificates for a bundled price around $80/MWh. This is roughly half the cost of AGL Energy's ((AGL)) Broken Hill and Nyngan solar projects.

The broker envisages the developments for both Origin and AGL are an opportunity to increase near-term earnings. With the pair having a stated target of over 1,000MW in renewables projects the near-term uplift could be 5-6% or more, the broker maintains.

Credit Suisse believes the drop in PPA solar prices does put a cap on how far wholesale electricity prices can rise, yet retains a view that tighter climate policy will necessarily lead to higher wholesale electricity prices which will benefit the companies' existing portfolios.

Aged Care

The federal government has flagged changes to the Aged Care Funding Instrument (ACFI) as expenses have grown ahead of forecasts, driven by higher complex health care claims, largely because of an increase in frailty.

To cut the rate of growth the government plans to halve the indexing for complex health care funding, saving $1.2bn over four years. The budget papers indicate the government will look to further strengthen the way care funding is determined, separating resident needs from service provision.

The changes support Morgan Stanley's view of lower organic growth for listed operators in aged care and are slightly negative for Estia Health ((EHE)) and Japara Healthcare ((JHC)).

Outdoor Media

Growth in outdoor media hit 17% in the first four months of the year. This suggests to CLSA that APN Outdoor ((APO)) and oOh!Media ((OML)) are on track for upgrades to 2016 guidance. The broker upgrades earnings forecasts for APN Outdoor by 7.0% and by 4.0% for oOh!Media.

The broker believes the growth has been driven entirely by digital revenue and billboards have taken over retail as the strongest growing outdoor segment. Retail and billboards represent 80% of oOh!Media's earnings. APN Outdoor is not involved in retail but billboards represent 50% of earnings.

While roadside transit, street furniture and transport (train stations and airports) advertising declined in April, the broker is cautious about extrapolating this data further. Year to date these segments are still showing solid growth.

Real Estate Classifieds

New listings for the Australian property market grew 2.0% in April following 1.0% growth in March. Deutsche Bank suggests the lack of a significant rebound, despite easy comparables, is attributable to weaker volumes in the Sydney market.

The broker continues to expect the national market will grow in the June quarter, with other capitals and regional areas offsetting the Sydney declines. Given the significance of the Sydney market the broker continues to forecast lower revenue growth in the second half for REA Group's ((REA)) domestic operations as well as Fairfax Media's ((FXJ)) Domain.

Telstra And NBN

What is happening to Telstra's ((TLS)) NBN share? This is the question UBS asks after Australian Competition and Consumer Commission (ACCC) data revealed Telstra had 47% of NBN services in operation as of March 31, broadly consistent with its existing fixed data share. Yet, of the 941,000 NBN subscribers to date, 53% are regional.

UBS estimates that in regional Australia Telstra currently enjoys a 70% share, given the lack of unbundling from peers affords it an input cost advantage. Yet the ACCC data shows Telstra's regional NBN share is 52%, and this implies Telstra is losing regional market share as access costs equalise.

On the other hand, product differentiation and the Belong brand, which taps into value oriented metro subscribers, appear to be buoying Telstra's metro share. Its NBN metro share is currently 41% and outer metro share 46%. UBS believes Telstra needs to execute further on a lean operating model and differentiated product to hold a 50% fixed data share.

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