Sonic Healthcare Returns To Growth

This story features SONIC HEALTHCARE LIMITED. For more info SHARE ANALYSIS: SHL

-FY16 outlook still dependent on FX
-Funding risk cannot be ignored
-Renewed focus on acquisitions
 

By Eva Brocklehurst

Sonic Healthcare ((SHL)) has shelved a challenging year, providing an outlook for FY16 considered the best for some time. Guidance for earnings is in the range of $850-875m, at spot FX rates, which most brokers find reasonable and achievable. The risk is unexpected cuts to government funding.

The outlook for FY16 may be fine but as JP Morgan highlights, it does rely on cheap debt to fund the recent acquisition of Swiss Medisupport as well a currency tailwind that is dependent on the US business rebounding. The broker finds it hard to strip out the FX volatility from the divisions, although does note Germany is growing strongly and the negatives are mainly coming from Australia and the US.

While management highlights the stability of funding across jurisdictions, as reimbursement is never expected to change – until it does – JP Morgan believes this risk cannot be ignored.

Weak Australian trading and increased collection centre costs were a drag on otherwise solid EU trading, UBS observes. The broker also claims the company’s track record on guidance could be criticised as overly optimistic. Sonic Healthcare downgraded its FY15 guidance three weeks ahead of the actual result.

Be that as it may, UBS acknowledges the company has made an attempt to break with its past by providing a more comprehensive analysis of expected revenue. On the back of the details now provided UBS rates guidance as robust and achievable.

Credit Suisse downgrades estimates by 3-4% over the forecast period. The broker expects favourable FX, a recovery in US earnings and a full year’s contribution from Medisupport will improve the earnings profile. The offset is modest Australian earnings growth and a full year’s impact of the reduction to vitamin D fees. Moreover, higher expenses, tax rates as well as larger minorities payments will limit the degree of leverage for growth in FY16.

Margins were behind the sluggish growth, not sales, Macquarie asserts. Cost headwinds such as fee cuts in Australia, escalating domestic collection centre costs and restructuring charges in the US hampered the results but the broker has become more upbeat regarding the outlook. Several regulatory issues that plagued the company in the past year have now played out. Meanwhile, Macquarie believes plenty of synergy is still to flow from recent acquisitions.

Challenging market conditions were well flagged, in Morgans’ view. The broker remains confident of a solid recovery and a return to more stable earnings growth, given the organic volumes across all regions are improving and the US is returning to growth. Then there is the uplift from Medisupport and the UK JV. Moreover, the broker calculates there is around $200m in head room for future acquisitions.

On the back of this renewed enthusiasm for acquisitions, and the pull back in the share price after the FY15 downgrade, Citi upgrades to Buy from Neutral. The broker likes the earnings growth profile, meaningful acquisitions offshore and the upside risk from changes in Australian collection centre rent regulations.

Australian pathology has reasonable growth of 5.0% and the broker believes the business is better than what is implied by Medicare outlays, suggesting there are some market share gains being made. Citi contends re-regulation of collection centres would benefit both Primary Health Care ((PRY)) and Sonic Healthcare as it would entrench their market dominance.

The stock is not cheap enough yet for Deutsche Bank. The broker accepts the company should recover in FY16, on the back of a rebound in the US and contribution from the Swiss acquisition. However, the Australian Medical Benefits Schedule review requires caution, while proposed lab fee cuts in the US also raise some concerns. Deutsche Bank would consider buying the stock when funding fears are fully reflected in the price. Until then the broker maintains a Hold rating.

FNArena’s database contains five Buy ratings and three Hold. The consensus target is $21.99, signalling 5.5% upside to the last share price. Targets range from $20.47 (JP Morgan) to $24.00 (Macquarie).
 

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