It hasn’t been a good year for “fallen angel” Sonic Healthcare (SHL). Its shares are down 15% in 2024 while the overall market is up 7%. The fall from the post pandemic high of $46.63 in December 21 has been even more dramatic…………..down by 43% to Friday’s close of $27.02.
Sonic Healthcare (SHL) – 9/19 to 9/24
Source: nabtrade
Part of the fall is readily explicable – pathology giant Sonic lost the “sugar hit” from analysing all those Covid text samples. In FY24, Covid related revenue fell to just $62m from $485m in FY23. But the other reason is of its own making – acquisitions that haven’t fully met expectations, cost increases, margin pressure and finally, a downgrade to earnings guidance in May 24.
Apart from the idea that Sonic might now be good value, Sonic is also interesting in that it is one of the few companies that maintains a “progressive” dividend policy. Discredited by broker analysts, the progressive dividend policy is popular with many investors in that it “guarantees” that the dividend won’t be any lower than last year and in most years will be higher.
Source: Sonic Healthcare FY24
Sonic is currently yielding a relatively attractive 4.0%.
Let’s take a closer look at Sonic’s numbers and what the brokers have to stay to see if there is any valuation appeal.
Sonic’s FY24 financial result
Sonic delivered total revenue growth of 10% to just shy of $9.0bn in FY24. Adjusting for a reduction in Covid revenue, base business revenue grew by 16%. Stripping out the impact of revenue from new acquisitions, organic revenue grew by 6%.
EBITDA of $1,602m, down 6% on FY23’ $1,708m, was in line with the revised guidance of May 24. The fall in EBITDA was largely due to cost pressures. Importantly, Sonic demonstrated in the second half a return to margin expansion with the margin improving on the first half.
Sonic operates a global business, with more than 63% of revenue coming from outside Australia. In addition to pathology services (about 85% of revenue), Sonic provides clinical services (GP and medical assessments) and radiology services in Australia.
Source: Sonic Healthcare FY24
The US pathology business, Sonic’s biggest by revenue share (24%), grew base organic revenue by 3%. Australia, which includes “brands” such as Douglas Hanly Moir, grew base organic revenue by 10% due to strong growth from specialists driving complex tests and growth in GP referred income. Growth in complex testing in Germany drove organic revenue growth of 7%.
Looking ahead, Sonic has guided to EBITDA of $1.70bn to $1.75bn for FY25 (in constant currency), reflecting EBITDA growth of up to 10%. Interest expense will increase by around 25% (reflecting debt from acquisitions completed in FY24), meaning that net profit should increase by around 5%.
EBITDA growth is predicated on continued margin improvement from tight cost control and further headcount reduction to right size the company (which is nearing completion), and base business organic revenue growth from contract wins, indexation and optimisation of fees. Early synergy benefits from recent acquisitions in Switzerland and Germany are also expected, although these are weighted to FY26.
Sonic is investing in digital pathology and ai (artificial intelligence) solutions/tools. PathologyWatch, which Sonic acquired in January 2024, is a proprietary AI-enabled digital dermatology platform. It is currently being rolled out in Sonic’s US dermatopathology division.
What do the brokers say
The major brokers are in the main neutral on Sonic Healthcare, with 2 “buy” recommendations, 3 “neutral” recommendations and 1 “sell” recommendation.
Target prices vary from a low of $23.75 through to a high of $32.31. The consensus is $28.40, 5.1% higher than Friday’s closing ASX price of $27.02.
Ord Minnett wants to see stronger proof of organic growth in EBITDA (rather than from acquisitions). Meanwhile, Morgans expects earnings growth due to reduced employees and a lowered cost base, with recent contract wins providing incremental revenue. It sees ‘upside’ risk to earnings as the company continues to “turn the corner”.
On a multiple basis, the brokers have Sonic trading on a multiple of 23.9x forecast FY25 earnings and 21.8x forecast FY26 earnings. Macquarie feels these multiples are “elevated”, noting greater growth, returns and valuation appeal in CSL and Resmed.
The brokers forecast a prospective dividend yield of 4.0% (a total dividend of 108c in FY25). The company hasn’t provided any guidance on franking, but noting that FY23 dividends were fully franked and FY24 dividends were unfranked, and that about 40% of revenue is being earned in Australia, some level of franking should be expected in the medium term.
Bottom line
I think there is value in Sonic on a multiple of 24 times and earnings growth of 10%. AI will be a supportive medium/long term tail wind. I am more inclined to back Morgan’s view of “upside risk” to earnings than Macquarie’s take that other healthcare companies offer better relative value.
That said, I don’t think the market is about to re-rate Sonic. It will want to see proof that Sonic has “turned the corner”. It won’t readily forget the earnings downgrade in May.
Look for opportunities to add to the portfolio.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
