Sonic Healthcare (ASX: SHL) is an Australia-based healthcare company. Their main activities are – provision of medical diagnostic services and the provision of administrative services and facilities to medical practitioners. Its segments include Laboratory, Imaging and Other. The Laboratory segment provides pathology/clinical laboratory services in Australia, New Zealand, the United Kingdom, the United States of America, Germany, Switzerland, Belgium, and Ireland. The imaging segment provides diagnostic imaging services in Australia. Other segments include medical centre operations (IPN), occupational health services and other minor operations. Sonic Clinical Services (SCS) is the primary care division of the Company that offers a range of health services, including general practice (GP) clinics and after-hours GP services, occupational health services, remote health services and community and home nursing services.
Sonic share price has been sliding the last couple of months and has lost ground recently, down -9% in the past month and 0.57% lower than this time 6 months ago. The company benefited greatly from the COVID-19 pandemic. Sonic is the world’s third-largest medical laboratory company and had reported an impressive 166% increase in profits during its last earnings report. The first half FY21 net profit totalled A$ 678 million.
During FY20, the company’s main factor contributing to the latest results was driven by COVID-testing which boosted revenue increase. However, organic revenue growth remains average. Hence, we believe the current valuation of Sonic shares might be slightly high and we are questioning the ability of the company to maintain the momentum going forward.
Concerning Sonic’s financial results, after reporting a strong first half-year and starting the second half well, all Sonic’s business segments worldwide were almost simultaneously impacted by dramatic falls in its base business patient volume from mid-March 2020, caused by social restrictions and fear of infection. The declines in the base business revenues fluctuated significantly by market, but early stabilisation of levels became clear in late April, followed by the early recovery during May, at different rates in each market.
During Q3 2020, COVID-19 testing volumes ramped up through the period providing a partial offset. This enabled Sonic to report modest earnings growth for the year and allowed the company to retain its final dividend at the prior-year level.
Sonic could maintain a decent revenue growth rate which is substantially higher than usual since the end of 2020 and going forward FY21. The growth rate is predominantly supported by COVID-19 testing revenues. The uncertainty remains regarding the company’s income stream as it is dependent on the FY21 outcome of the pandemic situation. We believe, if the COVID-19 crisis persists, Sonic may continue to benefit from an increase in its COVID testing returns which surpass its base revenues. The company continues to play a central role in combating COVID-19, conducting the essential testing that enables treatment, contact tracing and quarantining.
As a global healthcare company with established quality credentials, and modern, extensive infrastructure in place, Sonic was able to respond rapidly and with conviction to make a meaningful contribution to pandemic control. However, recently, we saw some meaningful progress in the global vaccination campaign which may enable the return to normalcy by the second half of 2021. We believe that once vaccination reaches critical mass, the necessity for COVID-19 testing will diminish substantially which will therefore impact Sonic’s revenue which has tremendously contributed to the company’s financial results in FY20.
Sonic operates in the current demographic trend and expanding global healthcare markets that cater to increasing demand for diagnostic services arising from growing and ageing populations, new tests, and preventative medicine such as the COVID-19 PCR testing.
Sonic has shown over the years, its aggressiveness in developing its investment organically including outsourcing contracts and synergetic business acquisitions and joint ventures. However, the organic growth in the markets in which Sonic participates is likely to continue at an average ~5% per annum over the long term.
The firm acquired in 2019, Aurora Diagnostics which contributed to advancing the company toward the US anatomical pathology market, an estimated US$ 10 billion per annum market. Aurora provides a strategic platform for future growth in the United States, not only in anatomical pathology but also in clinical laboratory services and through hospital laboratory outsourcing. Aurora’s practices have relationships with approximately 23,000 referring physicians and more than 100 hospitals. Moreover, Sonic is also targeting Germany to develop opportunities with several acquisitions in the same field made to date addressing a highly fragmented €1B per annum market.
Sonic has reported its intention to slow down a bit its expansion with the company’s present focus for acquisitions is on its existing markets. The company has shown no immediate intention to expand its diagnostic imaging or medical centre businesses outside Australia, however, it is driving its effort to maintain a solid investment-grade profile with conservative leverage.
The short-term prospect of the company remains uncertain due to COVID-19 unpredictable nature. However, we believe with the rollout of the global vaccination campaign, the return to normalcy is expected for Q3-2021. Sonic’s revenue growth rates since the 2020 year-end have been substantially higher than the historical rates, amplified by strong COVID-19 testing volumes. Base laboratory business revenues during this period have been higher than in the prior year in most countries, with negative but generally improving growth in the US and UK. Imaging revenue has also been growing significantly above historical organic growth rates. The outlook is dependent on fluctuations in base business and COVID-19 testing revenues.
We think that due to the uncertain environment, the current growth rates may not be sustained. In general, Sonic’s experience has been that if base business volumes are negatively impacted by the pandemic, COVID-19 testing volumes tend to increase.
The COVID-19 crisis is impacting Sonic’s patient volumes and the company’s ability to provide core services. While the experience with the COVID-19 pandemic to date has demonstrated Sonic’s resilience and the important role of a major laboratory company in such a scenario, this may not be the case in every circumstance.
The global COVID-19 diagnostics market by revenue is expected to decline over the next 5-year estimated at a negative 9% CAGR for the period of 2021 to 2026. The RT-PCR testing segment constituted over 75% of the global COVID diagnostics market share. Since the FY20, the market grew significantly induced by the outbreak of the coronavirus pandemic, which has contributed to the increase in demand for rapid testing around the world. As the number of people suffering from COVID increases, the demand for rapid testing increases as well, in line with the rate of infection. The adoption of a population-wide testing approach, which includes household, individual testing, is one of the trends influencing the demand for COVID-19 diagnostics kits. The shift from symptomatic testing to mass testing in developed countries is another major factor affecting the market.
FY20 Financial Summary
For the six months ended 31 December 2020, Sonic revenues increased by 33% to A$ 4.43B billion. Net income increased from A$ 254.4 million to A$ 677.6 million. Revenues reflect Laboratory segment increase by 37% to A$ 3.93 billion, Imaging segment increase by 14% to A$ 303.6 million. Net income benefited from borrowing costs decreased by 8% to A$ 51.4 million (expense), utilities decreased by less than 1% to A$ 73.3 million (expense).
Source: Sonic Healthcare Ltd. Company’s Data
Sonic’s US business segment represents 27% of the group revenues with A$ 1,187 million, followed by Germany A$ 1,013 million which accounts for 23% and Australia, 22% with A$ 973 million. As of H1FY21, the group revenue steadily increased by 33% year-over-year with a net profit, up 166% from A$ 254 million to A$ 678 million year-over-year, exceptionally contributed by the unusually ramped up demand for COVID-19 testing.
US Business Segment
Sonic’s US business segment grew organically by 39% as of H1FY21. The US base business revenue went down 8% due to the second wave impact of infection in the country. The company repaid US$ 26 million from the government grants fully by February 2021.
Germany Business Segment
Sonic’s German business segment expanded organically by 58% as of H1FY21. The company has reported minimal impact on the base revenue despite the lockdowns and government measures to curb the spread of the virus.
Australia Business Segment
The Australian business segment reported a 26% organic growth in revenue which the base revenue grew modestly by 5% year-over-year. Sonic is a leading provider of COVID PCR testing in Australia and is maintaining PCR surge capacity in every state to assist with outbreak management.
As of H1FY21, Sonic reduced its exposure to net debt of A$ 374 million which includes a A$ 124 million exchange rate impact. The current total weighted pre-tax average cost of debt is approximately 2.5% with the debt cover ratio at its lowest since the last 20-year period. Sonic’s current available headroom is about A$ 1.3 billion before the FY21 interim dividend and is well-positioned to continue to pursue growth opportunities and support future acquisitions. However, looking at Sonic’s capital structure mix since the last 3-year, the company’s liabilities increased by 61.86% since FY17 and +44.11% in FY20 year-over-year. Despite the company demonstrating a strong balance sheet and a solid revenue stream, the gross profit margin is projected to remain flat over the next 5-year, which may limit further growth in the mid-term.
SHL spiked up to A$ 38 per share since the COVID-19 sell-off peak during the end of March 2020. SHL rallied up from A$ 20 low to A$ 38, up +90% before consolidating in a range between A$ 31 and A$ 37 from September 2020 to March 2021. The all-time high has been clearly rejected by the market participants with the price action sharply returning to the multi-year support at A$ 31 level, down -18%. Several attempts to reach back to the all-time high failed in the A$ 37 – 36 zone which now act as a solid mid-term resistance. SHL is now evolving at the A$ 31 multi-year support level which has been tested 2 times in 2020. If SHL fails to remain above the A$ 31 level, a sell-off might occur pushing the stock back to A$ 29, the 50% retracement level from the March 2020 – August 2020 swing high. SHL’s current momentum is in favour of a downside continuation supporting our projection and valuation of SHL at a fair value of A$ 29.7 per share.
Key price levels
SHL is currently progressing around the A$ 31 support level which is also the 38.2% Fibonacci retracement from March 2020 – August 2020 swing high. Since the attempt to break the all-time high, SHL price action is trapped in a consolidation range between the A$ 37 – 36 mid-term resistance and the multi-year A$ 31 support level. The key level to monitor is the A$ 31 level, which we believe if violated, may open the door to a sell-off and push the stock toward our target of A$ 29.7. On the other hand, if a rebound occurs, SHL may find support at the 23.6% Fibonacci level and provide enough strength to allow SHL to re-attempt a breakout above A$ 37.
Volume and momentum
Volume increases since the last 200-day with the 20-day volume average up by 18.25%. The price action remains neutral in the near-term, evolving in a range between A$ 31 and 36 per share.
- Market participants might be interested to enter at key support to buy the dip: A$ 29 and A$ 27
- Primary target price below $A 29.7 per share
- Secondary target price at $A 27 per share
- Consider reducing exposure if the price rebound above A$ 34 per share.
We are issuing a “Sell” recommendation on SHL as we expect the price to continue to dip below A$ 28 per share. The company is exhibiting a strong balance sheet and a consistent revenue stream with steady dividends distribution over the last 5-year. However, we believe, Sonic’s organic growth may be limited and distorted by the exceptional revenue growth rate derived from COVID-19 testing. This will lead to Sonic’s revenues declining once the pandemic is completely behind us.