In Good Health
Diagnostics and pathology giant Sonic Healthcare (ASX:SHL) delivered a solid set of 2018 fiscal results, with healthy revenue and profit growth, although management have flagged a more cautious outlook for the current year outlook. Nonetheless, the company provides a blend of defensive and growth characteristics with a strong track record for shareholders. Accordingly, we recommend holding the stock.
FY18 review
Group revenue for the year increased 8.2% to $5.54 billion, benefitting from a slight foreign exchange rate tailwind. In constant currency, revenue was up 7.1%. Through expansion into offshore markets, particularly Germany and the United States, Sonic has diversified its revenue base.
Source: Sonic Healthcare (ASX:SHL)
While exchange rate volatility can have a meaningful impact on Sonic Healthcare’s earnings in any given period, the underlying earnings run rate tends to be more predictable, albeit subject to periods of regulatory change. That said, it should be noted that while Sonic Healthcare does not actively hedge its currency exposures, it does use natural hedging, whereby it seeks to match foreign currency assets with same currency debt.
This is important to the extent that it limits the potential for Sonic Healthcare to breach its debt covenants due to changes in currencies. However, what it does not prevent is variability in reported earnings, which in our view is something that comes with the territory and should not be a deterrent for investors, due to the large market opportunity outside Australia for the business. In the year to 30 June 2018 statutory revenue received a boost of approximately $56 million from currency rate movements.
Examining the sales picture in more granularity, and the Australian Laboratory division saw revenue growth of roughly 6.3% to $1,403 million, marking it as the single largest division. This included six months of business from the national bowel screening contract that Sonic won from peer Primary Health Care in 2017 and launched by Sonic on 2 January 2018. The company said it is “tracking to plan” and is likely to bring in annual revenue of about $30 million.
The German Laboratory business is another major one for Sonic, with revenue of $1,148 million in FY18, representing growth of circa 12% in constant currency. That included organic revenue growth of about 3% and was negatively impacted by statutory insurance fee changes from April 2018. The acquisitions of Laboratory Bremen (July 2017) and the Staber laboratory group in July 2017.
On 3 July, the company announced that it has acquired Pathologie Trier (Acquiree), one of Germany’s leading anatomical pathology practices in Germany. The Acquiree runs a variety of pathology services from molecular pathology to tumour genetics services with annual revenues of circa €20 million. There are further acquisition opportunities in the region in the pipeline. Overall, the Laboratory division in Europe (including Germany) saw statutory revenue climb 14.5% to $2,064 million. Constant currency growth was 9.5%.
Laboratory statutory revenue in the US edged up 2.2% to $1,131 million, weighed on by the impact of Medicare fee cuts from January 2018. Constant currency revenue growth was 5.2% and revenue was supported by an acquisition in California and completed in January 2017, along with other minor acquisitions, contract wins and laboratory joint ventures with US hospital groups.
Imaging revenue increased 7.0% to $473 million, with expansion from greenfield opportunities and investment in technologies to improve workflow and the patient experience. There was a significant improvement in margins due to ongoing efficiency initiatives.
Source: Sonic Healthcare (ASX:SHL)
Organic revenue growth for Sonic Clinical Services (SCS), Sonic’s medical centre and occupational health businesses was about 3% and augmented by acquisitions and doctor recruitment to result in a 4% growth in the Other segment. Growth in the segment has been curbed by the Medicare rebate freeze, which is progressively being reversed. There are about 238 centres in the SCS segment and approximately 2,300 GPs.
At the group level, earnings before interest, taxes, depreciation and amortisation (EBITDA) increased about 9.2% to $948.3 million and in constant currency was up 7.3%. Underlying EBITDA was up 8.3% to $962.05 million and increased 6.4% in constant currency.
Source: Sonic Healthcare (ASX:SHL)
Net profit increased 11.2% to $476 million, boosted by a $21.1 million one-off non-cash net tax benefit in the US due to the new corporate tax rate there. Excluding the US net tax benefit, net profit was up about 6.5%. Earnings per share came in at $1.12, marking an increase of 9.9%. Sonic rewarded shareholders with a 6.5% year-on-year increase in the final dividend to $0.49 (franked to 30%), taking the full year dividend to $0.81 per share, up 5.2% over FY17. Sonic has a strong track record of increasing dividends.
Source: Sonic Healthcare (ASX:SHL)
Regarding the outlook, and Sonic expects underlying EBITDA growth to moderate to 3% to 5%, which is equivalent to EBITDA growth of 5% to 7% using current exchange rates. This includes the impact of known fee reductions in Germany and the US and some volatility in Germany after April 2018 regulatory changes. The guidance excludes future acquisitions.
Turning to the charts, resistance around the August 2017 all-time high of $23.76 was surpassed earlier in the year, which was suggestive of higher levels ahead over the broader horizon. The February high of $24.97 has also been usurped, but prices have fallen back below support at $25.82. Medium-term momentum remains in favour of the bulls, as backed by the bullish moving average crossover present (where the 50-day moving average red line crosses above the 200-day moving average green line).
Regarding the monthly chart, dynamic support is indicated at the green uptrend line. Positively, and from a longer-term standpoint, prices have closed (on a monthly-basis) above the 78.6% Fibonacci retracement of $23.28. Long-term momentum remains favoured to the upside, as evident from the series of higher lows and higher highs, which are characteristics of a dominant broader term uptrend in place.
Summary
Sonic Healthcare (ASX:SHL) continues to seek growth via its offshore expansion activities in Germany and the US via a combination of acquisitions and joint ventures. Recent growth initiatives are expected to be earnings accretive from the first year of operations and have mainly been funded from internal resources. The company still has headroom to grow further from existing facilities.
We were content with the FY18 results, although growth is expected to moderate this year due to some impacts on fees in the German and US markets. Sonic shares are trading on circa 22.8 times estimated FY19 earnings, falling to 21.9 times the following year. The projected dividend yield is 3.3%. Overall, we are comfortable with the risk/reward trade-off and recommend holding Sonic.
Accordingly, Sonic Healthcare (ASX:SHL) will remain firmly held in the Fat Prophets portfolio.
Disclosure: Sonic Healthcare (ASX:SHL)is held within the Fat Prophets Australian Share Income Managed Account Portfolio.
