Still a healthy diagnosis
Sonic Healthcare’s interim results were positive with the pathology provider reporting it is on track to meet full year guidance. Revenues increased by a healthy 8%, while EBITDA gained 9% and net profit surged 16%, bolstered by a one-off net tax benefit in the United States. We retain a positive view on the long-term prospects for the company given scope for expansion offshore.
1H18 snapshot
Sonic Healthcare (ASX:SHL) reported a statutory profit of approximately $229 million for the interim period ended 30 December 2017. That marked a 16.2% year-on-year increase, however less a one-time US net tax benefit of about $20 million, the increase was around 6.0%. Diluted earnings per share increased 14.9% to 54.1 cents. The dividend was given a modest 1 cent, or 3.2% boost to 32 cents.
Source: Sonic (ASX:SHL)
Discussing the results, Sonic CEO Colin Goldschmidt stated, “Sonic Healthcare continues to perform strongly, with the half year results particularly pleasing in light of fewer working days in the period versus the comparative period and the impact of two hurricanes on our US business. Achieving a 20-basis point margin improvement in these circumstances is an outstanding result. Ongoing organic revenue growth for the group of approximately 5% on a like-for-like basis is also very positive.”
Turning to the results in more detail and Sonic’s 1H18 revenue of $2.67 billion represented a solid 7.9% year-on-year increase at the statutory level. Revenue was affected by fewer working days than in the period being compared to, so it was a solid result, supported by acquisitions in Germany and the US and hospital partnerships in the US. Group organic revenue was up around 5% at constant currency exchange rates after normalising for differences in work days.
Sonic (ASX:SHL) provides results on a constant currency basis as well given its increasing exposure outside of Australia.
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 marked 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.
The following chart provides the breakdown of Sonic’s revenue by business and geography in 1H18:
Source: Sonic (ASX:SHL)
Examining the sales picture in more granularity, and the Laboratory division saw revenue growth of roughly 8%, including 3% organic (~4% normalised for working days) revenue growth. The Australian Laboratory business delivered strong organic revenue growth of 4.6%. Sonic has a strong brand and market position in Australia.
US revenue was up 4.3%, with organic revenue growth of roughly 2% on a constant currency basis after adjusting for working days and the impact of hurricanes Harvey and Irma. Additional growth came from an acquisition in California completed in January 2017.
The European Laboratory business led the way in terms of percentage growth, up 12.6% in constant currency terms. Normalised, Belgium growth was 7%, the UK at 6%, Switzerland some 5% and Germany 4%. German growth was bolstered by the Staber laboratory and Bremen. Imaging (Australia) organic revenue growth of 9% was impressive, normalised for working days.
Source: Sonic (ASX:SHL)
In addition to clinical laboratories and diagnostic imaging, Sonic has other smaller businesses that it reports within the Other category, along with corporate office costs. The most significant of these are the Independent Practitioner Network (IPN) medical centre business and the Sonic HealthPlus occupational health business. Together, at the end of 2017 these involved 236 primary care clinics across Australia, providing facilities and administrative services to more than 2,200 General Practitioners. According to Sonic’s 2017 Annual Report, some 70% of all Australians live within 10 kilometres of an IPN/Sonic HealthPlus clinic.
The Other segment saw revenue increase 8.8% from FY16. Sonic’s medical centre and occupational health businesses saw 4% organic growth, supported by acquisitions and doctor recruitment. Growth in the medical centre business was impacted by the Medicare rebate freeze, which is being progressively reversed. Indexation is being reintroduced.
At the group level, earnings before interest, taxes, depreciation and amortisation (EBITDA) grew 9% to $445 million.
The EBITDA margin improved 20 basis points year-on-year despite fewer working days in the 1H18 period. EBITDA included $6 million of non-recurring costs linked to acquisitions and restructuring, so underlying EBITDA was higher at $451 million.
The company EBITDA growth was strongest in the imaging business, which received support from investments made in equipment and greenfield sites in recent years, along with ongoing efficiency initiatives. EBITDA growth in the laboratory business was boosted by acquisitions in Germany and the US and the margin showed “strong accretion” after normalising for working day differences.
As touched upon earlier, reported net profit of $228.55 million was down 16.2% higher year-on-year, but included an approximate $20 million one-time US tax benefit. Adjusting for that, net profit was up approximately 6.0%. Diluted earnings per share increased 14.9% to 54.1 cents.
Gearing was effectively unchanged at the end of 2017 at 38.3%, compared to six months earlier when it was also 38.3%. Debt cover was 2.7 times, also unchanged and well below the 3.5 times bank covenant limit, while interest cover declined from 10.8 times at June 2017 to 10.4 times at December 2017.
Summary
When reporting interim results, after seven months of the fiscal year Sonic said it remained on track to achieve full year guidance issued in August 2017. At that time, Sonic expected underlying EBITDA growth of 6-8% in the current fiscal year, excluding the impact of currency movements and any future acquisitions.
The pipeline of acquisitions prospects remains “robust.” Sonic shares are trading on circa 21.8 times estimated 2018 earnings, falling to 20.3 times the following year. The prospective yield over the same time frame is 3.3% expanding to 3.6%. With the Australian business responding positively to management’s recent initiatives, a more stable operating environment and the offshore business still gaining momentum, we believe a premium rating is warranted.
Accordingly, Sonic Healthcare (ASX:SHL) will remain firmly held in the Fat Prophets portfolio. For Members without a current holding, we recommend Sonic Healthcare’s shares as a long-term Buy.
Disclosure: Sonic Healthcare (ASX:SHL) is held within the Fat Prophets Share, Income Model.
